Dear Friends,
Over the last two weeks, markets rebounded with two main macro drivers. The first is decreasing yield pressure from bond markets as a result of the Fed’s dovish rate decision and decreasing treasury supply for the rest of the year. The second driver is the improved earnings of S&P 500 companies both in market breadth and forward estimates. Find out more about the ongoing market dynamics in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. Markets Rebound with Cooling Job Data and Falling Treasury Yields
Wall Street’s main stock indexes rallied on Nov. 3rd as bond yields fell sharply after data showed signs of slowing U.S. jobs growth and an uptick in unemployment, boosting hopes that the Federal Reserve is done with its interest rate hiking campaign. The Labor Department’s report showed nonfarm payrolls increased by 150,000 jobs in October, much less than the expected 180,000 increase, partly due to strikes at Detroit’s Big Three automakers. Data for the last month was revised lower to show an increase of 297,000 instead of 336,000. The unemployment rate edged up to 3.9%. For the week ended on Nov. 3rd, the S&P 500 gained 5.9%, its biggest gain since November 2022, and Nasdaq added 6.6%, also showing its biggest gain since Nov. 2022. The Dow showed a weekly gain of 5.1%, its biggest since late October 2022.
Falling Treasury yields helped launch an explosive rebound in stocks and lifted U.S. government bonds from 16-year lows. Now some investors worry that further declines in yields could keep the Federal Reserve in a hawkish stance for longer, potentially hurting asset prices over the longer term. The paradox highlights how the relationship between yields and financial conditions – factors that reflect the availability of funding in an economy and are watched closely by central bankers – has come into focus in recent months. Surging Treasury yields sapped investors’ risk appetite and weighed on stocks over the last few months by helping tighten financial conditions as they raised the cost of borrowing for companies and households. That relationship has reversed in recent weeks. U.S. 10-year yields – which move inversely to bond prices – have fallen nearly 50 basis points from their highs, while the S&P 500 has rebounded about 6.5% in that period.
2. Fed Extends Pause on Rate Hikes
Federal Reserve Chair Jerome Powell hinted the central bank might be done raising interest rates for now but was careful not to rule out another increase after officials extended a pause in hikes. Officials voted unanimously on Nov. 1st to leave rates unchanged at a 22-year high. “The committee is proceeding carefully,” Powell said during a press conference where he said nothing to shift the market’s expectation that officials won’t raise rates in December. At Fed officials’ September meeting, most projected one more rate increase this year, but some have spoken in recent weeks as though they aren’t eager to hike again unless hotter-than-expected economic data force their hand. Powell echoed that sentiment by repeatedly highlighting how much inflation has fallen, rather than emphasizing the economy’s recent strength.
The big questions for the Fed center on what officials are looking to see in the economy, and what it would take for them to conclude they are moving in the right or wrong direction. A continued slowdown in inflation could allow them to continue holding rates steady, while any acceleration in price pressures could lead them to hike again. Since their July rate increase, the economic outlook has been buffeted by three forces that have differing implications for policy. First, economic activity picked up, defying expectations of an imminent slowdown. Second, inflation continued cooling. Core inflation, which excludes volatile food and energy prices, and which peaked at 5.6% last year, hit a 2.8% annualized rate over the April-to-September period, according to the Commerce Department. Third, financial conditions have tightened amid a swift run-up in longer-dated Treasury yields, leading borrowing costs to rise for households and businesses. Increases in longer-term interest rates boost costs for mortgages, auto loans, and business debt, all of which could slow economic growth.
