Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research

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The Quick Facts

• Stocks posted a historic rally in November, with the S&P 500 up 9.1%.
• The tech-heavy Nasdaq 100 gained 10.8% in November as Big Tech dominated again.
• Except for Energy, down 0.7%, all sectors posted gains, led by Technology, up a staggering 12.9%.
• The Bloomberg U.S. Aggregate Index returned 4.5% in November as the yield on the 10-year Treasuries sank 60 basis points to 4.33%.
• The CBOE Volatility Index (“VIX”) fell to the lowest level since pre-pandemic.
• Cooling inflation readings raised expectations for future Federal Reserve (“Fed”) rate cuts.
• The market is now pricing that the Fed is done hiking and will start cutting interest rates by March 2024.

Optimism returned to the market in November, as cooling inflation readings raised expectations for future Fed rate cuts, boosting asset prices. The U.S. stock market posted its best month in almost a year and a half, and one of its best Novembers in decades. The S&P 500 Index advanced +9.1%, for its second-best November since 1980, behind only the pandemic-fueled rebound in 2020. The surge in stocks was part of a pan-markets rally triggered by a plunge in bond yields that accelerated as signs mounted that policymakers are managing to tame inflation without breaking the economy. In a year in which little has gone right in the U.S. bond market, November turned out to be a month for the record books. For bond investors bracing for a possible third straight year of losses — an unprecedented streak in the Treasuries market — the rally was desperately needed. The Bloomberg U.S. Aggregate Index returned +4.5% in November and is now up +1.6% YTD.

U.S. consumer spending, inflation, and the labor market have all cooled in recent weeks, adding to evidence that the economy is slowing—seemingly matching the Fed’s preferred glide path toward a “soft landing.” Inflation-adjusted personal spending rose only 0.2% last month after a downwardly revised 0.3% advance in September.

November Asset Class Performance

S&P 500 3Q earnings results were stronger than expected and represented the first quarter of year/year EPS growth since 3Q 2022. Sequential margin expansion represented the bright spot during earnings season, while sales results beat expectations by a smaller magnitude.

All sectors were in the green in November except for Energy, down -0.7%. Growth proxy Communication Services and Technology lead the market YTD at +46.4% and +49.8%, respectively, whereas the defensive Utilities sector is the worst performer YTD, down -8.9%. Large-cap Growth stocks outperformed Large-Cap Value stocks by +3.4% in November, and the Russell 1000 Growth index is outperforming the Russell 1000 Value index by +31.0% YTD.  The Russell 2000 Index – widely regarded as the world’s most closely followed gauge of smaller companies – declined for the third consecutive month in October but reversed course in November with a 9.0% gain for the month.  Over the last three years, the total return of the Large-cap Value index is now also behind the Large-cap Growth by -2.4%. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up +10.4% in November, +1.2% better than the S&P 500. Over the last three years, the ESG index is up +25.8% and -6.3% behind the S&P 500 on a total return basis. Emerging markets equities were up +8.0% in November and are now in the green YTD at +5.7%.

November’s equity gains were accompanied by a bond rally that saw the yield on the 10-year U.S. Treasury slide to 4.33% from a peak of 5.02% intraday in October, representing its biggest net monthly decline since December 2008. Shorter term 2-year U.S. Treasury declined -41 basis points for the month to yield 4.68%.  The yield curve remains inverted but less so. The U.S. Aggregate bond index rose 4.5% in November for its biggest monthly gain in over 35 years, while the Municipal Bond Index closed November up 6.3%. As inflation falls and the labor market softens, the “soft landing” or “no landing” scenarios are getting priced in. October was the 21st consecutive month with an unemployment rate below 4.0%. However, the report showed slower payroll growth, rising unemployment, and slower average hourly earnings growth, which is exactly what the Fed wants to see.

