October mid-month market update

By Moneyfarm Quantitative Analyst Giorgio Broggi

Welcome to your monthly market update. Once again, the spotlight has been on monetary policy, with the American central bank projecting a more prolonged restrictive monetary policy. A more hawkish Federal Reserve than expected has led both stocks and bonds to suffer.

What surprised the market, in particular, was the increase in expectations for interest rates in the medium and long term, especially for 2024. The next year was supposed to be a year of rate cuts, with the markets pricing in about four cuts by December 2024. However, the new blue dots, representing the expectations of participants in Fed decisions, now anticipate only two cuts in the next 15 months. The reason? A surprisingly resilient economy, according to Federal Reserve Chairman Jerome Powell. So much so that the Fed has improved its economic projections for growth and employment.

In summary, the American central bank expects a stronger economy and will therefore keep rates (slightly) higher next year. At first glance, this doesn’t seem like the worst-case scenario, especially in a market context where inflation continues to decline, with the Core PCE for August (Powell’s preferred measure) low and below expectations at 0.1%. Why, then, did the meeting impact the markets?

There are two main reasons.

First: Money markets found themselves having to reprice the expected level of interest rates for next year, putting pressure especially on the long end of the curve and impacting the American stock market, which has rather high valuations. Additionally, Powell has sent conflicting messages about growth, not appearing particularly convinced of the possibility of a soft landing, also casting doubt on positive economic projections. In short, the Fed seems increasingly certain that rates will remain higher than market expectations, but it doesn’t seem equally certain about its optimism regarding economic growth. The stock market, especially the American one, had no choice but to adjust downward, dragging global markets along with it.

On the other hand, Europe remains in a fragile situation. The economic surprise index continues to show that macroeconomic data is below expectations, also due to Chinese weakness, and the outlook continues to worsen. Sentiment data, such as the PMI, remains subdued, with German manufacturing data staying below 40 points (remember that the threshold indicating an expanding economy is 50 points). Inflation, although declining, remains problematic. The ECB has stated that it has reached the peak of interest rates but remains, in tone, entirely focused on the battle against rising prices.

For now, European companies have held up well, with a “mere” approximately 3% year-on-year drop in earnings per share (about half compared to American companies), but the situation in China and the rise in energy commodity prices are concerning. The coming months could be turbulent, but the valuations of this asset class reflect this, urging us to avoid underweighting this geography too much in portfolios, keeping an eye on the medium and long term.

Meanwhile, the price of oil has surged as the Israel-Palestine conflict reignites volatility in the Middle East after a shock attack on Israel by Hamas brought renewed instability to the region. More than 1,100 people have died since the conflict between Israel and Hamas broke out over the weekend. US futures surged as much as 5.4% in New York, at one point topping $87 a barrel. 

While Israel’s role in global oil supply is negligible, the conflict threatens to embroil both the US and Iran. The latter has become a major source of extra crude this year, alleviating otherwise tightening markets. Increased application of American sanctions on Tehran could constrain those shipments.

Now, let’s turn to our positioning. This year, we have maintained a rather conservative stance compared to the past, focusing on shorter-term government bonds and high-quality credit.

We remain cautious, confident in the validity of the adopted positioning. Pressure on interest rates, especially in the long term, and specific risks in the background (such as the real estate crisis in China and the war in Ukraine) lead us to prefer a cautious and well-diversified approach, waiting for the peak in U.S. interest rates and clearer signals from the Fed before returning to increased risk. Despite the results in September, we believe that macro factors are overall reassembling in a non-traumatic way, with the economy remaining strong and inflation continuing to decline.

We maintain constant attention to market dynamics, ready to act at the opportune moment. As always, we are available for clarification and additional information.

Giorgio Broggi: Giorgio joined Moneyfarm as a Quantitative Analyst in December 2021 and he is a member of the Investment Committee. Prior to joining the company, he worked at Barclays Wealth Management and S&P Market Intelligence, gaining expertise in Funds Research and ESG Investing. Before starting his professional life, he successfully completed a double-degree at Eada and EDHEC Business School, obtaining two Masters in Finance and specialising in factor investing and portfolio construction. He is a CFA charterholder.