Anything is still possible for equity markets – Episode 139 of Damien’s Midweek Markets

The 139th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about equity markets and the impact of the latest US inflation figures.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 139

After last week’s show, we experienced a period where equity and bond markets faltered as bond yields and signs of bond market stress increased. Fortunately, this was bookended by periods where investors focused on corporate earnings releases, which provided a bounce for equity markets and some much-needed stability for bond markets.

In last week’s show, I mentioned how Amazon was due to announce its earnings figures after the show and that perhaps they might take on even more importance and influence on which way markets would go in the short term. It turns out that Amazon’s earnings did just that. With equity markets teetering at critical support levels, following recent weakness (don’t forget that US stocks had just endured their worst day for over a year) Amazon’s exceptional earnings report beat analysts’ expectations and saved the day. The impact of Amazon’s blowout earnings was to send US tech stocks, and equity markets more broadly, higher.

But new US economic data released last Friday showed an unexpected surge in employment the previous month. Joe Biden greeted the news by saying that it was a sign that “America’s job machine is going stronger than ever”, however, investors took it as a sign that the US Federal Reserve may end up hiking rates even more aggressively. The 10 year US treasury yield exploded higher to 1.92% while US stocks gave up most of their post-Amazon earnings gains.

By Monday increased stress in bond markets was also evident in Europe, as investors rushed to price in a series of potential interest rate hikes from the European Central Bank (ECB). The problem is that the ECB has stressed that it would cease its large scale bond-buying programmes before hiking rates. And it’s these bond-buying programmes that have helped to keep a lid on the government bond yields of highly indebted countries such as Greece. Of course, rapidly rising bond yields increase the cost of servicing these debts and so sparked memories of the European debt crisis from over a decade ago. If you recall the debt crisis ultimately led to a number of European countries, including Greece, being bailed out, ultimately putting the eurozone and the Euro under threat. The strain beneath the surface of bond markets subsided somewhat as this week progressed, but even if investors missed it they can’t have failed to notice that the 10 year US treasury yield hit 1.97% while the 10 year UK gilt yield rocketed to 1.5%. It continues to be a tough year for bond investors.

As mentioned, as the week progressed bond markets began to settle, with bond yields stabilising, albeit at these elevated levels. This helped buoy equity investor sentiment alongside some strong earnings numbers from the likes of Disney, Uber and Siemens which offset some of the disappointment seen elsewhere from the likes of Credit Suisse.

It means that by the close of play on Wednesday (yesterday) equity markets stood on the brink of breaking out of their recent range-bound trading range (which on the S&P 500 is between the 50-day moving average at 4611 and the 200-day moving average at 4450). In the UK the FTSE 100 is now just 1.6% below its all-time high achieved back in May 2018 - still enjoying the rally in energy stocks. Indeed commodities also continue their steady rise. It means that those investors with commodity exposure and exposure to the FTSE 100 (or at least key UK companies such as BP) but that are also underweight bonds and tech stocks are enjoying a great 2022.

There is a certain amount of irony that with oil at a 7 year high for example, the rise of ESG and ethical investing has meant that many armchair investors don’t have exposure to some of the best performing assets classes of 2022. Which have mostly been those assets that have been driving or benefiting from inflation. I’ve had commodity exposure for some time in my own £50k portfolio which I run live for 80-20 Investors. If you want to see what’s in that portfolio then you can do so by taking out a free trial.

Ultimately the market continues to try to work where inflation will peak and how respective central banks will respond. So today’s release of the latest CPI inflation number in the US was being billed as determining whether equity markets would finally break higher or lower, out of their recent ranges. Many analysts painted the market's reaction to today’s inflation number as binary, anything above 7.25% would cause tech stocks to collapse once again, while anything below would potentially give the US Federal Reserve room to be less aggressive when tightening monetary policy. This would send tech stocks higher. In the end, the CPI number was 7.5% (a 40 year high), above analysts' expectations of 7.25-7.3% sparking a pullback in tech stocks in the US, and therefore the wider US stock market indices. As I make this show the S&P 500 is due to open down 1%, while the tech-heavy NASDAQ 100 is due to open down 1.5%. The initial negative reaction was reflected in Europe, but the FTSE 100 remains in positive territory for the day.

The 10-year treasury yield has risen to 1.98% following the CPI number but the biggest moves can be seen on the shorter-dated 2-year note where the yield jumped from 1.354% to 1.434%. Don’t forget you will always see the biggest reaction to potential interest rate changes in shorter-dated bonds. The US dollar index also initially jumped in value following the inflation data.

However, recent history has shown that market reaction is rarely binary. So keep an eye on US stock markets into the close today and in the coming days to see if a trend develops. Once again on the downside keep an eye on the 4222 level on the S&P 500, but also the 50-day and 200-day moving averages that I mentioned earlier. Can the FTSE 100 continue its strong start to the year and reach its all-time high of 7877? Will treasury yields in the US continue to rise and break above 2% on the 10 year note? Will bond yields continue to rise in Europe and cause renewed investor jitters?

There’s still that feeling that the markets are sitting on a knife-edge and are looking for a sense of direction from central banks. Anything is still possible.