The rebound in equities indices over recent weeks is gathering steam - but in some markets more than others. How have stock averages performed and which indices are best to join the rally?
After heavy weakness over Q3, Q4 has seen a firm rebound across most markets but that performance has not been uniform across the indices space. While some markets have gained well others haven seen more muted action. We also need to consider the price action across the year as a whole with regard to how important recent rallies have been.
Which Indices Have Performed Better?
For example, the circa 16% gain in the S&P (as of 17 Nov, 2022) off the October low is being celebrated. However, the index has only recovered around 40% of its losses from the 2022 highs.
On the other hand, indices like the FTSE have only rallied around 10% off the lows, but this has recouped more than 70% of the year’s losses. We examine here which indices are performing best and where the better opportunities lie moving forward, as well as the key factors driving current price action.
In terms of the biggest recovery of losses over the year, the FTSE and the Dow Jones have led the way. The FTSE has recovered almost 80% of the year’s losses, having only shed around 13% from the year’s highs at its lowest. The Dow has recovered around 62% of the year’s losses, having shed roughly 24% at its lowest point, reflecting a larger real gain than the FTSE.
Which Indices Have Performed Worst?
Looking at the Nasdaq however, we can see a very different set of results. The tech-orientated index has recouped around 24% of the year’s losses. Given that the index was down around 37% at its lowest point, this is a far weaker set of real gains than we’ve seen when compared with the Dow. The difference in performance between US blue chip stocks and US tech stocks feeds nicely into the current discussion on factors driving the markets.
What’s Driving Stock Markets?
The first thing to address is that the current rally across most indices can likely be viewed as a ‘short squeeze’ given the heavy selling that preceded it this year i.e. we are in a bear market. The driver behind this order book clear-out is the big shift in Fed rate hike expectations.
Fed Pivot Expectations
Across Q4 traders have grown increasingly expectant of a shift in Fed tightening in line with what other central banks such as the BOC and RBA, which have both recently pivoted to a slower pace of tightening. This view has seen bond yields coming off recently, fuelling a shift back towards equities.
US Inflation
The latest US inflation data for October has further amplified this dynamic. With CPI seen falling sharply to 7.7% from 8.1% prior, traders have now moved to almost fully price in a smaller hike in December. With vice fed chair Lael Brainard commenting that she views a slower pace of tightening as likely appropriate, the near-term outlook for the dollar looks tilted towards further losses, which should further support equities.
Dow Performance vs Nasdaq
Looking at the performance divergence between the Nasdaq and the Dow this year suggests that fears over the health of the US economy are starting to take hold. One of the main arguments for the Fed to slow down its rate hikes is to limit the impact on the economy. The poorer performance in tech stocks integrates with this narrative. Better performance in the Dow in part reflects investors and asset managers allocating more capital to blue chip stocks, which is a defensive portfolio move.
Near-Term Outlook
The perception that a slower pace of rate hikes is the first step towards the Fed ultimately ending its monetary tightening is supporting the current rally. Amidst that backdrop, the Nasdaq then secondly the DAX, the biggest victims of rate hikes, are now the biggest beneficiaries. But since more value-based indices like the FTSE 100 and Dow Jones suffered less damage, the recovery, although smaller as a percentage of the index price, is greater as a percentage of the prior decline.
Put another way, the FTSE and the Dow are still outperforming for investors but without the volatility and potential for short-term gains during the rally that might attract day traders.
Let’s finish analyzing the technical layout in the Dow.
Dow 30– Weekly Chart
Source: FlowBank / TradingView
The rally in the Dow off the YTD lows has seen the market breaking above the bearish trend line from YTD highs. Price has also recently cleared through several key resistance levels and is currently stalled ahead of the 34,130 level. While above the broken trend line and above the 33,220 level, the outlook remains bullish with a break of current resistance opening the way for a move up towards 35,400. However, if price fails at the test of the August highs, risks of a rotation lower start to build.
