Current Market Observations

Financial markets posted another weekly gain pushing November to a positive month overall and helping equities post back-to-back monthly gains for October and November 2022. Further, bonds posted positive returns; in fact, their largest monthly gain since 2008. Positive returns in both markets helped balanced portfolios regain a lot of lost ground in markets since the beginning of 2022. See the summary returns immediately below but note importantly that the NASDAQ returned +2.09% for the week while the 10-Year U.S. Treasury fell 18 basis points to close the week at 3.56%. Just over one month ago, the 10-Year Treasury was 69 basis points higher at 4.25%.  

Global Economy 

Big news last week was Fed Chairman Jay Powell’s speech at the Washington, D.C. Brookings Institute where he confirmed that smaller interest rate increases are ahead and mostly likely as soon as the December FOMC (Federal Open Markets Committee) meeting. Chairman Powell further cautioned that monetary policy would remain restrictive until progress on combating record high inflation continues. Charts 1 and 2, both by Valley National Financial Advisors and Y Charts, show recent downward inflationary trends – PCE (Personal Consumption Expenditures) and Core PCE and U.S. Retail Gas Price.

As demonstrated by both charts, the Fed’s tight monetary policy is impacted inflation but clearly more work is needed. We expect to see several rate hikes in 2022-23; albeit modest hikes such as +0.25-0.50%, rather than the aggressive +0.75% rate hikes we have seen thus far in 2022.  

Most market prognosticators are still calling for a recession in 2023 solely based on historic patterns and economic data. While a recession may happen in 2023 – by whichever measure is popular now since NBER (National Bureau of Economic Research) does not seem to be the decider any longer – looking at market indicators today (labor, consumer health, bank balance sheets and loan delinquency rates, and corporate earnings), any recession will most likely be modest and short-lived. 

Policy and Politics 

Several key U.S. and Global issues remain:  

  • China is easing COVID-19 lock-down rules, easing supply chain concerns, and helping to open Chinese global supply chains. 
  • Russia/Ukraine War shows no signs of abating even as we move closer to winter and the resulting impact on Euro-zone energy prices. 
  • OPEC votes to keep crude oil production at current levels which helps Russia (OPEC member) rather than disrupts Russia’s oil revenue stream. 
  • The bankruptcy filing of cryptocurrency FTX continues to unwind but one clear outcome from this will be deeper and further government oversight and regulation of this nascent industry.

What to Watch 

  • U.S. Durable Goods New Orders for October 2022, released 12/5/22 (prior +0.39%) 
  • U.S. Initial Claims for Unemployment for week of Dec 3, 2022, released 12/8/22 (prior +225k) 
  • U.S. Core Producer Price Index Year Over Year for November 2022, released 12/8/22 (prior +6.68%) 
  • U.S. Index of Consumer Sentiment for December 2022, released 12/8/22 (prior 56.8) 

Mixed messages abound in the markets today. So-called market experts all suggest a recession is coming in 2022. But U.S. equity markets are rallying (the Dow Jones Industrial Average is up +20% since its October 2022 lows) and U.S. fixed income markets have found a sweet spot as the 10-Year U.S. Treasury has fallen nearly 70 basis points since peaking in October. A recent post by asset manager BlackRock noted that the TINA Trade (There Is No Alternative) has given way to BARB (Bonds Are Back). We believe both remain in place—meaning a balanced and diversified portfolio is the surest path to long-term wealth creation.

The Numbers & “Heat Map”

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.

US ECONOMY

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.

CORPORATE EARNINGS

NEUTRAL

The estimated growth rate for Q3 2022 is 2.2%, which was adjusted upwards from 2.2% last week. So far, with 99% of S&P500 companies reporting actual results, 70% of them reported a positive EPS surprise and 71% beat revenue expectations.

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 torising rates, such as construction and manufacturing, have started to level off.

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%. Shelter, food, and gasoline remain the main contributors to elevated inflation.

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.

MONETARY POLICY

NEGATIVE

The Fed approved a fourth consecutive 75 bps hike earlier this month 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%.

GLOBAL CONSIDERATIONS

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.

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.

Current Market Observations

Equity markets posted gains across all three major indexes with the Dow Jones Industrial Average once again leading the way with a +2.39% gain for the week. The S&P 500 Index rose by +2.02% and the tech-heavy NASDAQ, made up of stocks that historically favor low interest rates, rose by only +0.73%. Interest rates fell last week when the minutes of the November 2022 FOMC (Federal Open Markets Committee) meeting indicated policy makers had agreed that a “slowing in the pace of future interest rates would soon be appropriate.” The 10-Year U.S. Treasury note fell by 15 basis points to close the week at 3.68%. Lastly, as we discussed last week, oil, a key economic component and critical ingredient in industrial production, fell to $76.28 for a barrel of Brent crude oil. China COVID-19 lockdowns and related slowing economic conditions in China contributed to oil’s falling price. 

