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Chief Investment Officer, William Henderson, comments on Bonds Market.
Mixed inflation data released last week put a new tenor of concern into the markets as investors worried that the latest data challenged the current consensus that the Federal Reserve Bank would be slowing its pace of interest rate increases. All major market indexes posted negative returns for the week, with the tech-heavy NASDAQ selling off -3.99% while the Dow Jones Industrial Average fell by only -2.77%. Additional U.S. inflation data is due this week, and a Fed policy decision will follow on Wednesday when the central bank is expected to raise interest rates by +0.50% percentage points.
Global Economy
As mentioned above, last week’s inflation data weighed heavily on the market, sending a mixed message to investors. Chart 1 below from Valley National Financial Advisors and Y Charts shows monthly U.S. PPI, U.S. Core PPI, and yearly U.S. PPI and U.S. Core PPI. Year-over-year data shows that inflation is falling, having peaked in July of 2022. However, monthly data – in this case from October to November 2022 – still showed a modest uptick. This mixed message puzzles investors because it does not give the Fed a true green light to halt further interest rate hikes. Additional information is due this week that will show U.S. Consumer Price Index and U.S. Core Consumer Price Index data, as well as the U.S. Inflation rate for November 2022.
The U.S. Federal Reserve Bank wraps up this week’s meeting on Wednesday, and the bank is widely expected to raise interest rates an additional +0.50%, marking the seventh-rate hike for 2022. Fed Chairman Powell will hold a press conference after the meeting announcement, and investors will watch for any signs that point to the crucial “Fed Pivot” or change in the interest rate path. We believe there will be a reasonable period (six to 12 months) before the Fed changes its interest rate path from hiking to cutting rates. The U.S. Inflation rate is still running well above their “target” rate of +2.50% (~7.75% in October 2022), and there needs to be time for the rate hikes we saw in 2022 to percolate through the economy and thereby slow the inflation rate.
What to Watch
Indeed, inflation is coming down, as we have seen in prices for crude oil and retail gasoline. But the Fed still has work to do – we know this, and it is common knowledge on the street. However, uncertainty about a pivot continues to weigh on the markets and investors. The consumer continues to show resilience, especially regarding spending. (Watch for retail sales data being released this week.) The labor market also remains healthy, with the unemployment rate below 4.00%. We are ending this week’s observations on a positive note. Last week, Bloomberg released a survey of Fund Managers’ predictions for 2023 (Chart 2) and showed an optimistic outlook for markets. We may see some softening in corporate profits or even a modest recession, but watch for 2023 to offer positive returns for stocks.
THE NUMBERS
The Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.
MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.
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US ECONOMY |
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CONSUMER HEALTH |
NEUTRAL |
Real GDP for Q2 2022 decreased at an annual rate of 0.6% (up from the first estimate of -0.9%) marking the second consecutive quarter of declining GDP. The second estimate for Q3 2022 shows Real GDP to have increased by an annual rate of 2.9%, up from the previous advance estimate that reported a 2.6% gain. |
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CORPORATE EARNINGS |
NEUTRAL |
The earnings growth rate for Q3 2022 was 2.4%, which was adjusted upwards from 2.2% last week. All of the S&P500 companies reported actual results, 70% of them beat EPS expectactions while 71% beat revenue expectations. For Q4 2022, earnings are expected to decline by -2.5%. This would be the first negative growth since Q3 2020 (-5.7%). |
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EMPLOYMENT |
NEUTRAL |
U.S. Nonfarm Payrolls for November 2022 increased by 263,000 and the unemployment rate remained unchanged at 3.7%. Wages have risen more than expected at a rate of 5.1% YoY. Service sectors contributed the most to the increase in jobs while industries that are sensitive to rising rates, such as construction and manufacturing, have started to level off. |
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INFLATION |
NEGATIVE |
The annual inflation rate in the U.S. increased by 7.7% for October 2022 compared to the expected 7.9% — showing some signs of deceleration. Core CPI was also reported below expectations at 6.3% versus the estimated 6.5%. November inflation data will be released on December 13th withan expected CPI of 7.3%. |
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FISCAL POLICY |
NEUTRAL |
Senator Manchin and Majority Leader Schumer reached an agreement on the latest tax and energy bill with incentives for green energy, electric cars, and conversely oil & gas companies for exploration. No changes in private equity taxes or higher tax rates for the very wealthy were enacted. The bill has been officially passed by the Senate. President Biden announced student loan forgiveness of up to $20,000 subject to income limitations. |
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MONETARY POLICY |
NEGATIVE |
The Fed approved a fourth consecutive 75 bps hike in November which took its target range to 3.75%-4.00% – the highest it has been since 2008. The Fed hinted at potentially reducing the magnitude of future rate increases from 75 to 50 bps but also mentioned the possibility of a new higher target range closer to 5%. A new rate hike announcement is expected for later this week. |
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GLOBAL CONSIDERATIONS |
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GEOPOLITICAL RISKS |
NEGATIVE |
Russia held controversial referendums for the annexation of four Ukrainian regions and the Russian Parliament unanimously recognized these regions as part of Russia. Ukraine and Western countries have condemned these actions by Russia by declaring them illegitimate and illegal. Additional sanctions are being imposed on Russia by many countries. |
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ECONOMIC RISKS |
NEGATIVE |
COVID-19 lockdowns in China are easing which should help the global supply chain recover. On the other hand, the Russian-Ukraine war does not show signs of abating. Gas supplies from Russia to Europe have decreased by 88% over the past year and EU countries have agreed to cut gas usage by 15% as gas prices have more than doubled. The U.S. is now dealing with a major diesel shortage with national reserves at their lowest levels since 1951 and a ban on Russian products that willintensify the issue. |
The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.
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