To my clients:

It was a mixed week for North American stock markets with the Canadian TSX finishing down 1.4%; the U.S. Dow Jones Index up 1.2%; and the U.S. S&P 500 down 1.5% .

As with most of 2022, markets have experienced more negative than positive days in recent weeks. However, there was a notable change in stock market behaviour yesterday. Experience has taught me not to get too definitive in declarations about such events because, well, the stock market can make one look foolish. Nevertheless, yesterday’s development was surprising and something worth paying attention to given historical precedent.

So what happened? In a nutshell, a disappointing U.S. Consumer Price Index (CPI) for the month of September was released. Unfortunately, it was not only higher than expected, but also higher than the preceding month. Moreover, the “core” measure, which excludes food and energy prices, rose to a pace of 6.6% year-over-year, which represents a new multi-decade high. Notwithstanding my previously stated concerns about the backward looking data (most notably: owner equivalent rents) driving these readings (see my September 23rd weekly update Fed Speak Remains Aggressive; But I Suspect the Bark is Greater than the Bite for more), the release undoubtedly disappointed investors who were looking for a further slowing of pricing pressures. Overall, the persistence of inflation will likely encourage both the U.S. Federal Reserve and the Bank of Canada to continue raising rates even higher.

But it was the stock market’s reaction to another disappointing inflation report that was the “surprise” I referred to off the top. Initially there was the expected drop, with the Dow Jones Index falling over 500 points in the first half hour of trading. But then the markets reversed course and climbed steadily throughout the day finishing over 800 points higher. This was a “reversal” of over 1,300 points! In fact, this was one of the larger “intraday reversals” (when the market starts off lower and finishes higher) for the U.S. market on record. It was a surprising development that caught most investors off guard given how poorly markets had responded to high inflation readings throughout most of the past year.

Let me be clear: there’s no fundamental explanation for this recent turnaround. Moreover, it’s just one day and may turn out to be an anomaly. But, this development leaves me reflecting upon a few learnings I have gleaned over the years, which are all related to some extent. First, when investor sentiment is near an extreme, there may simply be a lack of enough sellers to push prices meaningfully lower. Second, some of the largest daily stock market returns can occur at the most challenging of times, when investors least expect it. And finally, stock markets often bottom on bad news, in anticipation of future improvement.

Again, I don’t want to be too definitive in suggesting yesterday’s reversal might prove to be “the” turning point. But in the fullness of time, it wouldn’t surprise me either. Certainly as the U.S. Fed continues to raise rates, the economy will slow more. A mild recession is almost a given at this point. But, as I’ve said many times before, if the recession remains mild, I believe markets have already priced in such an outlook. We shall see if yesterday’s developments may have been the markets way of beginning the process of looking through to “the other side” and the better times to follow any mild recession.

That’s it for this week. All the best.

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
3200-1055 West Georgia │ Vancouver, BC │ V6E 3P3
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