Global Economy 
As mentioned above, the aggressive COVID-19 lockdowns in China are reverberating across the global economy impacting both the supply and demand components. On an inflationary front, China’s lessening demand for industrial products like oil and rare earth elements used in the production of batteries and solar panels, will certainly aid the global efforts to combat inflation. (See Chart 1 below from Valley National and Y Charts showing the price of oil year-to-date 2022). However, China is a key supplier of goods such as iPhones, TVs and of course, solar panels all of which remain in high demand globally. The news from China about social unrest and protests in several major cities including Beijing due to their aggressive zero-COVID policy weighs heavily on the timing of China’s eventual emergence from the pandemic. 

COVID lockdowns may seem like a “China Problem,” but China currently remains the crossroads for the global supply chain and any unrest in their supply chain will percolate through the world’s economy as we saw in 2020-21. However, many countries, importantly the United States, learned from this event and have begun “on-shoring” their production. For example, Intel is building a $20 billion chip manufacturing facility in Ohio and Ford is building a $5.6 billion battery and vehicle manufacturing campus in Tennessee. We believe that investment in U.S. manufacturing is critical to the future of growth and stability of our economy, and that this wave of internal investment and innovation is just starting. 

Policy and Politics 
This week, the Bureau of Labor Statistics releases the U.S. Job Openings figure for October 2022 (gathered from the Job Openings and Labor Turnover Survey – JOLTS). The September figure showed 10.72 million job openings, an increase from August of 10.28 million openings. (See Chart 2 below from Valley National Financial Advisors and Y Charts). The so-called JOLTS survey is known to be a closely watched data point by the FOMC because it is an important measure of the tightness in the job market. A softening labor market would certainly help to ease inflationary pressures such as wage growth. 

What to Watch 

  • While not an economic indicator, the unraveling of the FTX cryptocurrency mess continues to hold a pall over the entire cryptocurrency market as uncertainty abounds. Markets hate uncertainty. 
  • Case-Shiller Composite 20 Home Price Index Year-over-Year for September 2022 released 11/29/22 (prior +13.11%) 
  • U.S. Job Openings: Nonfarm for October 2022, released 11/30/22 (prior 10.72M) 
  • U.S. PCE (Personal Consumption Expenditures) Price Index Year-over-Year for October 2022, released 12/1/22 (prior +6.24%) 

Summary 
While problems remain in the economy, including such risks as China-influenced supply disruptions and inflation, we are seeing seeds of a turnaround and a lessening in inflationary pressures such as falling oil prices. Meanwhile, the Dow Jones Industrial Average closing at 34,347 as of 11/25/22, has rallied +20% since bottoming on September 29, 2022, at 28,726. Stock markets have historically been excellent predictors of future economic results. Further, the VIX (the CBOE Volatility Index) fell again last week to 20.4, down from a recent high of 33.6 on October 11, 2022. The VIX is used as a barometer for fear and uncertainty in the future markets. As we mentioned last week, the time between Thanksgiving and Christmas is typically a quiet, calm time on Wall Street and the VIX is certainly sending that message. We would love to simply say keep calm—but rather we say keep vigilant and focus on matters that grow wealth over extended periods of time.

Current Market Observations   

Equities rallied early in the week after an inflation report (U.S. Core PPI Year Over Year for October 2022 dropped to +6.68% from +7.12% in September 2022). However, the rally was brief as concerns about the pace of future interest rate hikes by the Fed, China “Lockdown” issues and retail sales data to be released this week renewed concerns of a recession in 2023. For the week, The Dow Jones Industrial Average was unchanged, the S&P 500 Index fell –0.69% and the tech-heavy NASDAQ fell by –1.57%. We review U.S. Treasury yields spreads and inflation data, including the drop in crude oil prices, below. 

Global Economy 

Last week’s inflation report (Core PPI) showed a modest drop in prices that producers are paying for goods and services. A major component for production is oil (consumers are equally impacted by oil prices). West Texas Intermediate crude oil continues to fall each week. Chart 1 from Valley National Financial Advisors and Y Charts showing WTI prices since 2008 Oil prices have come down dramatically since the spring of 2022 and are nearing the levels we saw after the 2008-09 recession when modest growth was the norm. Recall that petroleum products and byproducts are in every industry (agriculture for fertilizer production), transportation (planes, trains & automobiles (timely reference), and plastics of every kind, so lower prices in oil eventually translates to lower prices in everything else. 

