Equity markets continued their recovery from October’s lows, with developed market equities gaining 7% and emerging market equities rallying by nearly 15%. The bond market also registered a strong month with yields in the US and Europe retreating significantly, leading to a 4.7% rally for the Global Aggregate Bond index.
At the beginning of November, ongoing concerns about inflation and further central bank tightening were at the forefront of investors’ minds. Central banks did deliver another round of steep policy rate hikes. The Federal Reserve (Fed) and the Bank of England (BoE) raised policy rates by 75 basis points (bps) to 4.0% and 3.0% respectively. However, despite headwinds from tighter monetary policy, investor sentiment improved significantly after the release of US inflation numbers for October. The 7.7% year- on-year (y/y) increase was below consensus expectations, fuelling the market’s hopes that US inflation has now peaked and could prove less sticky than initially feared. The idea that falling inflation could mean that the end to the rate hiking cycle is not far off, gave both stocks and bonds a boost.
In China, policymakers introduced an easing of some control measures and increased their drive to vaccinate more of the elderly, which re-ignited hopes that the country is moving incrementally towards the end of its zero-Covid policy. While an announcement of a complete end to zero-Covid still looks someway off, it ignited a turnaround in performance of Asian and emerging market equities in November. A strong recovery in Chinese demand would be beneficial not only for China but also for all major trading partners in the region.
Exhibit 1: Asset class and style returns
Macro data continues to point to a resilient US economy. Retail sales were better than expected, with growth of 1.3% compared to the previous month. We continue to observe a wide gap between very negative consumer sentiment and actual consumer behaviour as excess savings and a resilient labour market currently appears to be prevailing over growing concerns about a loss of consumer purchasing power. The unemployment rate rose slightly to 3.7% in October and continuing jobless claims increased, but only moderately.
However, the slump in housing activity is concerning. Housing starts, which in April topped 1.8 million units (annualised) for the first time since 2006, fell to 1.425 million units in October. Existing home sales for October showed a further decline in sales. The sharp increase in the 30-year fixed-rate mortgage over the year is depressing housing affordability to levels last seen in 2006.
US inflation cooled slightly in October. Prices of goods and autos fell, as supply chain disruptions continued to ease. Food, services and shelter inflation were stickier. Going forward we expect inflation to continue to ease as the global growth backdrop is weakening. The S&P 500 rallied 5.6% and US treasuries returned 2.7%.
Exhibit 2: World stock market returns
The October eurozone CPI (consumer price index) rose 10.6% y/y, a new high. Food prices and energy costs were the main drivers. Europe continues to feel the effects of the energy crisis and the delayed price pass-through to end customers. In October alone, energy costs in Italy rose by 24.1% m/m and thus made a significant contribution to inflation in the region. Nevertheless, there was also some positive news on the inflation front. Producer prices in Germany fell by 4.2% in October. This is the first monthly decline since May 2000 and is a first sign that inflationary pressures from input prices are easing. The preliminary Eurozone CPI release for November, also showed a slight easing in inflation down to 10% y/y.
The risk of running out of gas this winter has further reduced for Europe in recent weeks, thanks to relatively mild temperatures and reduced demand. At the end of the month, storage is at 93% of capacity.
Indicators of economic activity in the eurozone surprised to the upside in November. The eurozone composite purchasing managers’ index (PMI) improved slightly to 47.8 vs. 47.3 and consumer confidence improved from very low levels. European equities rallied 6.9% and eurozone government bonds returned 2.4%.
In the UK, headline inflation hit 11.1% y/y in October, driven by rising food prices and utility bills. Core inflation remained stable at 6.5% y/y. Like in the eurozone, economic activity in the UK improved from depressed levels. Retail sales grew by 0.6% m/m compared to -1.5% m/m in September and consumer confidence improved slightly to -44, which is still below previous cycle lows. Nevertheless, consumer spending is likely to be under pressure going forward, given the squeeze on incomes. The Office for Budget Responsibility (OBR) expects real household incomes to fall by 7% over the two years to April 2024 – that’s despite £100 billion of government support. The OBR also anticipates a 1.5% drop in GDP for 2023. Despite this, the FTSE All-Share rallied by 7.1%. UK Gilts returned 3%.
Exhibit 3: Fixed income sector returns
On 11 November, policy makers in China announced 20 measures to relax Covid restrictions. This included a shortening of the quarantine period from 10 days to eight days and making secondary contacts no longer in scope for quarantine. Despite some further restrictions being put in place towards the end of the month, Asian equity markets reacted very positively to the drive to vaccinate more elderly people and hopes of a less restrictive Covid policy going forward.
Economic data in China surprised mostly to the downside. The composite PMI at 48.3, imports at -0.7% y/y and retail sales at -0.5% y/y all came in weaker than expected and continue to signal a slowdown in growth. Monetary policy was eased along with some support being provided to the property sector. Asian stocks rallied 18.8% over the month.
Exhibit 4: Fixed Income government bond returns
Exhibit 5: Index returns for November 2022
As we move into the final month of 2022, bond and equity markets have recently been able to recover some of the steep losses that occurred in the first nine months of the year. In our new Investment Outlook 2023 – “A bad year for the economy, a better year for markets” – we laid out three scenarios and their potential impact on asset classes. In our core scenario, we see developed markets falling into a mild recession in 2023 on the back of tighter financial conditions, less supportive fiscal policy in the US and the loss of purchasing power for households. Despite remaining above central banks’ targets, inflation should start to moderate as the economy slows, the labour market weakens and supply chain pressures continue to ease. In such a scenario, we believe the market performance in November – equities and bonds both providing positive returns for investors – could be a blueprint for 2023.