The markets seldom move as investors would expect. Last week was certainly a testament to that. After a very strong employment report, long bonds rallied and yields dropped. In fact, the two-day move down in 30-year Treasury yields was the largest such move since March 2020.1 This is certainly not normal market behavior, especially in such a strong and tight labor market, which produced both higher-than-expected job gains and wage growth.
The strength in long bonds is causing the yield curve to become even more inverted — an unwelcome sign that typically projects future economic weakness. This shift down in yields over the past two months has also helped produce a staggering rally in the stock market. Despite two straight quarters of negative earnings growth (ex-energy) and lower future earnings estimates, the broad stock indexes bounced strongly in October and November. In fact, the two-month gain in the Dow Jones Industrial Average was the largest since 1938.2 This proves once again that most market predictions are futile in such an unpredictable market.
As we close 2022 though, financial reality will have to match these sharply positive price moves. Since earnings are not increasing along with stock prices, the valuation component of the indexes expanded. The S&P 500 Index’s P/E ratio increased from 17x to 19.5x, accounting for nearly all of the market’s gains over the past two months.
But with expected earnings moderation, it should be much tougher to get further gains without some significant positive news from somewhere else — a resolution in Ukraine, a reopening in China or a more dovish Federal Reserve. 2023 is already shaping up to be one of the most interesting years in recent memory — which is quite a statement, given what we’ve experienced the past few years.
1Source: CNBC- U.S. 30 Year Treasury; as of 12/5/22
2Source: CNBC- U.S. Markets; as of 12/5/22
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