We can’t make too much of one day’s results, but central bankers must have been ghoulishly pleased with Thursday’s equity market action. Weak U.S. economic data, lower commodity prices and falling bond yields are not widely considered positive because they highlight growing risks of a North American recession, but they also signal a potential easing in inflation pressure and a change in sector leadership.
Firstly, the monthly survey of U.S. manufacturers by the Institute of Supply Management showed much weaker activity than economists expected. The new orders component of the survey, the most forward-looking segment, fell into contractionary territory.
Copper and oil prices were down sharply on the day, a reflection of growing fears of an economic slowdown. The copper price, considered an effective gauge of global economic growth by many, is now more than 20 per cent lower than the peak in March.
Crude, while still elevated thanks to Russia’s invasion of the Ukraine, is more than US$13 lower from the June 8 high.
Bond yields are also pricing lower growth. The government of Canada five-year bond yield – an important determinant of domestic mortgage rates – fell from 3.33 per cent to 3.19 per cent on Thursday and is now 40 basis points off the June 14 high. (It was little changed on Friday.)
Importantly, global freight rates set another post-pandemic low Thursday. The Shanghai to Los Angeles Container Freight benchmark is 36 per cent lower than the peak in September, 2021. This suggests that inflationary supply chain disruptions are being addressed.
None of this is to suggest that the battle against inflation has been won. Labour markets remain strong and food and energy costs continue to stretch household budgets. For investors, however, we may be reaching an inflection point whereby lack of economic growth supersedes inflation as the primary concern.
I took a snapshot of S&P 500 sector performance around midday Thursday and it was a textbook reaction to slowdown fears. The most economically sensitive sectors – energy, materials, financials and industrials – were the worst performers, down between 1.5 per cent and 4.4 per cent. Defensive market sectors – utilities, consumer staples and health care – were higher by more than 1 per cent.
The market sectors that perform well in an overheating, inflationary economy are the exact opposite of those that outperform as growth slows.
Some of the relative sector performance reversed on Friday, but if it does become evident in the coming weeks that an inflection point has been reached, it will become obvious quickly. The economically sensitive sectors such as energy that have generated strong returns year-to-date would fall back in favour of those like utilities that do well as bond yields fall.
-- Scott Barlow, Globe and Mail market strategist
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Compiled by Globe Investor Staff