3. Eurozone Inflation Slows More Than Expected
Consumer prices are slowing more than expected in the eurozone, driven in part by falling energy prices but also by lower food and services inflation. The consumer price index, which measures how fast prices are rising in the 20-member euro area, stood at 2.9% in October, dropping sharply from 4.3% the month before and below economists’ expectations for a reading of 3.3%, according to a poll compiled by The Wall Street Journal. Inflation was brought lower notably by energy prices, which were some 11% lower in October compared with last year when price spikes from the Russia-Ukraine crisis resulted in natural gas supply shortages. In September, energy prices were 4.6% lower on year. Food inflation also continued to ease, reaching 7.5% in October from 8.8% the month before. Core inflation, a measure stripping out volatile food and energy prices, meanwhile eased to 4.2% from 4.5%, in line with economists’ expectations.
Inflation cooled across most of the zone’s major economies in October. In Germany, the eurozone’s powerhouse, harmonized price rises eased to 3.0%, while in France they cooled to 4.5% and in Italy to 1.8%, bringing the latter country in line with European Central Bank targets. Easing inflation will nevertheless add to the sense that the European Central Bank’s tight monetary policy is cooling demand in the currency union. By the end of October, the European Central Bank decided to leave rates where they were after a cycle of successive hikes that took the key deposit rate to an unprecedented 4.0%. The euro zone’s economy unexpectedly contracted in the third quarter, figures showed on October 31st, and ECB President Christine Lagarde has said that activity in the bloc is weakening as faltering industrial output spreads to other parts of the economy.
4. Oil Set for Third Weekly Decline
Oil prices rose on Friday but are set to fall for a third week amid signs of slowing demand and as market attention turns to a key meeting of OPEC and its allies this month which will determine the group’s next move in production. Brent crude futures for January were up 84 cents, or 1.1%, at $80.85 a barrel at 1109 GMT, while U.S. West Texas Intermediate (WTI) crude futures for December were at $76.52, up 78 cents, or 1%. Both contracts are set to fall about 5% on the week.
“Concerns about demand have replaced the fear of production outages related to the Middle East conflict,” Commerzbank said. Weak Chinese economic data this week increased worries of faltering demand. Additionally, refiners in China, the largest buyer of crude oil from the world’s largest exporter Saudi Arabia, asked for less supply from Saudi Arabia for December. The Organization of the Petroleum Exporting Countries and allies led by Russia, or OPEC+ as the group is known, meet on Nov. 26 to set production policy, and the focus will be on whether Saudi Arabia extends a 1 million barrel-per-day voluntary cut set to expire at the end of this year. “We believe the chances that Saudi Arabia will extend its unilateral … cut well into 1Q24 is certainly increasing given renewed market concerns about Chinese demand and the broader macro-outlook,” RBC Capital Markets analyst Helima Croft said.
5. Japan to Spend $13 Billion for Chip Industry
Japan’s government will allocate roughly 2 trillion yen ($13 billion) to support efforts to boost its chip industry, marking the latest move by the Asian nation to reclaim its past glory in the critical sector. The country is a leading provider of chipmaking tools and materials that lost its edge in manufacturing in recent decades and is now providing subsidies to chipmakers to build capacity. Some of the funds, which will be earmarked through a supplementary budget for this fiscal year, are expected to be used to support Taiwanese chipmaker TSMC and chip foundry venture Rapidus, which aims to manufacture cutting-edge chips in Hokkaido. The chip industry allocation is part of Prime Minister Fumio Kishida’s 13.1 trillion yen spending promised in the 2023/24 extra budget which his government approved on Friday.
To fund the spending, Japan is set to issue close to 9 trillion yen ($59.8 billion) in bonds, raising some concerns about ballooning debt. Japan’s efforts to regain its position as a leading manufacturer of chips are “impressive”, the head of a leading chip research organization said on Thursday. Japan, a leading provider of chipmaking tools and materials that lost its edge in manufacturing in recent decades, is providing large subsidies to domestic and foreign chipmakers to build capacity. Countries around the world are looking to strengthen their control over chip supply chains after global shocks including the pandemic and trade tensions between the U.S. and China.
