Is The Market Looking For An Excuse To Drop Again?

Two days ago Global equities fell on concern?China?may have to tighten its Covid curbs further, undermining prospects for global growth.

Is this a turning point in the recent rally, or just a blip? Is the market looking for another excuse to drop?

The fall came in the face of a recent increase in ‘risk on’ appetite during the month of November where most stock markets have rallied off October lows.

The reason for sentiment improving? General consensus is that inflation may have peaked,?but the only surprising news here is that it took so long. Usually when we hit extremes of anything, we overreact and cause a different problem. What are the chances that in 12 months’ time we’re battling deflation?? After all, it was only 3 years ago that Bloomberg Business week had a front cover asking the question: ‘Is Inflation Dead?’

Maybe the reason for the recent rally is that we have reached the point where it can’t get any worse – although we’d be a little cautious of this as it can often lead to, well, things getting worse.

Or maybe it’s just a continuation of the 2022 theme: no-one knows.?Market unpredictability has been everywhere this year and trying to make sense of it all just isn’t possible.

Assets have moved in unexpected directions, and most investors have struggled to work out why.

A perfect example of this was when JP Morgan CEO Jamie Dimon, came out on the 11th?October that the ‘S&P500 could easily go down another 20% from here’. He cited inflation, interest rates, the war in Ukraine and quantitative easing.

None of these reasons have gone away and all are still in play, yet since that day the S&P500 has rallied over 10% (in fact, the rally started pretty much the day after he said it).?Almost every Wall Street CEO or market commentator has had egg on their face at least once this year.

The CEO of one of the largest investment banks in the world literally called the bottom of the market by saying it will probably keep going down.

This sums up 2022 for many investors.

Commodities have been no different.

Oil started the month near $90 a barrel. After the invasion, being cut off from Russian oil meant that the commodity reached $140 a barrel before stabilising more recently back to below $100. At the start of November, a barrel cost around $92.

Since then, it has slumped?to its lowest level since last December. Early yesterday morning we saw it drop to below $74 before bouncing as Eurasia Group said OPEC+ said it will seriously consider a new production cut.

How can oil be below where it was last December? We’re in the middle of an energy crisis.

Strangely, (although maybe nothing seems strange any more) gold has also had a poor year. As stocks and oil have dropped, so has gold – although a strong rally this month of over 7% has helped bring it back to almost flat on the year.

However, this is during a year when risk assets have plummeted and gold is considered the alternative to risk assets, so this also makes no sense.

It should be the perfect time to own?gold. The yellow metal has historically rallied when inflation is high, since it’s a physical investment that can serve as a store of value. It’s also usually a firm favourite during periods of geopolitical uncertainty, when it’s seen as a safe haven.

But gold prices haven’t surged. In fact, at the start of November they we down almost 20% from their recent March peak. That put gold on the cusp of a bear market!

Breaking it down: Gold prices skyrocketed in early March along with all commodity prices (especially wheat, gas and oil) as fears about the consequences of Russia’s invasion of Ukraine mounted.

Since then, however, other market dynamics have come to the fore. It is easier to find reasons once it has happened, but the truth is,?nobody would expect gold to drop during a year comprising an energy crisis and inflationary panic.

Here is our best guess; if in doubt, blame the Fed.?The central bank has been aggressively hiking interest rates in a bid to bring down inflation, which remains stubbornly high, especially as the war in Ukraine bolsters food and energy prices.

The Fed has pushed the US dollar to a new two-decade high (it has since dropped a bit although not much). The greenback is up 11% against a basket of major currencies so far this year, having hit nearly 20% at one point, this is a huge rise.

Those movements have been hurting stocks. But they’re also affecting gold.

That’s in part because transactions of commodities, including gold and other precious metals, usually happen in dollars. A stronger currency makes it more expensive for foreign investors to buy in, and can reduce demand, pushing down prices.

Another factor is the effect of the Fed’s tough hiking cycle on US government bonds.?Yields on these bonds, which move opposite prices, have jumped as the Fed has tightened policy. The yield on the benchmark 10-year US Treasury was last at 3.67%, up from about 1.5% at the start of the year.

Gold competes with all government bonds as a safe haven investment.?And when investors can get better returns on the latter, the former looks far less attractive.

