Market Overview|Quilter Cheviot

Stocks surge as inflation falls

Market Overview | Quilter Cheviot

By Alan McIntosh, Chief Investment Strategist

The United States led a strong rally in equity markets last week, boosted by the release of inflation data which suggests that high price pressures in the world’s largest economy are easing. The Consumer Price Index (CPI) for October showed a year-on-year increase of 7.7%, the lowest level for this reading since January, while the core reading, which strips out food and energy, pulled back to 6.3% – down from a 40-year high in September of 6.6%.

US large cap indices gained by just under 6% to post their best week since June, moving up to their highest levels in two months. Growth stocks, and technology shares in particular, jumped sharply higher on falling bond yields, with US tech indices up over 8% – the majority of the gains coming on a monster move higher on the day of the CPI release. US Treasury yields fell sharply on the news and the 10-year Treasury yield ended the week at 3.81%, down 35 basis points.

As encouraging as the latest inflation data is, it is unlikely to imminently impact Federal Reserve policy with further interest rate increases still expected. However, it does alleviate some of the pressure on monetary policymakers and supports a slowdown in the pace of increases. This reduces the chance of a central bank mistake, as they are now less likely to overtighten to the point of inflicting unnecessary damage to the economy and therefore the risk of a deep recession has receded.

US large cap benchmarks ended last week up around 14% from their intraday low for 2022, which was made just over a month ago on the release day for the September CPI. Despite the strong bounce US indices are still down by around 15% year-to-date and there remain a number of sceptics who question the recent gains, pointing to the summer’s circa 18% rally to show that a large move higher does not conclusively prove the bear market is over.

While that is yet to be seen, it is worth pointing out some clear, and comparatively more favourable, differences between the current rally and the one in the summer. The present dynamics differ in that monetary policy is now in restrictive territory and inflation looks like it is falling back. Furthermore, it is not just the latest CPI release that supports this, as several inputs are suggestive of disinflation.

The “R” word

The United Kingdom and Eurozone will shortly enter into recession, according to prominent recent forecasts. UK GDP fell in the third quarter for its first quarterly decline since early 2021, when a Covid-19 lockdown curbed economic activity, with the Bank of England predicting that the contraction will mark the start of a recession that could last two years. Jeremy Hunt, Chancellor of the Exchequer, said following the data release that tough decisions on tax and government spending are needed in the 17 November budget.

A 0.5% contraction in the eurozone economy in the fourth quarter will be followed by a 0.1% fall in the first quarter of next year, triggering a technical recession, according to the European Commission forecast. High energy prices were cited as the main reason for negative economic growth. In 2023 annual growth is expected to drop to a meagre 0.3% from 3.2% this year.

UK large cap shares ended the week pretty much flat but there was a strong mover higher in mid cap benchmarks. A further recovery in sterling provided a headwind to large caps, as the pound rose over 3% to end the week at 1.18 against the US dollar. Bond yields continued to decline, with the 10-year gilt yield falling 18 basis points to 3.35%.

European bourses gained just shy of 5%, largely due to the US inflation data. German equities outperformed while French stocks lagged. The single currency ended the week with similar-sized gains against the US dollar as sterling, rising to 1.03. High inflation data kept Italian, French and Swiss bond yields near recent highs, although the German 10-year bund yield decreased by 13 basis points to end the week at 2.16%.

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