U.S. Equity Markets finished Tuesday led by the 1.48% rally in the NASDAQ 100. Markets finished higher – reversing Monday’s losses as investors received a slight boost from positive retail earnings on this holiday-shortened trading week. Momentum continues to build among investors that the Fed will slow the pace of tightening in December and are not far from its terminal rate. The Richmond Fed Manufacturing Index was largely in line with expectations, showing another month of contraction in activity. Overall, a largely quiet Tuesday as investors anticipate a slight influx of market news this afternoon in advance of Thursday’s Thanksgiving holiday. Yesterday, I discussed the Federal Reserve’s current rate-hike cycle could be approaching its peak. Central bank policymakers like San Francisco President Mary Daly and St. Louis President James Bullard recently commented they want to get interest rates to at least 5% before they pause or stop raising rates. Even Board of Governors member Christopher Waller, a noted hawk (inclined to raise interest rates), said last week that he is open to slowing the pace of hikes. Throughout this year, members of the central bank have said they want to get to a point where they feel monetary policy is restrictive once more. In other words, it is weighing on inflation growth. A number of members including Vice Chair Lael Brainard have said we are already there. But they would like to go a bit further to ensure inflation growth comes back to the 2% target. So, considering the Federal-Funds Rate is already at 4%, that means we don’t have too much further to go until we hit the 5% mark. In past rate-hike cycles, the Fed has sought to keep raising rates until the real fed-funds rate turns positive. That metric is derived from current interest rates minus the U.S. Bureau of Labour Statistics’ Consumer Price Index (“CPI”) annualised growth. My analysis suggests that could happen as soon as March 2023, which would give the central bank reason to rethink its current course. Based on the stock market outcomes from past rate-hike cycle peaks, the change will function as a tailwind for the S&P 500 Index. With history as our guide, we want to try and discover when the event of a positive real Fed-Funds rate might take place. I turned to the monthly CPI growth as our guide. Since July, the number has averaged an increase of 0.25%. Over the past five years, the gain has averaged closer to 0.3%. we could see the real Fed-Funds rate turn positive as soon as March. The next step was to go back and look at the S&P 500’s performance once rate increases have stopped and after the first-rate cut comes into play. I observed all of the cycles going back to 1980 when inflation growth was this high. When investors are fearful of the central bank aggressively raising rates, they want to hang on to their money. After all, the investing environment is fraught with uncertainty. Liquidity dries up and investors are uncertain of how rising rates will affect consumer sentiment and balance sheets. When Money Managers are uncertain, they tend to sell first and ask questions later. So, by raising funds now, those Money Managers are sitting on cash, or in safety assets like U.S. Treasury bonds, seeking the opportunity to invest it once more. Based on the above results, once investors get a sense that uncertainty is gone, they begin to pile back into risk assets like stocks. The gains are far better than the historical 9.1% increase. In fact, the two tightening cycles, in 1983 to 1984 and 1994 to 1995, closest to the current one saw the best returns. Forecasting is not an exact art, and a lot can change between now and March. For instance, we could see inflation slow further next month as the central bank continues its tightening, speeding up the path to positive rates. But this at least gives us an idea of when the Fed might start considering that rate hikes are weighing on inflation. That is an important time frame for Money Managers trying to forecast the end of the Fed’s rate-hike cycle. You see, yields are becoming increasingly attractive on U.S. Treasurys and on companies with fortress-like balance sheets and steady cash flows – like Hershey (HSY), McDonald’s (MCD), or Coca-Cola (KO). So now is the time to start doing our homework and preparing. Because if we get another large pullback early next year, those big-money investors don’t want to miss out on potential returns they may not see again for some time. They will be encouraged to lock in high yields on great companies while they still have a chance. Then, as yields begin to fall, those same Money Managers will work their way down the investment food chain, looking for other opportunities and attractive returns, in turn, supporting a long-term rally in the S&P 500. Within the S&P 500 Index, all the 11 sectors finished higher. European Markets closed positive. Markets ended higher as attention continues to focus on global central bank policy amidst the backdrop of a Euro-Zone recession. The OECD’s latest economic update showed that high inflation is likely to persist into 2023 for much of Europe, with the U.K. and Germany projected for economic contraction. The European Union Commission also poised to introduce gas price cap for one year in 2023 amid industry criticism. In other news, Euro-Zone Consumer Confidence improved in November, but is still deep in negative territory. In Asia, Markets ended largely mixed as a second slow trading day was largely dominated by Chinese speculation. Concerns continue to grow over China’s response to its grooving COVID-19 outbreak. Broker Nomura estimated that about 20% of China’s Gross Domestic Product is now again in some form of restriction or lockdown. The People’s Bank of China urged banks to increase its credit support for certain sectors struggling with output from COVID-19 restrictions. Meanwhile, the Reserve Bank of New Zealand is expected to hike its interest rates by a record 75 basis points Wednesday. Elsewhere, Oil rose 1.32% while Gold closed flat.
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