Is This The Inflection Point?

Telemus Weekly Market Review November 7th - November 11th, 2022

It was a stellar week for stocks as the S&P 500 rose +5.9%. All of the week’s return came during the back half of the week following the Bureau of Labor Statistics October reading for the Consumer Price Index (CPI). Thursday’s release showed prices rising 0.4%, consistent with last month. Given the uptick in gasoline prices, the expectations were for a higher inflation reading. What was more impressive is core CPI, or the measure excluding more volatile food and energy items, rose only 0.3% over the past month, after having risen +0.6% the last two months.

Markets assessed October’s inflation report as a sign that we may finally be restraining inflation. This interpretation was extrapolated into expectations that the Fed may not need to raise rates into 2023 and that come December a 0.5% increase in interest rates by the Fed may be more likely than 0.75%. This perspective led to a notable drop in Treasury yields, which dipped lower by roughly a quarter of a percent along some points of the yield curve during Thursday’s session (the bond market was closed on Friday in observance of Veterans Day). Lower rates proved to a be a catalyst for stocks of higher growth companies, particularly those in the technology sectors, which are more sensitive to higher interest rates. In fact, during the week the technology sector gained 10%, while the year’s top performing sectors including energy, utilities, health care and consumer staples all rose less than half the rate of the S&P 500.

We interpret the strong trading in the back half of the week as a short-term reversal. Some trading desks indicated hedge funds were large buyers as they covered short positions or began taking on a less defensive posture. Mutual funds were net sellers of equities as portfolio managers took advantage of higher prices and exited positions. What we found noteworthy was a contrasting indicator in the bond market. High yield bonds underperformed the broader bond market as spreads, or the difference in yield between a junk bond and a corresponding Treasury, widened indicating greater risk aversion in this segment of the market. This viewpoint was supported by less than stellar news that included layoffs at Twitter and Meta along with a disappointing consumer sentiment reading out of the University of Michigan.

In a year where stocks have been down over -20% and bonds down as much -17%, a week where there is a strong rebound is a welcome respite. As stocks sold off between mid-August and mid-October, they reached a point where they had gotten oversold based on technical measures. Having now rebounded over 10% from lows on October 12th, stocks are now nearing an overbought condition. Moreover, stock valuations have returned to levels that back above long-term averages. This has transpired despite slowing economic conditions, declining corporate earnings (outside of energy companies), and a Federal Reserve whose rhetoric remains hawkish. We don’t view this week as an inflection point for these reasons. In fact, the oscillating nature of markets naturally leads to episodes where behavioral sentiment drives stocks to oversold or overbought levels. From a historical perspective, following the bursting of the technology bubble, between 2000 and 2002 there were 14 trading days where the tech heavy NASDAQ Composite gained 6% or more, only to be foiled by the larger downtrend.

We do view this week’s CPI release with a sense of optimism. With the excess from prior years having worked out of stock valuations and investors garnering yields from their bonds, we have developed a more constructive view in our long-term investment expectations. In the near-term, however, we remain cognizant that we are navigating shifting economic conditions and therefore we seek to remain balanced, not getting overly optimistic or pessimistic, as we work through the oscillations of the market cycle.

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