Last Week in Review – November 6, 2023 – from Stephen Colavito
The S&P 500 Index recorded its most substantial weekly gain in nearly a year, as signs of a slowing economy and a policy statement from the Federal Reserve that was generally perceived as dovish led to a sharp decrease in long-term bond yields. Growth stocks and the technology-heavy Nasdaq Composite Index outperformed somewhat, but the gains were broad-based and led by the small-cap Russell 2000 Index, which scored its best weekly gain since October 2022.
Last week was the second-busiest week of earnings season; markets also appeared to be moved in part by trades made by institutional investors to recognize tax losses before their fiscal year ended on October 31. Index rebalancing and “window dressing” before month-end holdings disclosure may also have been at work.
Along with earnings, last week, companies brought a slew of policy statements, economic reports, and geopolitical developments for investors to digest. A primary driver of sentiment appeared to be the Fed’s policy meeting that concluded Wednesday. The Fed left rates steady, as was widely expected. Still, investors seemed encouraged by the post-meeting statement, which signaled that the recent runup in long-term Treasury yields had achieved some of policymakers’ intended tightening in financial conditions. Fed officials also seemed comfortable with the recent upside surprises in economic data, merely tweaking their description of the pace of economic growth from “solid” to “strong.”
US - MARKETS & ECONOMY
Last Friday’s closely watched payrolls report seemed to confirm that the labor market was cooling, with wage pressures hopefully—in the eyes of investors, at least—soon to follow. Employers added 150,000 jobs in October, below expectations and the lowest level since June, and September’s substantial gain was revised lower. Meanwhile, the unemployment rate rose to 3.9%, its highest level since January 2022.
Average hourly earnings rose 0.2%, less than expected, although September’s gain was revised to 0.3%. The 12-month increase fell to 4.1%, its lowest level in over two years, but still above the roughly 3% level that policymakers often consider compatible with their overall inflation target of 2%. The Labor Department’s quarterly employment cost index, released Monday, surprised modestly on the upside, indicating an annual wage increase and benefits of 4.3%.
Encouragingly for workers and investors, preliminary estimates of productivity growth in the quarter were better than expected, with unit labor costs declining. The 4.7% gain in productivity was the best showing since businesses began to reopen in the early stages of the pandemic in the third quarter of 2020.
US – EQUITY MARKET PERFORMANCE
SOURCE: BLOOMBERG. THIS CHART IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. PAST PERFORMANCE CAN NOT GUARANTEE FUTURE RESULTS.
US YIELDS & BONDS
A final factor boosting overall market sentiment appeared to be the U.S. Treasury’s announcement that it would sell USD 112 billion of longer-term securities at its quarterly refunding auctions the following week, slightly below its original projection of USD 114 billion. That downward revision seemed to remove a large overhang on the bond market, as worries have intensified recently that demand for Treasuries would be unable to keep up with the expanding supply necessary to fund swelling federal debt levels.
The above factors combined resulted in a plunge in long-term Treasury yields over the week, with the yield on the benchmark 10-year U.S. Treasury note tumbling from 4.88% to an intraday low on Friday of around 4.48%, its lowest level since late September. (Bond prices and yields move in opposite directions.) The municipal bond market enjoyed the tailwind of falling Treasury yields and also benefited from relatively light primary issuance.
Credit-sensitive bond sectors also performed well, especially following the Fed’s announcement on Wednesday. Heavy issuance in the investment-grade corporate market was met with solid demand, while the high-yield bond market benefited from a lack of new issues and the upgrade of Ford's debt to investment grade, which will soon move it out of the high-yield.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth -0.06 bps to 5.39%
2-yr: -0.22 bps to 4.85%
5-yr: -0.35 bps to 4.51%
10-yr: -0.33 bps to 4.58%
30-yr: -0.31 bps to 4.77%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index rebounded from the previous week’s loss and ended 3.41% higher. Major stock indexes also rallied, lifted by expectations that interest rates may have peaked. Italy’s FTSE MIB surged 5.08%, France’s CAC 40 Index jumped 3.71%, and Germany’s DAX climbed 3.42%. The UK’s FTSE 100 Index added 1.73%.
European bond yields broadly declined as expectations rose that major central banks have completed their monetary policy tightening cycles. The yield on the 10-year German sovereign bond fell to its lowest level in more than two months. Swiss and French bond yields declined, as did the yield on the UK 10-year government bond.
