Markets were up more or less in unison last week despite, or really because of, largely weak economic data in the US and mixed results from the US earnings season. This potentially (hopefully) points to a slight moderation in the need for the US Federal Reserve to raise rates quite so aggressively, something the market has been pining its hopes on for the last 6 weeks. There is quite a lot of conjecture and debate amongst market commentators about the impact of interest rates (particularly real, after inflation, rates) on markets but this recent episode is another indication that this remains the most important factor affecting the direction of markets and the relative performance of different markets, arguably more so than corporate earnings. The chart below shows that the 10% rebound in the Nasdaq started the same day that rate rise expectations started to moderate and longer term rates fell. Medium term inflation expectations also started to moderate which means that the real borrowing rate has flatlined, remaining in slightly positive territory.

That meant that, despite some influential companies reporting earnings last week, it was the large US tech stocks (many of which are reporting this week) that set the mainly positive tone for markets. Mediocre news of the economy is good news for stocks. This is especially true for tech stocks and so the Nasdaq ended up 2% last week having rebounded 10% of its lows in mid-June.  but remains more than 20% under water this year. Similarly Tesla, Amazon, Apple and Microsoft were all up strongly last week on top of double digit gains in the prior weeks but remain 20% or so off their highs of late last year. Despite the increasingly dire headlines coming out of Europe around deepening energy shortages, weakening economic output and rising inflation the European stock market has largely tracked the broader US market while Japan’s stock market continued to surge on a weak Yen and presumably a better environment for its exporters. In Australia we have witnessed a similar environment but it is the ‘quality’ mid-cap and smaller growth companies that have been the lightning rod for a slightly kinder interest rate outlook. Again many of these companies have risen by some 20-50% in recent weeks but remain depressed compared to the beginning of the year. Still, given the concentrated nature of our market it was the 5% or so rises from the major banks that contributed the most to a 3% rise for the local market last week. Banks are often seen as beneficiaries of rising interest rates (and therefore lending margins) but in this cycle the potential fragility of borrowers (especially mortgagees) has overridden this and most local banks (apart form NAB) are down for the year. They have also all rallied since long-term rates started to ebb in June. Clearly the inflation and interest rate outlook remains important and seems to be trumping weakening economic data and earnings for now. This is a fairly nuanced outcome for investors who may be hesitant to wish for the recession that policy makers increasingly believe will be the unavoidable cost of lowering inflation. That said corporate bond markets may also be giving grounds for optimism as credit spreads, having spiked in recent months, have started to tighten again, a move that gathered pace last week. This may provide a hint that the soft landing that investors, consumers and policy makers alike crave is achievable.  On the other hand there is a growing appreciation of the extent to which companies were able to shore up balance sheets during the free money frenzy of COVID stimulus. This is another illustration of the mixed up nature of the data we are seeing and the difficulty in applying historical analogies to the current situation. Whether this turns out to be a mere ‘bear market rally’ or bottoming in sentiment is unlikely to become that much clearer in the next few months but this week is one of the weeks where there will be quite a few data points to digest including a raft of US and European manufacturing surveys, inflation data here and in the US and of-course the much anticipated Fed rate decision. The Fed is widely expected to raise short-term rates by another 0.75% but, as with the half (by market value) US corporations that report this week, it will be the guidance and outlook that is arguably more important.