This week was marked by heavy economic and financial releases:
- Industrial production data in the powerhouses that are the US and China showing slowdown and contraction.
- Inflation data in Europe being stronger than expected, and in some cases (like Spain) moving back up.
- Employment data in the US was much stronger than expected, as indicated by JOLTS (jobs openings) and NFP (non-farm payroll); i.e. new jobs created month-on-month.
- Central banks hiking rates:
- o BoE hiking rates by 50bp to 4%;
- o ECB by 50bp to 2.50%;
- o Fed 50bp to 4.50%-4.75% range.
THE MARKET RALLY CONTINUES
To the outsider, these should mean lower equity markets. Entrenched inflation and full employment do not make a happy couple! Lower economic growth is a warning sign of a major slowdown. This is confirmed by earnings releases by the companies on the S&P index being down the last quarter for the first time since the pandemic.
In reality, this is not what happened at all. A more realistic snapshot is:
- Western equity markets rallied during the week:
- o S&P +1.7%
- o Nasdaq +3.4%
- o Russell +4.2%
- o DAX, CAC and FTSE +1.6%-+1.7%.
- China was the exception, as exits from the market led to a drop of 5% in stock prices, with a few doubts emerging on how strong the reopening of the economy can be.
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- Bond yields across the board went lower, too.
THREE MAIN REASONS
The reaction can be explained, first and foremost, by the fact that market participants expect the central banks to be near the end of the hiking cycle. They are firm believers that global inflation has peaked. As a result, they expect central banks to cut rates from the end of 2023. The conviction was reinforced during the press conference of the Fed, at which Chair Powell did not push back on these rate cut expectations.
The second factor explaining the rally has been FOMO (fear of missing out) among retail investors. The new year has seen retail come back to markets reminiscent of price action in the summer of 2021. Dow Jones is near its all-time high, and FTSE is at an all-time high.
The third factor explaining the very strong rally this week is the way the hedge fund industry operates. Tolerance for losses has diminished over the years; long gone are the days when investors did not mind a 10% loss if potential gains at the end of the year were 20% to 30%.
Most institutional investors these days abhor losses, making hedge funds much more risk averse. By definition portfolios start at zero gain at the beginning of the year. If they commence the year with heavy losses, the ability to dig oneself out of the hole is significantly compromised.
This is what we witnessed this past week – hedge funds all bailing out of tech positions at the same time and creating a snowball effect forcing more positions to be stopped at a loss across the spectrum of sectors.
