November was a very positive month for the securities markets. The S&P 500 index, which measures changes in the value of 500 large US companies, rose 8.9% after three months of decline. The value of the Stoxx50 index, which shows the performance of large European companies, also increased by 8%.
The European and US bond markets also received a good injection of adrenaline in November. There was hope in the markets that the cycle of rising interest rates could end for the time being and that central banks could start lowering them as early as the first half of next year.
Bond prices rose sharply in November as interest rates were cut. While at the beginning of the month the expected yield on ten-year German government bonds was 2.76%, by the end of the month it had fallen to 2.23%. The ten-year U.S. Treasury yield was 4.79% at the start of November and 4.33% at the end.
Markets are optimistic as central banks are believed to have finally managed to keep inflation under control by raising interest rates. The euro area’s 12-month inflation rate, which was still at 2.9% in October, slowed to 2.4% in November. For comparison, the inflation rate in the United States was 3.2% in October and 3.1% in November.
Central banks have tried to calm the market euphoria by warning that until victory over the specter of inflation is certain, they will keep short-term interest rates at current levels for some time. However, markets seem to believe that central banks will also lower these interest rates soon.
In November we found ourselves in a context in which the change in stock prices was mainly driven by expectations about central bank interest rate policy and the economic results of companies once again became irrelevant. This month, it was companies with low profitability and weak balance sheets that raised prices more than others, because falling interest rates will help them the most.
So called Magnificent 7 or the seven largest US technology companies, which until the end of October had provided almost all of the performance of the S&P 500 index this year, remained below the market average in November.
Figure 1. Average 2023 return of the seven largest US technology stocks (grey) compared to the average return of the remaining 493 companies in the S&P 500 Index (light blue)
Although the economic results of US companies have been quite good this year, most of the increase in stock prices has come from rising earnings multiples.
Figure 2. Components of S&P 500 Index Returns 2019 – November 2023. Green: Corporate Earnings; light blue – multiples of stock earnings; grey: dividends
I suspect that despite the slowdown in the inflation rate, it is still too early to say that price increases are finally under control. The economic environment is quite difficult all over the world. The low economic growth achieved is mainly due to the increase in public spending and the growing debt burden.
November’s significant stock market rally is largely based on the belief that, despite concerns, the U.S. economy has managed to avoid a so-called hard landing in this economic cycle.
However, if we recall the period before the 2008 financial crisis, short-term interest rates had increased by 4.25% from July 2004 to June 2006, reaching 5.25%. In September 2007, the US Federal Reserve cut interest rates for a long time by 0.5 percentage points, and then another six times, bringing the short-term rate to 2% by April 2008. But it failed to prevent the collapse of the country’s real estate prices and the financial crisis that followed. It wasn’t until September 2008 that stock markets suffered a sharp decline during the financial crisis.
I believe that in the current economic environment it is important to think seriously about diversification and look for companies and projects that offer strong cash flow. It is also important to consider how well the risks of the investment portfolio are distributed. The 2008 financial crisis showed that in a crisis situation it was not very helpful to diversify your stock portfolio across different regions and economic sectors, as essentially all markets moved together in one direction. Fortunately, the world of investing is not limited to stocks and bonds and, in difficult circumstances, low leverage real assets can be safer than listed shares.
The fact that stock markets rise in anticipation of a decline in interest rates is in itself positive, but I fear that now is not the right time to increase risks in the investment portfolio, and one should instead think about asset protection .
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2023-12-22 09:20:59
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