Investors are dumping risky assets as they believe that the Federal Reserve, and other central banks, is close to achieving its goal of fighting inflation.
The MSCI All-Country World Index rose by 9 percent in November. This was the best month for the global equity benchmark since November 2020, when the news of a breakthrough made in the race to create a Covid-19 vaccination sent stocks soaring.
In the US the benchmark S&P 500 Index and the technology-dominated Nasdaq Composite index both posted their best months since July 2022. Gains of 8.9% and 10.7% respectively.
The gains coincided with the increasing bets on the interest rate in the US as well as the Eurozone having peaked and set to be reduced in the first half next year.
The bulls got a boost on Thursday, when Eurozone inflation for November dropped to 2.4%. This was well below the forecast, and it is also the lowest rate since July 2021. It pushed Europe’s Stoxx600 up by 0.5 percent.
Torsten Slok is the chief economist of investment firm Apollo. He said that “the market has now embraced the idea that there’s no inflation problem.” If inflation is not a concern, then the Fed will no longer be a concern. If the Fed no longer poses a problem. . . Risky assets need to do better.
He added that the key question is whether this chain of reasoning is correct.
Since the beginning of last year , the Fed is fighting to get inflation back on track towards its 2% target. The Fed’s most aggressive rate-hike campaign in decades triggered a painful stock market decline last year.
Wylie Tollette is the chief investment officer of Franklin Templeton Investment Solutions. He said that rate increases had been “a dark cloud over risk assets”. Rate increases put pressure on stocks because they reduce the relative attractiveness in future earnings of companies and increase the appeal of safer assets like government bonds. These rates also increase the costs and default risk for corporate borrowers who are more at-risk.
Tollette said that “now, most market participants, including ourselves, believe the Fed may actually be done”, and will succeed to bring inflation under control, without causing a painful recession.
Christopher Waller said this week that he is “increasingly certain” of the Fed’s monetary policy and that, should inflation continue to fall, you could “start lowering the rate simply because inflation’s low”. Futures markets have priced in a quarter-point cut to the policy rate by May.
This confidence is reflected in recent data that shows a slowdown in price increases and a cooling of the job market, even though overall economic activity remains strong.
Tim Murray, T Rowe Price’s multi-assets strategist, says that the combination of these factors creates a “Goldilocks environment”. “We are not in a recession but the economy is not recovering so quickly that the Fed will have to put the brakes on” to prevent inflation.
Incorporated debt markets have reflected the renewed risk appetite seen in equity markets. According to the data group EPFR, almost $17bn poured into corporate bond funds during November. This is the largest monthly inflow of money since July 2020.
This demand has driven borrowing costs down for the riskiest of companies. Ice BofA’s index measures the average yield of junk-rated debt. It has dropped from 9.5% at the end October to 8.56% as of the last day of Thursday. This is the biggest monthly drop since July 2022.
The Vix volatility index, Wall Street’s fear gauge, is also hovering at its lowest level in years, a sign of the optimism among investors.
Investors in Europe predict that the European Central Bank (ECB) will begin cutting rates at the beginning of next year. Officials have been careful to not declare victory and warn that inflation may rise in the next few months.
Analysts and investors predict that the S&P 500 will surpass its closing high of all time in 2024.
Some investors are worried that the rally may have gone too far. Vanguard and Robeco, two large asset managers, have recently warned that valuations were stretched.
Analysts expect corporate profits to grow by more than 10% next year. However, weaker-than-expected economic growth may affect earnings and stock values. Apollo’s Slok also warned that better than expected economic data could “throw a wrench in the current rally”, by reigniting fears that rates will have to be raised for longer.
He said that it was premature for the market to be rallying this much. “We’re not out of trouble.”