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Market Insights – October 31, 2022

Each week, our Investment team shares its market views with you !

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Essentials

The S&P 500 gained almost 9% in October, one of its best monthly performances so far this year. The rally, which comes after two very bearish months, was spurred by investors’ hopes that the US Federal Reserve will soon change course and that inflation will continue to ease.

Unsurprisingly, the European Central Bank raised its key rates by 75 basis points to 1.5%. But in Germany consumer prices rose 11.6% year on year in October – a sign that inflation has yet to stabilise in Europe. That figure also suggests that the ECB will continue to hike rates despite the economic slowdown.

Yields on long-term sovereign debt began to stabilise in early October. Confidence has also returned to the corporate bond market, where risk premiums have started to drop off, especially on high yields. Corporates may be about to catch up and outperform government bonds.

Asia – looking to the future

China’s weak economic recovery has been one of the biggest disappointments in Asian markets over the past ten months. Even though Beijing seems just as determined to reboot its economy as the US Federal Reserve is to combat inflation, we have yet to see any tangible results. The Chinese government has made several supportive statements and introduced a variety of stimulus measures in recent months and seems ready to pull out all the stops; it has further eased its monetary policy and continues to inject cash into the system – moves that run counter to those made by most other policymakers around the world.

China’s recovery is being driven mainly by exports and infrastructure investments but is being handicapped by the government’s zero-COVID policy and a slump in the property sector. Fortunately, things should improve next year. It looks like Beijing might begin loosening its COVID restrictions in the coming months, starting in October with the partial lifting of Hong Kong’s quarantine requirements. This could be followed by steps to restore confidence in the country’s property market. The construction industry makes up a hefty chunk of China’s economy, so it’s hard to imagine a genuine rebound in growth unless that industry stabilises.

The markets overreacted in the immediate aftermath of the National Congress of the Chinese Communist Party, with international investors rightly seeking a higher risk premium on Chinese equities. Yet the extreme pessimism has only heightened the dislocation between valuations and company fundamentals. Investor confidence, which is currently at its lowest in years, should gradually start to return to more normal levels in the months ahead.

Elsewhere in Asia, more cyclical, globally exposed economies – like those of Taiwan and South Korea – will necessarily be affected by slowing demand in Europe and the US. But GDP growth is expected to pick up in the region in 2023, contrary to the outlook for most other major economic blocs. These are just some of the reasons to be patient and optimistic about the outlook for next year.

USA – could there soon be a little less uncertainty ?

At the moment, US investors are so focused on corporate earnings releases and the upcoming Federal Reserve meeting that another key event seems to have gone unnoticed, especially on this side of the Atlantic. On 8 November, the US will hold its mid-term elections, with 435 House seats and 35 Senate seats up for grabs. The stakes are high, since President Biden and the Democrats could lose their weak control over both houses of Congress. Yet, while that outcome might not be good for the president, it could give US markets a boost.

First of all, stock markets don’t like uncertainty, and once the election is over, there will be a little more visibility on the political landscape over the next two years. In the past, the months after a mid-term election have been good for equity indexes.

Second, the most likely outcome is that the Democrats will lose their majority in Congress, which will be good news for investors. If power has to be shared, it will be much harder for President Biden to pass any kind of reform, and reforms are another source of uncertainty and market volatility. Markets usually prefer the status quo, and US equities tend to deliver higher returns during power-sharing periods.

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