No Santa Claus rally this year
Since mid-October, the US stock index S&P 500 has risen by 10 percent on an expected pivot by the Federal Reserve. Despite the recent rise, the broad index has fallen more than 15 percent this year but despite inflation expectations coming down and with it the trajectory of interest rates, the December outlook for a housing rally looks bleak.
Buy the rumor, sell the news. In this case, it should mean that the buy mode has been passed for some time, and that it was when the CPI came in at 7.7% that was a buy signal, but an upcoming rate hike from a still hawkish Powell and impending recession were the sell side's other side.
Nothing is ever priced in. The market is now expecting a slightly lower rate hike of 50bp in December instead of the recent hikes of 75bp. The latest Federal Open Market Committee (FOMC) meeting notes hinted both at slightly lower hikes ahead, but also that there was a long way to go before rates are normalised.
In other words, equities have taken the win in advance. An inflation rate of 7.7 percent is admittedly lower than 9 percent, but it is still well above the Fed's target of 2 percent. Moreover, the fact that inflation is coming down is not because the Fed has raised interest rates by a few percent, but because a recession is slowing demand and therefore also rising prices. In addition, China remains closed, which in turn is also helping to keep demand for commodities and energy down. However, in a scenario where China opens, inflation could pick up again, which could lead to further downside on the stock market.
The overall picture for December is thus negative, but with room for choppy trading in the sideways direction. What happens next remains to be seen, but there is much to suggest that the worst is yet to come.
Although multiples have come down to softer levels than at the start of the year, we are still close to an average over the last few decades and that calculated on the previous year's gains. This means that even if multiples remain at the same level going forward, equities could still fall as earnings forecasts are downgraded due to inflation and a recession. Moreover, if the multiples are to go down on top of that, it means there is further downside for equities in 2023.
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