6. China, U.S. Confirm Biden and Xi Will Meet in San Francisco
The U.S. and China made it official, announcing Friday that President Biden and Chinese leader Xi Jinping will meet next week for a summit that both powers say they want to keep their sprawling rivalry in check. The summit in the San Francisco Bay Area, which U.S. officials said will take place next Wednesday, will be the leaders’ first face-to-face meeting in a year. It comes after a period of spiraling tensions over technology, U.S. support for Taiwan, and other issues and follows months of painstaking maneuvering by both governments to stabilize ties. In confirming the much-anticipated meeting, senior Biden administration officials previewed a lengthy agenda of trouble spots they expect to come up, including the Israel-Hamas war, North Korea, and China’s backing of Russia during its war on Ukraine.
For substantive outcomes, the U.S. and China look close to reaching agreements on key Biden asks, though the administration officials declined to confirm any progress. Both sides have in recent weeks moved closer to resuming contact between their militaries, with the Pentagon accusing China of making dangerous intercepts of U.S. and allied craft to push them out of the region. The U.S. is also seeking Beijing’s help in choking off exports of chemicals shipped to Mexico where they are used by drug cartels to make fentanyl. For Beijing, Xi is looking for some breathing room in relations with the U.S. as he tries to deal with a weakened economy, stem an outflow of foreign capital, and cope with tightened American restrictions on technology transfers. China is also looking for assurances in Taiwan, the self-ruled democratic island that Beijing claims. Chinese officials want Biden to commit to opposing Taiwan’s formal independence, according to people briefed on the preparations.
Financial Markets
1. Dow Jumps 300 Points Friday as Stock Market Heads for a Winning Week
Stocks rallied Friday, recovering the ground lost in the previous session as Treasury yields stabilized. This latest move put the major averages on track to end the week higher. The Dow Jones Industrial Average advanced 328 points, or 0.9%. The S&P 500 climbed 1.3%, while the Nasdaq Composite added 1.8%. Stocks are staging a rebound after higher bond yields caused a mini sell-off on Thursday and snapped the longest winning streaks for the S&P 500 and the Nasdaq Composite in two years. On a weekly basis, the S&P 500 is up 0.9%, while the tech-heavy Nasdaq is on pace to advance nearly 2%. The 30-stock Dow is up 0.3%.
The benchmark 10-year Treasury yield hovered around the flatline after jumping more than 10 basis points Thursday. A Treasury Department bond auction — and comments from Federal Reserve Chair Jerome Powell about the possibility that more intervention could be needed to quell inflation — sparked the move higher in yields a day earlier.
2. Green Fees Overtake Fossil Fuels for Second Straight Year
For a second straight year, banks are making more money providing loans and underwriting bond sales for green-related projects than they’re earning from fossil fuel companies. Together, banks have generated about $2.5 billion of revenue from climate-focused financing so far this year, compared with $2.2 billion from their work with oil, gas, and coal companies, according to data compiled by Bloomberg. It’s a big change from as recently as 2020 when lenders pocketed almost double the fees from Big Oil than they did from backing green initiatives.
Still, such a narrow green-to-fossil fuel ratio is far from where we need to be, says Trina White, an analyst at Bloomberg NEF who focuses on sustainable finance. White explains that the challenge will be ensuring the private sector seizes on that opportunity in pursuit of 1.5C scenarios, which are more likely to prevent catastrophic warming. Doing that, however, will require an extraordinary ramp-up in investment. “We need to see both real-economy investment and bank financing in low-carbon energy sources more than quadruple this decade relative to fossil fuels,” she says. BNEF analysts use a metric that tracks investment in the energy-supply system across a range of industries. Analysts have determined that the ratio of clean energy investment to fossil fuels needs to hit 4 to 1 by the end of the decade if the planet is to avoid the worst ravages of climate change as laid out in the Paris Agreement of 2015. That ratio was 0.8 to 1 at the end of 2021, according to BNEF. Banks have faced considerable criticism in recent years for their support of the fossil fuel industry, the primary source of planet-warming pollution. Financiers have sought to defend themselves by claiming they want to assist in the transition to a low-carbon economy by staying engaged with the industry’s most responsible for the accelerating climate crisis.
