Welcome to the latest episode of my monthly YouTube show where I discuss what is happening in investment markets and what to look out for. This month I talk about the likelihood of a Santa rally in 2022 or whether we might in fact see something similar to 2018.
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Abridged transcript - Damien's Market Update - December 2022
If you recall in last month’s video we entered November with optimism but also with potential hurdles to overcome. Optimism because we were entering the best 6 months of the year for stocks markets which meant that if seasonality continued to exert its influence over markets, as it had done in previous months, then November was likely to be positive for US stocks. This in turn would be positive for other global equity markets.
But the potential hurdles included the US midterm elections, which passed by without much consequence to investment markets and new inflation data, which was being eagerly awaited, especially in the US. I mentioned last time that if the inflation data came in higher than expected it was likely to be bad news for bonds and equities. But of course the converse was also true and as it turns out, US inflation data published during November undershot analysts’ expectations and lit a firework under investment markets.
The softer inflation data sparked a large-scale shift in the market narrative (surrounding interest rate hikes) and asset allocations. The Fed pivot was back on, As result we saw extreme one-day moves in bond and equity markets. To give you some context, in the hours after the inflation data was released we saw a 5.3% rally in the S&P 500 which was the best day since April 2020. There was a 7.5% rally in the tech-heavy Nasdaq, the best since 2020. US treasury yields saw their biggest one day drop since 2009. Currency markets also saw extreme moves, with the pound rallying more than 8% against the US dollar from its November low to the end of the month.
To further illustrate the scale of the market shift during the rest of the November, November’s performance rankings are almost the complete inverse of those for the period covering January to the end of October. The worst performing sector all year had been Chinese equities, but following Covid reopening hopes, it was the best performing sector in November, with the average Chinese equity unit trust up a staggering 20% during the month. Another good example was UK Index Linked Gilts. At the other end of the scale, 2022’s top-performing asset class was Latin American equities, which benefited from strength in commodities, but it turned out to be the worst performing asset class in November.
As November progressed, markets were looking for a sense of direction, and so spent a lot of time consolidating after such aggressive moves. In the end equity markets did break higher after US Federal Reserve Chair, Jerome Powell, gave a news conference in the final days of the month which the market interpreted as dovish in nature.
One of the big trends in investment markets during 2022 has been US dollar strength. If you call up the US dollar index chart on your phone (DXY) and look at the year-to-date chart you can see that the dollar hit a multi-decade peak in the autumn before collapsing in October.
Whenever the dollar has rallied the S&P 500 has fallen and vice versa. Since mid-October the US dollar index has been falling so it's no surprise then that the S&P 500 has been rallying hard. If there is one chart to keep an eye on then it is the US dollar index.
With the US dollar weakening further after November’s US inflation data and Powell’s speech, it meant that we closed out November with the second successive month of gains for most global stock markets. Even Asian equities, which had a negative October, had their best month in years. In fact Hong Kong's Hang Seng index had its best month since October 1998. To give you an idea, the MSCI Asia ex Japan index finished November up 15.37%, the MSCI EM Index was up +11.49%, the DAX +8.63%, the FTSE 100 was up +6.74%, the S&P 500 rallied 5.34% and the Nikkei 225 finished November up +1.38%.
But if you are looking at your portfolio and wondering why you do not see such numbers, especially on your US equity funds, the strengthening of the pound (especially against the dollar) mentioned earlier will have reduced those positive equity returns.
It means that historical seasonality struck once again in November, with bond and equity markets close to breaking out of their 2022 downtrends as we enter December.
If investment markets continue to follow historical season patterns, as they have done in recent months, then investors will be banking on a strong December for equities.
Back in 2020 I published a research article for 80-20 Investor members that looked at the odds of a positive December (a Santa Rally) in a given year. Its findings included the fact that the odds of a positive December were an impressive 73% in the US, although there were signs that in recent history the Santa Rally was losing some of its potency.
While December is now the third best month of the year for US equity returns, it had previously been the best month of the year before the 9.2% drop in the S&P 500 during December 2018.
Interestingly UK equities fared better than their US counterparts over the 26 years prior to my research being published, rallying 1.84% on average in December which was almost twice that of the S&P 500 and three times that of the NASDAQ 100. In fact, the FTSE 100 is also more likely to experience a positive December, with the odds of it happening sitting at 85% of the time.
Another positive omen for stock markets is that the S&P 500 closed out November above its 10 month moving average. (read my 80-20 Investor article on "Navigating market tops and bottoms"). Plus the S&P 500 closed above its 200 day moving average, for the first time since March, which is a positive sign.
But as ever, there are hurdles to overcome in December. The US Federal Reserve will deliver its latest monetary policy decision on 14th December while the Bank of England and the European Central Bank will deliver their respective decisions on 15th December.
These will likely determine whether investors see a Santa Rally in stock markets, but also in bond markets into the year end. Bear in mind, that much of the euphoria during October and November has been the result of investors front-running and pricing in a dovish pivot from the Fed. Any hint that the Fed’s monetary policy outlook is more hawkish than currently priced in could see markets unravel. But of course, if their dovish assumptions are confirmed then stocks will likely take-off. Interestingly, back in 2018 the unseasonal slump in US equities occurred partly as a result of a more dovish Jerome Powell hinting that the Fed would likely make fewer rate hikes in 2019, after it had already raised interest rates four times in 2018. That does have some similarities with 2022.
Interestingly, it’s early days but December has already got off on the wrong foot, with the S&P 500 finishing down on the first 4 trading days of the month, a feat that’s not occurred in any month since September 2018. Make of that what you will. The catalyst for the negativity was economic data once again in the US, which suggested a stronger than expected jobs market, causing the market to question its dovish pivot narrative once again.
We’ve been here many times before in 2022, with markets overreacting to new economic data before creating a narrative around future monetary policy decisions from global central banks.
At the end of the last video I provided some technical analysis insights to keep an eye on. This time, on the US dollar index keep an eye on its 200 day moving average and a key support line around 105. If the dollar weakens further then it is likely to be good news for risk assets. On the S&P 500, to the upside 4042 is the 200 day moving average and 4062 just above is an important line of resistance. Beyond that it opens the gate to testing 4100 and 4150. On the downside watch 3920 and 3900 (we currently sit just above 3940).
For the FTSE 100, it has recaptured the all important 7300 level (which is also where its 200 day moving average has been) and quickly rose to 7500, as it usually does, which is where it sits currently. The FTSE 100 wants to hold 7500 to avoid another revisit to 7300, in order to base and move higher. Equity markets are now on the cusp of breaking out of some of 2022’s most established downtrends, but it will likely need a Santa rally to get them over the line.
One final thought. Keep an eye on bond yields, such as the 10 year US treasury and the equivalent gilt yield. In recent days we’ve seen yields moving without reference to the direction of equity markets. When equity markets tumbled after the hawkish jobs data in the US, bond yields didn’t move in kind. It suggests that bond markets might be becoming less worried that inflation will prove sticky and that in fact central banks will be forced to limit further rate rises and potentially begin a new rate cutting cycle. The bond market is perhaps focusing more on the possibility of recession. It’s early days but when the bond market speaks it often pays to listen.
