Looking in review, we can see that 2023 was a gigantic vote of no-confidence in the economic direction of our country. First, let's talk about the whole year, then we’ll look at how the year ended. The financial/economic story of 2022 was driven by the following facts:
- Inflation became undeniable. It was real. It was high. It turned out not to be transient.
- The Fed spent the year raising rates and signaling continued rate hikes in the future.
- Expected hikes, as implied by the futures market, always rose for most of the year.
- Almost all financial markets lost value.
- In almost all cases risky assets sold off more than safer assets, signaling pessimism about future growth.
- Despite the fact that the Fed actively fought inflation and markets signaled it would continue to do so, markets sent mixed signals about whether it would succeed.
- Global markets were down, but U.S. was worse than the rest of the world.
- The facts above are a sum-up of the whole year, but these patterns were not consistent, and markets shifted back and forth between bullish and bearish, between growth pessimism and optimism and between rising and falling interest rate expectations as the Fed pivoted back and forth between its conflicting dual mandates.
- Last week broke the pattern on a small scale, but not nearly enough to reverse the major themes of the year.
So, what specifically happened last week? Some economic data having to do with housing and with unemployment claims were worse than expected. Predictably, that led to dovish (more easy, less tight money) trades.
- The futures market shifted slightly toward expectations of smaller hikes.
- The CME (Chicago Mercantile Exchange) Fed Watch Tool shifted in such a way as to imply that if the predictions of future hikes turn out to be wrong, the hikes will more likely be smaller than expected rather than larger.
- Gold rose.
- The dollar fell.
- Inflation hedges led non-inflation hedged investments.
Exception to the dovish trade:
- Most markets fell.
Since tighter money often leads to economic slowing, then a slight move away from tight money would make slowing less likely. That would mean pro-growth trades, which is what we tended to see last week.
- Copper rose.
- Stocks outperformed bonds.
We shall see in the detail below, the comparative returns within asset classes (e.g. one sector of stocks vs. another; one class of bonds vs. another, etc.) and the variations between sectors were also almost universally anti-growth.
This coming week, there are a lot of economic data coming out. We'll get private supply chain managers surveys, various labor market reports and the Fed minutes, which is a big one. Knowing what the Fed did at the last meeting matters, but knowing why they did it, might matter more.
Bond Markets Last Week: Stocks generally outperformed bonds, which constitutes a pro-growth signal. In addition, variations between the different types of bonds were generally sending pro-growth signals.
Treasury bonds, the ultimate safety play, lagged high-credit-quality corporate bonds, which are considered a little riskier. That's a pro-growth trade: when business slows down, companies find it harder to make their debt payments, but the government can always tax or print more. So, corporate bonds are more likely to default and forward-looking investors sell them now rather than risk being left holding the bag if a company defaults on its debt service payments. Last week, markets acted as though growth might be high enough for well-financed corporations to make those payments. That's 'risk on'.
In addition, low-credit-quality corporate bonds lagged high quality corporate bonds and also treasuries. That also is a pro-growth trade, a 'risk on' trade. If investors are driving down the price of 'super-safe' treasury bonds more than 'junk bonds', they're probably getting more confident about growth. So generally, the more risky the bond, the better the return. That means investors felt comfortable reaching for the higher yields that come with higher risk because they saw the growth risk picture improving a little.
And, it just so happens that last week, being a dovish one, inflation-hedging treasuries overperformed their non-inflation-hedging alternatives. That means that last week, the purest expression of inflation risk, the spread between two investments that are alike in every way except for how they compensate investors for inflation, showed investors getting more worried about inflation. Markets are just not convinced that the Fed can beat inflation.
Real Estate Last Week: REITS performed somewhat negatively. This breaks the dovish and pro-growth and persistent inflation trade patterns of other markets during the week. REITs have a slight tendency to perform between stocks and bonds, but slightly closer to equities, which is what they did last week. Possible explanations are that markets believe the housing bubble is popping and that mortgage rates will remain high. In other words, in this case markets might be looking at bad economic news and not turning it into good market news via expected Fed changes.
U.S. Stock Markets Last Week: Domestic equity markets were generally down last week, but unevenly so.
Growth stocks led value stocks across two out of three size categories. They slightly lagged in large cap.
That is consistent with both the dovish trade and the pro-growth trade. Please see previous weekly analyses for an explainer on growth vs. value effects of interest rate changes and growth expectation shits.
In addition, the growth sensitive sectors and style-boxes outperformed the sectors and styles which tend to be resilient during slowdowns. This fits the pro-growth pattern of trades last week.
Global Stock Markets Last Week: International equity markets were mostly down for the week, though they generally outperformed U.S. Markets.
Partly that was a fall in the value of the dollar, but that fall was modest, and not enough to account for U.S. underperformance based on currency effects alone.
Emerging Markets slightly overperformed Developed ones. That's probably somewhat due to direct interest rate effects, because EM tends to be more sensitive to rising US rates, as capital flows to places where it can get a higher yield and EM is more volatile and therefore more vulnerable to such outflows. So the normal effect of falling rate expectations in the U.S. would be to strengthen EM relative to the U.S. and relative to DM. And that is what happened last week in sync with other dovish trades. That would also fit with the fact that last week was good for the commodities complex. So markets have continued to believe the U.S. will not likely avoid the global slowdown which markets have been registering this year.
The fact that markets had a very slight blip towards optimism in the last week of the was not nearly large enough to break the overall trend for the year. Yes, there was volatility and investors shifted in their expectations back and forth innumerable times throughout the year, but the trend of 2022 was clear, a belief that more trouble is coming in 2023.
Jerry Bowyer is financial economist, president of Bowyer Research, and author of “The Maker Versus the Takers: What Jesus Really Said About Social Justice and Economics.”