The Bank of England (BoE) held interest rates at a 15-year high of 5.25% for the second consecutive meeting but warned that rates would have to stay at a restrictive level for “an extended period of time.” BoE Governor Andrew Bailey said the bank “will be watching closely to see if further interest rate increases are needed, but even if they are not needed, it is much too early to be thinking about rate cuts.”
The central bank’s latest projections showed the inflation rate halving by year-end and dropping below the 2% target at the end of 2025, which is later than previously forecast. The BoE estimated that the economy would expand 0.1% for the rest of this year and remain flat in 2024.
Japan’s stock markets gained over the week, with the Nikkei 225 Index and the broader TOPIX Index returning around 3%. Although the Bank of Japan (BoJ) tweaked its yield curve control framework, monetary policy remained highly accommodative, supporting sentiment. The central bank’s dovish stance weighed on the yen, however, which briefly weakened past the 151 level to the U.S. dollar. The Japanese currency has remained under pressure, given the interest rate differential between Japan and the U.S.
The BoJ remained committed to its ultra-loose monetary policy stance at its October meeting, leaving its short-term lending rate unchanged at -0.1%. However, the central bank adjusted its yield curve control framework for the second time in three months to allow yields to rise more freely—it will now regard its 1.0% ceiling for 10-year Japanese government bond (JGB) yields as a reference rather than strictly capping interest rates at that upper bound. However, the BoJ said it could announce unscheduled bond purchases or fixed rate operations at its discretion, dependent on the path of global yields. Over the week, the JGB yield rose to 0.91% from 0.87%, hovering around its highest level over a decade.
In the Outlook for Economic Activity and Prices, BoJ policymakers raised their consumer price index (CPI) forecasts substantially for fiscal years 2023 and 2024, both to 2.8% year on year, above the central bank’s 2% target. They said that the outlook for price growth depends on the assumptions regarding crude oil prices and the government’s economic measures, as well as asserting that underlying CPI inflation is likely to increase gradually toward achieving the price stability target.
Lastly, last week, stocks in China gained as speculation that U.S. interest rates may have peaked offset broader concerns about the country’s slowing growth. The Shanghai Composite Index rose 0.43%, while the blue-chip CSI 300 advanced 0.61%. In Hong Kong, the benchmark Hang Seng Index added 1.53%, according to FactSet.
China’s factory activity returned to contraction in October. The official manufacturing Purchasing Managers’ Index (PMI) fell to a below-consensus 49.5 in October, down from 50.2 in September, as production growth slowed. The nonmanufacturing PMI slowed to a lower-than-expected 50.6 from 51.7 in September. (Readings above 50 indicate expansion.) Separately, the private Caixin/S&P Global survey of manufacturing activity fell to a below-forecast 49.5 in October from September’s 50.6. The private study of services activity edged slightly higher but also lagged the consensus estimate.
More evidence of China’s property slump underscored investor concerns about a critical growth driver for the economy. New home sales by the country’s top 100 developers fell 27.5% in October from a year earlier, easing from the 29.2% drop in September, according to the China Real Estate Information Corp. In a further sign of the sector’s downturn, real estate loans declined to RMB 53.19 trillion in September from the prior-year period, according to the central bank. The level of loans was RMB 100 billion less than a year earlier and marked the first year-on-year decline since the data became available in 2005.
China’s ongoing housing market decline remains a severe drag on its growth outlook for many investors despite recent indicators suggesting a demand recovery after Beijing rolled out a flurry of stimulus measures. Although China is widely expected to attain its goal of 5% gross domestic product (GDP) growth in 2023, many observers believe that the economy remains vulnerable, given insufficient governmental support for the housing sector. According to S&P Global Ratings, under a bear case scenario, China’s GDP growth could slow to as low as 2.9% next year as property sales fall as much as 25% from 2022.
THE WEEK AHEAD
This week, investors will eagerly await the release of updated earnings results from key companies, including Berkshire Hathaway, Activision Blizzard, Viatris, Gilead Sciences, Lucid Group, Uber, Twilio, Unity Software, The Walt Disney Co, Take-Two Interactive Software, AMC Entertainment, Fiverr International, and Illumina. Additionally, remarks from US policymakers, including Fed Chair Powell, will take center stage as investors seek insights into the future direction of monetary policy. Meanwhile, the economic calendar is relatively light, with a preliminary estimate of Michigan consumer sentiment for November, foreign trade figures, the IBD/TIPP economic optimism index, and the weekly jobless claims report. US consumer sentiment is expected to remain at October's five-month low, while the trade deficit likely widened to $60.2 billion in September from $58.3 billion in August.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
This message is informational and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. San Blas Advisory is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, available upon request.