Here we are, saying thanks and goodbye to an excellent November for both bond and equity markets. US bonds rallied and bond yields melted from the end of October, remember, and the melting bond yields gave the S&P500 one of its biggest gains for a month in November. The index gained more than 9% in November and is up more than 10% since the end of October, and the Nasdaq 100 gained nearly 12% last month and is up 15% since its October dip. Note that yields are one – and an important – part of the valuation story, because when yields on low-risk assets fall, valuations of riskier assets automatically rise. But there is also a fundamental leg to the US equity story.
Hot off the press, the US Bureau of Economic Analysis reported that total corporate profits grew by 3.3% in the third quarter, reaching an annualized rate of nearly $3.3 trillion. This figure is just shy of the previous all-time high of $3.3 trillion set in Q3 of 2022. And the significance lies in the fact that this increase in profits demonstrates the adaptability of U.S. companies to the post-COVID operating landscape of higher wages and increased borrowing costs.
The debate now is whether such a strong November will spoil our Santa Claus rally, or whether U.S. equity markets will continue to add to their gains in December. Looking at the overall corporate fundamentals, there is no reason for the rally to suddenly stop unless we get some shocking data – like a very bad jobs report or a very sharp drop in growth numbers to subpar levels. And even then, some of the bad data would be tamed by dovish Federal Reserve (Fed) expectations, right? And my 10-year experience in the equity markets reminds me that valuations are never too high. Of course, for the past decade, the market has always been in a zero interest rate regime, and that’s changed since last year, but it still feels like you’re never thin enough, you’re never rich enough, and stocks are never valued enough.
But if you look at the technical indicators, US equities are now in overbought territory; they have been bought too fast and too short and a small correction in the next few sessions would be healthy. However, this doesn’t rule out the possibility of another rally once the overheated technical indicators cool down. A Santa rally is still on the cards if the Fed members continue not to mention the rapid fall in US yields to justify a more hawkish policy stance.
The good news is that inflation is falling. Yesterday’s PCE data confirmed that the US PCE index fell from 3.4% to 3.0% in October, and core inflation eased from 3.7% to 3.5%, as expected. The fact that the data was in line with expectations did little to sway bond buyers, and as a result we saw the US 2-year yield rebound above its 200 DMA and consolidate there this morning.
Now, inflation can be a bit tricky and tends to make unexpected comebacks. Europe isn’t quite out of the woods yet, as the labor market remains robust and the European Central Bank (ECB) remains dovish. However, one of the main drivers of inflation in Europe, the Russian gas nightmare, is mildly over as the region has taken massive steps to prepare for this winter season, reducing its dependence on Russian gas to just 12%. That’s a big drop from 40% before the Ukraine war.
Moreover, OPEC seemed a bit overwhelmed by events this week, as the group announced an additional 1mbpd cut that will be shouldered by cartel members, on top of the 1mbpd cut that Saudi Arabia will extend into next year. But the latter was nowhere near appetizing enough to get the oil bulls going. The barrel fell to $75 and should continue to find sellers at the 200 DMA, near $78.