The Fed’s preferred measure of inflation declined in October, the latest sign that price increases are slowing down but are still above the 2.0% Fed target rate. The Personal Consumption Expenditures (“PCE”) Price Index rose +3.0% Y/Y, vs +3.1% in September. Core PCE, which excludes food and energy, rose +3.5% vs +3.7% in September. The November Federal Open Market Committee (“FOMC”) meeting kept rates unchanged, as expected, and Fed Chair Powell offered the status quo, noting that we are still a long way away from the 2.0% target. Fed fund futures are now pricing in a 57% chance of a 25 basis point cut in March 2024.

Oil futures, as measured by the WTI Crude Oil $/bbl., declined -6.2% in November. YTD oil futures are down -5.0%; since the late September peak of $93.7, they have declined -19% to close November at $76/bbl., another tailwind for the U.S. economy. Gold spot prices were up +2.6% in November to close at $2,036/Oz, up +11.6% YTD. The U.S. Dollar Index, which indicates the general international value of the U.S. Dollar, lost -3.0% in November and is now flat YTD. Since inflation peaked in 2022, the dollar has declined -9.6%. A weaker dollar is generally good news for both equity markets and commodities, just as a strong dollar tends to hold back stocks and other risky investments. Digital asset valuations were also up in November, with Bitcoin up +8.9% and +128.2% YTD while Ethereum was up +12.7% in November and +70.6% YTD. Bitcoin’s price surge reflects a stronger appetite for risk assets, rising demand for a “digital gold,” and optimism regarding a spot Bitcoin ETF coming to market in the U.S.

Interest rate volatility has been constant since the Fed began its rate-hiking cycle in 2022. While equity investors look to the well-known CBOE Volatility Index (“VIX”), bond investors focus on the less famous ICE BofA MOVE (“MOVE”) Index, which measures bond market volatility. The MOVE Index had its fourth YTD spike above 140 in October, trending lower in November, but remaining elevated at 115 compared to historical averages, which reflects the highly uncertain rate environment. The VIX dropped to below 13 in November after a second half of 2023 high at 23, below the fear gauge’s long-term average of roughly 20. The VIX is now at its lowest level since pre-pandemic.

Chart of the Month – 5-year, 5-year Forward Breakeven Inflation

The 5-year, 5-year forward breakeven inflation rate is a measure of expected inflation over a five-year period that begins five years from today. It is derived from the difference in yields between nominal government bonds and inflation-protected government bonds (“TIPS” or Treasury Inflation-Protected Securities). Nominal government bonds are standard government bonds with a fixed interest rate. The yield on these bonds reflects both the real interest rate and the expected inflation rate. TIPS are designed to protect investors from inflation. The principal value of TIPS increases with inflation, and the interest payments are based on the inflation-adjusted principal. The yield on TIPS reflects the real interest rate because it is adjusted for inflation.

The 5-year, 5-year forward breakeven inflation rate is calculated by taking the difference between the nominal yield on a standard 10-year Treasury bond and the real yield on a 10-year TIPS. This calculation provides a market-based measure of the average expected inflation rate over the five-year period that begins five years from now.

Investors and policymakers often use this measure to gauge market expectations for future inflation. If the 5-year, 5-year forward breakeven inflation rate is higher, it suggests that investors expect higher inflation in the future. Conversely, a lower rate suggests lower expected inflation.

The Fed pays attention to various inflation indicators, and the 5-year, 5-year forward breakeven inflation rate is one of them. Understanding inflation expectations is crucial for central banks like the Fed because it can influence monetary policy decisions. If inflation expectations are too low, the central bank might implement policies to stimulate economic activity. Conversely, if expectations are too high, the central bank will take steps to prevent actual, current inflation from rising too rapidly. As longer-term inflation expectations rise above 2.5%, the Fed will tilt in a more hawkish direction. Any threats to the Fed’s “Inflation-fighting credibility” will be met with tighter Fed policy.

Quote of the Month

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man” – Ronald Reagan

Major Asset Class Dashboard

RELATED LINKS

Macro & Markets: December 2023 – An Update from Chief Investment Officer, Michael G. Dow

Beacon ‘Pointe of View’ – A Market Update November 2023

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