Betting on a November rally

Market recap

• Equity markets rallied this week alongside a sharp retreat in bond yields. The S&P 500 rose 5.9%, led by banks and consumer discretionary.

• The Federal Reserve left interest rates unchanged, as widely expected, and market expectations that they are done tightening continued to firm.

• Meantime, the October payrolls report landed just right, with a 150k increase in jobs, a one-tick move up in the jobless rate (a little more slack helps at this stage), and cooler wage growth. In an instant, the punishing selloff in the Treasury market has turned, at least for now, with 10-year yields down almost 50 bps from when they touched 5% in mid-October.

The Fed

Last week, the U.S. Federal Reserve (Fed) opted to hold interest rates steady, following through with a much-anticipated pause and causing markets to rally. Fed Chairman Jerome Powell’s comments were constructive because even though they included both hawkish and dovish perspectives, they provided additional clarity. First and foremost, Powell highlighted that higher interest rates are having their intended effect on the economy. As such, the Fed is less concerned about rising inflation than they are about the pace of it coming down. The indication from the meeting is that, as opposed to rationalizing why they should stop, they are not asking why they should raise further—a nuance that seems to imply that they’ve done enough to justify no more rate hikes. Our analysis is that Powell is willing to trade no more rate increases for a broader acknowledgement that rates will stay higher for longer—in other words, that more hikes can be avoided as long as markets realize that cuts won’t be happening in the near future. Equity markets reacted positively to this news and the U.S. dollar (USD) stayed strong, while on the bond side, the 10-year Treasury yield came down dramatically.

Bottom Line: There is momentum in markets following the Fed’s most recent announcement, which potentially sets the stage for a Q4 rally.

Labour

Last week also saw a historic agreement reached between the United Auto Workers (UAW) and Detroit’s Big Three automakers—Ford, General Motors, and Stellantis (which owns the Dodge and Chrysler brands). Obviously, whenever a labour dispute ends, that’s positive news. For the automakers, it means that their costs have gone up, but on the bright side, they were able to avoid supply disruptions thanks to built-up inventory and now they’re able to move forward with a deal in place. This is an important resolution—we’d been worried about the potential for a series of labour strikes across sectors that would, in essence, hold the U.S. economy hostage. Thankfully, that never materialized. Other strikes in the automotive industry and other sectors continue, but this was the big one, and in our view, the others don’t hold the same potential for economic disruption.

Bottom Line: With a resolution to the UAW strike in place, potentially severe economic consequences across sectors have likely been prevented.

Emerging Markets

What’s the outlook for Emerging Markets (EM)? Let’s take a closer look at a few key economies. To start, Mexico is an economy that has benefitted from issues in China, with the United States and Canada turning to it as an alternative. This means, however, that Mexico is now tied at the hip with its northern neighbour, meaning it could be negatively impacted by any recession that occurs in the U.S. India is another economy that has benefitted from shifting supply chains, and both its population and wealth can be expected to continue to grow. China, conversely, is an economy in the crosshairs, with geopolitical risks, supply chain hiccups, and the failure to bounce back from COVID like other economies all contributing to negative investor sentiment. The primary concern is the property sector, which has sapped consumer confidence. The government has not intervened in the crisis as much as Western governments likely would have, and that’s been a real differentiator in terms of weakening consumer demand and slowing growth in the short term. Finally, Japan is the oddball—it hasn’t followed the herd when it comes to central bank activity, and it doesn’t feel the need to borrow from anyone else’s playbook. We expect this approach to continue, but its dive back into interventionism is worth monitoring. As such, we have reduced our emerging market exposure to an underweight.

Bottom Line: Given the current state of China in particular, we’re feeling somewhat less bullish on EM than we have in recent months.

Positioning

In our most recent monthly meeting, an important discussion was around whether we thought a rally could occur heading into the holiday season after the setbacks in markets during September and October. Our answer is yes, and as such, we have moved to an overweight to equities. We also think that the time is right to move back to the broad S&P 500 versus an equal weight index as we think the technology names have room to run again. As always, we’ll continue to examine opportunities and reposition as needed.