Market Commentary: Renewed Optimism

NewEdge Wealth Market Thoughts ben Emons
January 12, 2023


Markets awaited with excitement for the December US CPI report. The number came exactly in line with expectations and the market took it as another piece of evidence that inflation is slowing down. Yet, there is a change of sentiment about what slowing inflation means for the economy. 

Since October, the speculation about the Chinese economy reopening has driven investors to Chinese and Asian equity markets in anticipation of China’s pent-up demand for commodities, foreign products, and services. 

An indicator of China’s demand for commodities is producer inflation. For all of 2022, China’s PPI has been negative, or in deflation, but it has begun to reverse as domestic activity picked up after the lockdowns ended. Conversely, the US CPI and PPI are heading lower as the economy is slowing, attributed to the Federal Reserve’s rate hikes. 

Within China, however, the rebounding PPI is having a “reflationary effect” on global markets, while the country’s stock and bond markets are recovering. It has become a catalyst for investors to change their views about recession, monetary policy, and corporate earnings. The reopening of the second-largest economy could have a material impact on the global economy and change expectations for inflation and interest rates. 



As US inflation moderates, helped by lower energy and gas prices, and while growth is remaining firm, thanks to improving exports and resilient personal consumption, real growth in the US has continued to surprise to the upside, as seen in the GDPNow forecast for 4Q22 now over 4%. China’s reopening could have the dual impact of boosting global growth (further helping US exports), while potentially reigniting energy-related inflation as its demand for fuel bounces back.

So, as Jeff Gundlach says to listen to the bond market and not the Fed, we’d say listen to the economy.  And the economy is saying growth could continue to surprise to the upside.

The reopening of China is coming through the metals sector, with the S&P 500 sub-index for Steel & Copper index having outperformed by 38% since late October. Other sectors like real estate, furnishing, retail, and airlines have shown positive returns supported by lower yields and lower energy prices. 



The markets are on a potential change of course if the China reopening gains momentum. Since the start of the year, US stocks that trade at low multiples, and companies that have a direct link to the Chinese economy, are benefiting from renewed investor optimism. This includes steel companies and airlines with international flights to China. 

Meanwhile, expectations for interest rate increases by the Federal Reserve have been moderating recession fears. Further softening in oil and gas prices has pushed expectations for the Consumer Price Index to a two-year low, with the Cleveland Fed CPI Nowcast — a real-time forecast of December inflation — currently at 6.5%. 

Some of the other beneficiaries of a benign inflation picture have been US investment-grade credit and High Yield, which has performed surprisingly despite concerns about a recession hitting earnings. More specifically, banks and insurance companies’ bonds have delivered a 3.5% return year-to-date, which could become a support for bank stocks that are trading at a 15% discount to the S&P 500 as they go into 4Q22 earnings season with low expectations for results.

There have not been all winners, however. Some sectors like emerging market bonds, materials, healthcare, energy, utilities, and Bio-Tech stocks are up modestly. A softer US CPI and PPI and a recovery of China PPI may also drive investor capital into these lagging sectors. If interest rates continue to fall, it could spur rebound rallies in profitless Tech (such as ARKK innovation is already up 7% YTD). 

All in all, many of the areas that performed the worst in 2022 are rebounding the most in 2023, while 2022’s relative winners have become laggards in the first trading days of this year.



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