If you’re raising interest rates, what would you rather hold, gold or something that’s going to provide you with yield? Contrary to what the papers have been saying, now is the perfect time to be buying government debt,?including gilts.

What’s going to happen next??Well, despite everyone holding out hope and waiting for any comment that central banks are going to stop raising rates, it looks unlikely that this will be imminent.?Getting inflation under control is their main priority and in the US, there is nothing to really stop them as the economy still looks very strong.

After the Fed announced its latest rate increase, others followed. The Bank of England?pushed rates in the UK to their highest level since 2008. Sweden, Indonesia, Vietnam, Norway and Switzerland all hiked, too.

That means gold is unlikely to launch a comeback in the near term. If you can get a decent yield by lending to the UK/US government, why not do that instead?

Almost as if to cement this point, yesterday Federal Reserve Bank of St. Louis President James Bullard?said markets may be?underestimating?the chances of higher rates and his New York counterpart John Williams noting policymakers have?more work?to do to curb inflation.

Apple?slumped?as Bloomberg reported that China turmoil is likely to result in a production shortfall of close to 6 million iPhone Pro units this year.

Retailers rose, with analysts saying Cyber Monday will paint a fuller picture of the holiday season.?The bout of investor anxiety also hit?Bitcoin, with?BlockFi Inc.?filing for bankruptcy?-- the latest crypto firm to collapse in the wake of FTX’s rapid downfall.?

China’s woes complicate expectations of its path to reopening, which -- along with speculation about more moderate Fed hikes -- had recently buoyed sentiment. Authorities deployed a?heavy police presence?in Beijing and Shanghai to deter a repeat of the weekend’s demonstrations. Chances are growing of?a messy exit?from the Covid Zero policy, analysts at Goldman Sachs Group Inc. warned.

“This is going to keep economic activity subdued in the country, and beyond,” said Fawad Razaqzada, market analyst at City Index. “The civil unrest is adding another layer of uncertainty over the economic situation there. It is certainly hurting investor sentiment across the financial markets.”

Just when the S&P 500 was trying to break above the highs of mid-November, sentiment turned negative overnight,?threatening?the market’s recent momentum. Timing is most inconvenient here as the index approaches a crucial technical zone in the shape of both the 2022 downtrend and the 200-day moving average.

Stock markets are in for a?wild ride?next year as they don’t yet reflect the risk of a US recession, according to strategists at Goldman Sachs and Deutsche Bank.

Their calls are a warning after equities rallied sharply in the past two months (since October the 12th) on bets that a peak in inflation will lead to a softening of hawkish central bank policies.

BlackRock Inc.’s Chief Investment Officer Rick Rieder sees a chance for rates volatility to turn lower and provide a necessary,?“though perhaps not sufficient”?condition for stabilization in risk assets markets.

Once again, it sounds like nobody knows and if anyone tells you otherwise, don’t trust them. The next 12 months markets will be up and down and all over the place.

Fed Focus

Since the Fed’s latest meeting, investors have parsed a bevy of economic data that somewhat eased inflation concerns, further strengthening the case for smaller rate hikes. This is pretty vague though as smaller rate hikes after two 75 basis point moves are really the only option on the table.?How much smaller is the question.

Last week the S&P 500 notched a weekly gain of 1.5% that took the index to the highest level since early September. The Nasdaq 100 also eked out a gain for the week.

Amid the challenges in China, the nation’s?central bank?on Friday cut the amount of cash lenders must hold in reserve for the second time this year, an escalation of support for an economy that’s being weighed down by Covid curbs.?

“We do not expect economic or market headwinds in China to abate significantly over the coming months,” said Mark Haefele, chief investment officer at UBS Global Wealth Management. “Policy support remains focused on stabilizing the economy, rather than spurring growth, in our view.”

As always let’s finish on some good news:

The FTSE 100 is defying global markets.

It is once again leading the way again with another strong say (so far).?The FTSE 100 is now one of the few stock markets in the world to be positive on the year. Don’t take too much of the Truss, Johnson, City, Brexit bashing to heart. The UK’s top 100 stocks are faring better than most in 2022.

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Looking forward to 2023 will their be strong directional movements either way?

Probably not.

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