Global markets have experienced more negative than positive days in recent weeks. There was, however, a notable change in equity market behaviour in recent days. While we are not convinced that the change marks a sustainable shift in trend, it was notable given historical precedents. We describe this in more detail below.
The U.S. consumer price index (CPI) for the month of September was released this past week. Unfortunately, it was not only higher than expected, but higher than the preceding month. The “core” measure, which excludes food and energy prices, rose at a pace of 6.6% year-over-year, a new multi-decade high. While monthly CPI is only one data point, its release disappointed investors, who were looking for a further slowing of pricing pressures. Overall, the persistence of inflation should incentivize central banks to remain on their rate tightening paths.
The equity market’s reaction to another string of disappointing inflation data on October 13th was a substantial decline initially, in-line with what investors would have expected. Unexpectedly, however, after the initial fall, equity markets sharply reversed course and finished meaningfully higher. The reversal was one of the larger intraday reversals for the U.S. stock market on record. Bonds responded in a somewhat similar fashion, albeit less emphatically. Overall, it was a surprising development that caught most investors off guard, particularly given how poorly markets had responded to high inflation readings throughout most of the past year.
There is no fundamental explanation for the intraday market turnaround. It may have been an anomaly. The development left us reflecting on a few learnings we have gleaned over the years. First, when negative investor sentiment is near an extreme, there may simply be a lack of sufficient 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. Finally, equity markets often bottom on bad news, in anticipation of future improvement.
We think that it is too early to expect on a sustainable market recovery at this point. The economic slowdown that is underway is expected to intensify in the months to come, as the monetary tightening of financial conditions works its way through the global economy. The tightening may solve the inflation challenge that markets have been grappling with all year, which in turn may help get us get closer to an eventual market inflection point. In the meantime, we will focus our market-related attention to the third quarter earnings season, which has now officially kicked off.
If you have any questions, please do not hesitate to contact us.
Drew M. Pallett LL.B. CFP
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities
Email: drew.pallett@rbc.com
Website: www.pallett.ca