One of the most important skills that analysts and investors need to develop is the skill of listening to what the financial markets are saying.
It is the process of interpreting the price action of different asset classes (stocks, bonds, commodities, currencies) both domestically and globally in relation to various developments. These include government and central bank actions, economic and business trends.
Knowing what financial markets are saying helps analysts and investors determine what is priced in, in turn improving their ability to respond correctly to new developments (either to buy or sell an asset class), helping generate excess returns or alpha.
The performance of financial markets has been quite interesting lately. Even though the US Federal Reserve remains very hawkish, with its chair Jerome Powell saying they will continue to raise rates and keep these elevated for the rest of 2023, financial markets are saying, “we don’t believe you.”
Note that despite continuous rate hikes by the Fed, the US dollar stopped appreciating and is now 11-percent lower than its peak. This is one of the main reasons why the peso is now trading below P55, after hitting a high of P59 in the fourth quarter of last year. The US 10-year bond rate is also dropping and is now 76 basis points below its peak of 4.24 percent. The Philippine 10-year bond rate is also falling and is now 150 basis points lower than its peak of 7.72 percent.
The weakness of the dollar and the decline in bond rates are due to increasing signs that inflation is on the way down. The Commodity Research Bureau index, which measures the price of a basket of commodities, is down 13 percent from its peak. Oil is also down 33 percent despite the ongoing war in Ukraine.
Economic activity in the United States is also slowing down as measured by both the manufacturing and services purchasing managers’ indices (PMI). Slower economic activity reduces demand driven inflation.
Finally, the reopening of China should help ease supply bottlenecks, also reducing inflationary pressures.
Because of growing signs that inflation is on the way down, financial markets believe it is inevitable for the Fed to pivot or cut rates despite the central bank saying that it won’t.
Meanwhile, stocks are going up globally because of two reasons. First is that the negatives are priced in. The year 2022 was a bad year with stocks falling due to rising rates and concerns that the Fed would overtighten. Now that inflation and interest rates are on the way down, there is room for stocks to go up.
Second is expectations that the United States won’t suffer from a hard landing. Although economic growth is slowing down, the unemployment rate remains very low at 3.5 percent. Coupled with the expected decline in Fed rates, the market thinks this should help the economy stay resilient.
The strong performance of the peso, bonds and stocks will most likely continue in the near term as inflation slows down further.
However, as I’ve discussed in my column last week, there are numerous risks. These include the possibility that the US economy doesn’t just slow down but also suffer from a steep recession as the Fed’s aggressive interest rate hikes work with a lag.
If on the other hand the United States doesn’t suffer from a hard landing, the Fed might possibly decide to just pause and not pivot to prevent the risk of inflation going up again.
Because of the numerous risks, I don’t think it’s a good idea for investors who buy stocks today to just be passive.
Pay attention to what is happening to the US economy and what the Fed is doing because if the US economy suffers from a hard landing or if the Fed decides not to cut rates, stock prices could go down. The happy ending that the market says it is anticipating will not materialize. INQ