November will be etched in the memories of investors as a remarkable month.
Risky assets, such as stocks and high-yield bonds, delivered exceptional returns. Even assets that are traditionally negatively correlated to them, such as US Treasury securities and gold, experienced notable upward price movements. Money that had been on the sidelines found its way into a diverse array of investment opportunities. Companies rushed to issue new bonds to finance investments and bolster their reserves. And all this fostered increased confidence and optimistic projections for the market and economy in the coming year.
This extraordinary November was propelled by four key factors: Goldilocks economic data, declining yields, falling oil prices, and a surge in the deployment of cash sitting on the sidelines. Together, they created an unusual convergence of the three primary risk factors shaping market returns and correlations. Extrapolating all this forward, however, is subject to important qualifications that might well be underestimated during a period of understandable euphoria.
Let’s start with the numbers that are so pleasing to most investment portfolios.
In November alone, the Nasdaq 100 experienced a 10.7% surge that, unlike the recent past, was not confined to a select few high-performing stocks. Indeed, the S&P 500, Dow Jones Industrial Average and Russell 2000 index of small companies all registered gains of nearly 9%. Similar robust advances were seen in other risk assets, including high-yield bonds. Notably, the VIX Index, known as Wall Street's fear gauge, sank to its lowest level in nearly four years and traded below 13 on several occasions during the month.
Risk-off assets too performed well in this risk-on month, contrary to what the traditional finance textbooks would tell you. Gold gained 2.7%, and a stunning broad-based drop in Treasury yields drove up the price of the 10-year US government bond.
The confluence of four factors played a pivotal role in these developments.
Firstly, most US economic data releases last month consistently supported the idea of a soft landing for the world’s largest and most systemically important economy, indicating continuous progress in reducing inflation without significant growth sacrifices. This was particularly the case for price data, all of which showed further declines in inflation, and the numbers for business investment and household consumption.
This paved the way for the second factor: notably lower Treasury yields, which reduced borrowing costs across households, companies and government entities. From mortgages to auto loans, and from corporate lines of credit to bond issuances by local and state governments, the cost and availability of funding improved significantly as traders bet that the Federal Reserve and other central banks have not only finished raising policy rates but would also be cutting them next year.
The drop in international oil prices reinforced the first two factors by alleviating fears of stagflation. Lower energy prices translate into reduced cost pressures for companies and households, increasing their flexibility to spend.