Global stock markets concluded October with significant gains, recovering from their lowest levels of the year. The main catalyst for this rebound is believed to be the growing belief among investors that central banks are nearing the end of the current cycle of interest rate hikes, despite little supporting evidence from economic data and official communications from rate-setters in the US, UK, and Eurozone.
The upward movement in equities began with volatile trading following the release of the latest US inflation data. Initially, this data caused US benchmarks to hit their lowest levels of the year, but they staged a remarkable recovery by the end of the day. This intraday swing, where the market was down by 2% at one point but closed 2% higher, was the largest for US stocks since the market turmoil induced by the pandemic in March 2020. While it is too early to confirm if the market bottom has been reached, this serves as another example of the wild swings that can occur around market bottoms and emphasizes the importance of remaining invested during bear markets.
By the start of the fourth quarter, US benchmarks had experienced their third-worst performance in the first three quarters since 1950. The only two years with worse returns were 1974 and 2002, both of which saw stocks bottom out in early October. This year's low was reached on October 13th, shortly after the US Consumer Price Index rose to a year-on-year rate of 8.2%. Although this figure is still below the peak of 9.1% in June, it exceeded expectations, and the core reading, which excludes food and energy, reached a 40-year high.
While inflationary pressures appear to be easing to some extent, it is increasingly likely that it will take time for inflation gauges to return to central bank target levels. The persistently high inflation data came just a few days after a strong US jobs report, which unexpectedly showed a decline in the unemployment rate to cycle lows of 3.5%. Both of these factors initially triggered selling in the markets as they reduced the likelihood of a dovish pivot from the Federal Reserve in the near future.
However, despite the lack of supportive economic data, Wall Street Journal journalist Nick Timiraos, known for accurately reporting previous changes in Fed policy, has indicated that officials have begun signalling a desire to slow the pace of interest rate increases and eventually stop raising rates. This statement sparked a rally on Wall Street, building on the earlier reversal prompted by the CPI data, resulting in substantial gains of around 7.9% for US benchmarks during the month.
Bond yields continued to rise even after the stock market reversal, with the US 10-year yield reaching its highest level since 2008 at 4.34%. However, yields pulled back by the end of the month, closing at 4.08%, a 28 basis point increase for the month. This pullback coincided with a reduction in expectations for the terminal Fed Funds Rate, which is now projected to reach around 5% in early 2023, up from the current 3.25%.
While further interest rate increases are anticipated in the US, UK, and Eurozone, investors are starting to believe that the end of the current hiking cycle is within sight. The US appears to be leading the way in this regard, as reflected in recent stock market performance, with US benchmarks outperforming their UK and Eurozone counterparts in October, with respective increases of around 3.0% and 6.6%.
In the UK, the recovery of the pound has posed a headwind for equities in the past month, as the GBP/USD rate has rebounded from its all-time low below 1.04 in September to trade around 1.15 at the end of October, representing a gain of approximately 3.1% for the month.
The restoration of credibility has been notable in the UK, following a period of political turbulence. Rishi Sunak's appointment as the new prime minister signifies a return to more conventional economic policies, leading to a remarkable recovery in UK assets. The pound has regained around 8% from its September low, and government bond markets have fully reversed their earlier sell-off. At the end of October, the UK 10-year gilt yield was 3.5%, approximately 100 basis points below its peak earlier in the month and nearly 50 basis points lower than its September close. The restoration of stability has provided more flexibility for the Bank of England, with the markets now expecting the base rate to peak around 5%, compared to over 6% less than a month ago.
China has also been in the spotlight, with President Xi Jinping securing a third consecutive five-year term as party chief. This development has caused a negative reaction in the markets, with the yuan depreciating and significant losses seen in Chinese equities. The market's reaction is attributed to concerns that Xi has surrounded himself with loyalists who may not challenge his leadership. Additionally, there was no indication of any change in China's zero-covid policy, adding to market uncertainty.
In summary, October brought more encouraging signs for the markets, with investors perceiving glimmers of light at the end of the tunnel. However, caution remains, and it is still premature to definitively declare that the worst of the market sell-off is behind us. Third-quarter earnings have been mixed, with some companies expected to struggle but still holding up reasonably well, while large tech companies have unexpectedly shown weakness. Inflation remains persistently high, and the job market remains tight compared to historical standards. Demand has softened in some areas but overall remains relatively robust. The ability of businesses to reduce expenditures quickly, as evidenced by the sharp drop in digital advertising, contrasts with the continued demand in other sectors where corporations remain committed to longer-term strategic campaigns.