This article explores how the Market will develop in Q4 of 2022, and what to expect from the outlook. Long-end yields are expected to rise. Commodities are expected to do well, and Fed policy is likely to tighten. It will also look at how the Fed’s tightening of policy will affect equities.
Market upside in Q4 of 2022
The market’s latest quarterly report shows that the dollar’s sharp ascent has weighed down non-US equities. The rising dollar adds to the pressure on global economic growth and erodes corporate profits. The market’s recent behavior has been a mixed one, with some sectors showing modest gains while others suffered massive losses. In addition, Q3 earnings season is quickly approaching, and Schwab’s Chief Investment Strategist Liz Ann Sonders warns that weaker-than-expected earnings could limit the upside.
Investor sentiment remains gloomy. Concern over the ability of the Fed to engineer a soft landing has driven interest rates higher, risk assets lower, and the dollar stronger. During the first quarter of 2022, the market experienced a downdraft, which continued in the second quarter after a higher-than-expected May US inflation print and a fall in US consumer confidence. In addition, the most underperforming sectors, such as emerging markets, continued to underperform year-to-date.
Commodities and equities perform well in 2022
The first half of 2022 was a difficult time for investors. Stocks and bonds worldwide sank, and inflation hit multidecade highs. The Russia/Ukraine conflict created new supply chain problems. As a result, the equity markets in the energy-importing countries declined. By contrast, commodity exporting countries saw significant price gains.
While stocks and bonds across all asset classes saw significant declines in Q3, the performance of non-US equities was more mixed. The strong dollar weighed on non-US equities, while commodity prices remained a rare bright spot. Global manufacturing activity decelerated, ending the quarter in neutral territory, a leading indicator of a slower pace of growth in the coming quarters.
Long-end yields rise
The yield spread, or difference between the three-month T-bill rate and the 10-year T-note rate, can be a leading indicator of an upcoming recession or recovery. It is calculated by subtracting the three-month T-bill rate from the 10-year T-note rate. If the yield spread is low, it means that the economy will grow less in the year ahead. Conversely, if it is high, then it indicates a more robust economy a year from now. The Fed is using this ratio to guide its short-term rate actions.
The “real” rate, which is the rate after adjusting for inflation over the next decade, was minus 1% at the end of 2018. If this is the case, the long-end yield will rise to 2% in 2022. While that is still negative, it is not as negative as it was in 2021.
Fed policy tightening weighs on stocks
As the second half of 2022 approaches, investors are likely to be nervous about the looming Fed rate hike and the perplexing economic situation. The Fed is pursuing its aggressive policy rate increases despite the slowing global economy and rising inflation. This uncertainty, combined with the sharp countertrend rally earlier this year, is likely to weigh heavily on the stock market in the coming quarters.
The Fed has already raised interest rates by nearly two percentage points this year, and its plans to hike rates a further 75 basis points next year are already weighing on stock markets. While the Fed has largely avoided the issue of excessive liquidity, some investors worry that quantitative tightening will negatively impact the economy. Some investors, such as Federated Hermes’ chief equity market strategist, recently increased their cash allocation to 20-year highs.
Manufacturing industry recovers fast from pandemic
The latest data on manufacturing production worldwide, released by the United Nations Industrial Development Organization (UNIDO), confirms that the manufacturing industry is recovering fast after the pandemic. While the recovery rate is relatively low, it is higher than it was a year ago, 3.3 percent. The recovery speed varies from country to country and sector to sector. For example, China’s manufacturing sector recovered quickly from the pandemic, exceeding its pre-pandemic level since the third quarter of 2020. However, the country experienced its lowest annual growth rate since 2006.
The pandemic had a traumatic impact on the labour market, but it was mitigated by the widespread use of temporary employment adjustment schemes. As a result, in Q4 of 2022, manufacturing GVA in Spain was only 3.7% below its pre-crisis level. This gap was narrower than that of its German and French counterparts. However, the recovery from the pandemic was hindered by successive outbreaks of the virus.