Markets improved last month across the board as interest rates pulled back on signs of slowing growth. U.S. markets were up by high-single to low-double digits, while international markets were also up by high-single digits. Even fixed income posted gains of around 5 percent. For the first time in a while, everything went up.
Looking Back
Interest rates and the economy. Interest rates drove the strong performance in November. Better inflation numbers raised hopes that the Fed would start cutting rates next year, and signs of slower but continued economic growth supported that idea. Between job growth slowing to more normal levels, lower but healthy consumer confidence and spending, and the continued weakness in manufacturing, the economy seemed to be settling into a soft landing, which should keep pulling inflation down.
In response, the yield on the 10-year U.S. Treasury dropped back to levels last seen in September, which drove markets higher.
Looking Ahead
Market expectations. December may see a change in expectations. Markets have been calmer this month, and there is some commentary that they may have gotten ahead of themselves. While the seasonal factors remain positive—years when markets are up as much as they have been this year typically finish strong—the size of last month’s gains could result in slower growth this month or even some giveback. Either way, conditions should remain positive, but less so than last month.
Potential risks. While overall conditions remain positive, there are still risks. Inflation may be returning in some sectors, which should be monitored. The ongoing wars in Ukraine and the Middle East could be more disruptive than markets expect. And, of course, domestic politics remain a concern. But with the fundamentals reasonably healthy and the macro picture stabilizing, many of the economic fears that pulled markets back in recent months may be subsiding.
The Fed. As we move into the end of the year, the key issues will be whether growth continues at a slower rate and inflation continues to move down. Market expectations on rates have changed rapidly. If the Fed continues to act in a more dovish manner, that positive reaction could continue. That said, given that the underlying reason for the Fed’s dovishness will be continued slower growth and higher rates, any reversal of those trends could lead to rates rising again. So, while there is an opportunity here, there is also some risk.
A Positive Outlook
Last month was great, as rates pulled back after three difficult months. Signs are indicating that this month will be positive as well. Looking forward to next year, we are still not out of the woods regarding inflation or growth. And while the trends remain positive, risks will pick up again over the next couple of months.
Things to watch will be employment, consumer confidence, and consumer spending. If these factors remain at pre-pandemic levels, where they are now, then a soft landing looks increasingly likely. Growth is slower but still healthy. Rates are down, but so is inflation. Earnings are up, and valuations have stabilized. In all cases, we seem to have achieved a balance between two opposite concerns. Right now, the economy is walking that tightrope pretty well, and that should continue for the rest of the year and into the first quarter of 2024.
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