3. S&P 500 Third Quarter Earnings Season Summary
At the end of the peak weeks of the Q3 earnings season for the S&P 500, both the number of positive earnings surprises and the magnitude of these earnings surprises are above their 10-year averages. As a result, the index is reporting higher earnings for the third quarter today relative to the end of last week and relative to the end of the quarter. The S&P 500 is now reporting year-over-year growth in earnings for the first time since Q3 2022. Overall, 81% of the companies in the S&P 500 have reported actual results for Q3 2023 to date. Of these companies, 82% have reported actual EPS above estimates, which is above the 5-year average of 77% and above the 10-year average of 74%. If 82% is the final number for the quarter, it will mark the highest percentage of S&P 500 companies reporting a positive EPS surprise since Q3 2021 (also 82%). In aggregate, companies are reporting earnings that are 7.1% above estimates, which is below the 5-year average of 8.5% but above the 10-year average of 6.6%. Historical averages reflect actual results from all 500 companies, not the actual results from the percentage of companies that have reported through this point in time.
As a result, the index is reporting higher earnings for the third quarter today relative to the end of last week and relative to the end of the quarter. The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings growth for the third quarter is 3.7% today, compared to an earnings growth rate of 2.6% last week and an earnings decline of -0.3% at the end of the third quarter (September 30). If 3.7% is the actual growth rate for the quarter, it will mark the first quarter of year-over-year earnings growth reported by the index since Q3 2022. Eight of the eleven sectors are reporting year-over-year earnings growth, led by the Communication Services, Consumer Discretionary, and Financials sectors. On the other hand, three sectors are reporting a year-over-year decline in earnings: Energy, Health Care, and Materials.
4. Eli Lilly’s Obesity Drug Gets FDA Approval
The Food and Drug Administration on Wednesday approved a hotly anticipated Eli Lilly obesity treatment, cracking the lid on what is widely expected to be one of the top-selling medicines in history. The Lilly drug, which will be marketed as an obesity treatment under the name Zepbound, is already sold as a diabetes treatment under the name Mounjaro. It will compete directly with Novo Nordisk’s obesity drug Wegovy. Lilly took a direct shot at Novo on Wednesday, saying it will set a list price for Zepbound of $1,059.87 for a month’s supply, which it noted is lower than Wegovy’s list price of $1,349.02. That lower price point for Zepbound hints at a coming commercial rivalry with Novo—and the struggle to secure insurance coverage of the medicine in the U.S.
Lilly shares rose 3.2% following the announcement, while Novo’s American depositary receipts initially fell and then returned to flat at the close. Lilly executives said on a Wednesday afternoon press call that Zepbound will be available in U.S pharmacies “right after the Thanksgiving holiday.” The announcement raised questions Wednesday about whether Zepbound’s lower list price would allow Novo to secure preferential insurance coverage for Wegovy. Pharmacy benefit managers, who negotiate with drugmakers on behalf of insurers, receive bigger rebates for higher-priced drugs and can give higher-priced drugs better treatment in coverage lists. On the press call, Lilly Diabetes president Michael Mason said that the company had opted for a lower list price in an effort to get more payers to choose to offer coverage of Zepbound. The drugs are expected to have enormous impacts on the healthcare system and society at large. Demand for the medicines could put enormous pressure on employers, insurers, and government programs that pay for medicines in the U.S. Estimates suggest that widespread coverage for medicines like Zepbound could create an acute spending crisis for some payers. At the same time, the health benefits of the medicines could impact the demand for a dizzying range of products, from junk foods to sleep apnea machines to glucose monitors used by diabetes patients.
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.barrons.com
(5) www.reuters.com
(6) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
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