Santa Claus stock market rally on the cards while 2023 prospects remain grim

Fund inflows into stocks seem to continue as fear of missing out and hopes of a year-end rally have provided good momentum with growth names leading the way. More interestingly, as a good gauge for current sentiment, recent downbeat earnings guidance by bellwether tech names such as Micron, Nvidia and Applied Materials were received with relative calm with the view that they could have been worse. 

Indeed, even the recent big market rally in China supports the notion that investors have adopted a stance of buy now, worry about fundamentals later, encouraged by slight tweaking of China’s Zero Covid rules, more state support for ailing real estate sector and generally more cordial meetings between Mr Xi and Western leaders in G20 that have raised hopes for thawing of relations. These support our near-term view formed late last month that there is simply too much money on the side-lines to expect more downside, leading us to make substantial changes to our recommended short sell list.

Moreover, weaker US economic activity, increasing momentum in job cuts, more weakness in housing-related data and falling used car sales support the view that some key components of inflation gauge may have indeed peaked. Meanwhile, the market’s definition of a ‘Fed pivot’ has evolved to less aggressive rate hikes going forward from hopes for actual cuts in interest rates in 2023 which now seems unlikely. 

So, although the case for a Santa Claus rally remains strong, we think so does the likelihood for another market leg down in early 2023 as investors come to terms with much weaker corporate earnings trend and the likelihood that even if global inflation is peaking, monetary policies will remain tighter for longer. However, for now we feel investors should be more aggressively positioned, mainly in growth stocks. 

Focusing briefly on developments in our own market in Japan, with both US and China shares rallying, Japanese stock prices have also been propelled higher with Nikkei Volatility Index seeing a drop of over 35% from early October and back down to near its two-year lows. Recent drop in the Dollar Index and threats of more covert intervention in the currency market have helped the yen regain some footing giving BOJ more breathing room to continue with its overtly lax monetary policy.

This is especially the case as super-long dated JGBs have rallied with yields easing from their mid-October highs despite Japan’s inflation gauge quickly approaching 4%, and continuing to disprove BOJ governor’s feeble explanations that this year’s price rises will prove transitory. Indeed, with governor’s tenure coming to an end next April, ushering in a more likely orthodox policy management, a potential turmoil in the Japanese government bond market is yet another of our major concerns going into 2023.