Industry experts are still calling for a modest recession in 2023. The September 2022 reading showed a 23% chance of a recession in 2023. This reading is higher than the long-term average of 14% and solely based on the spread between 10-year and 2-year US Treasury Notes. Certainly, this indicator is screaming recession in 2023. Chart 2 by Valley National Financial Advisors and Y Charts showing the spread between 10-year and 2-year US Treasury Notes. A negative spread, where the 2-year yield is higher than the 10-year yield, also called an inverted yield curve, has historically precipitated a recession. However, the start, depth, and duration of said recession is always unknown. At this point, economists are still calling for a brief and shallow recession for the U.S. and Eurozone in 2023. 

Policy and Politics 

Thankfully, Washington is in recess, so we are free from any new or intrusive regulations or laws. The massive $32 billion FTX bankruptcy and obvious fraud, if not actual criminal activity surrounding this cryptocurrency fallout must produce come form or government involvement. Investors in this space, after losing billions, might now wish for the Securities and Exchange Commission, FDIC or other oversight group to protect their investments.  

What to Watch 

  • U.S. Durable Goods New Orders for October 2022, released 11/23 (Previous +0.36%) 
  • U.S. Claims for Unemployment week of November 19, 2022, released 11/23 (Previous 222,000) 
  • U.S. Index of Consumer Sentiment November 2022 reading, released 11/23 (Previous 54.70) 

The Thanksgiving Holiday week marks the start of the holiday season on Wall Street. Traders sure up balance sheets and portfolio manager window dress their portfolios adding marquee names to their holdings. It will certainly cost more to put on the family Thanksgiving Feast this year. The American Farm Bureau Federation estimates that a classic Thanksgiving feast for 10 would cost $64.05, or $6.41 a person, up 20% from last year’s average of $53.31. That includes turkey, stuffing, sweet potatoes, rolls with butter, peas, cranberries, a vegetable tray, pumpkin pie with whipped cream, coffee, and milk, “with plenty for leftovers.” For $6.41 a person, Americans get to spend time with friends and family and share stories of happiness and Thanksgiving—to us, $6.41 seems like a bargain. Happy Thanksgiving. 

Current Market Observations   

Financial markets got a triple dose of good news immediately before the Veteran’s Day holiday weekend. On Thursday, the U.S. Inflation report for October 2022 showed a drop in the rate to 7.75% from 8.20% the prior month (See Chart 1). Further, a reasonable cessation in the Russia/Ukraine war seems imminent as Russia retreated from the Kherson region of Ukraine. Lastly, China announced a sweeping overhaul to its “zero-tolerance” practice regarding COVID-19 rules allowing the country to truly reopen its economy. Equity markets rallied (higher prices) sharply on the news, especially the NASDAQ (+8.10% on the week) which reacted favorably to lower interest rates (10-Year U.S. Treasury dropped 40 basis points to 3.82%) which help growth and technology companies as borrowing rates decrease. It would not be prudent of us to ignore another big story last week as Cryptocurrency trading giant FTX collapsed wiping out a $32 billion company overnight.  

US Economy 

Chart 1 below from Valley National Financial Advisors and Y Charts shows the U.S. monthly inflation rate. The sharp drop in the rate is the first tangible evidence that the Federal Reserve Bank’s tight monetary policy is finally curbing inflationary pressures. 

The move in the inflation data immediately impacted financial markets. The CME Group (Chicago Mercantile Exchange) Fed Watch Tool (Chart 2 below) now shows an 80% probability of “only” a +50 basis point rate hike at the December Federal Open Markets Committee meeting rather than a +75 basis point hike, which had been priced into the markets prior the lates inflation report. Chart 2shows the probabilities of changes to the Fed rate and U.S. monetary policy, as implied by 30-day Fed Funds futures trading data.This is a meaningful change in the futures markets as it shows that the end of the Fed’s current interest rate hiking cycle is nearing an end. The question remains around whether Chairman Powell can deliver the mythical “soft-landing” (slowing the economy to combat inflation but not slowing it so much that the economy falls into a recession). 

Policy and Politics 

The midterm election has concluded, and the results give us a weakly divided government with the Democrats maintaining control of the Senate and the Republicans gaining control of the House. As we have stated many times, financial markets appreciate a divided government because it ties the hands of any one party and prevents “unknown” events from impacting the markets. Overall, gridlock works – oddly, but truthfully. 

President Biden is meeting with Chinese leader Xi Jinping today, marking the first time the two leaders have met since Joe Biden took office. While more of a political show, the event does mark a time when relations between the U.S. and China are at a relative low point due to tensions between China and Taiwan. Any warming between the two countries will be viewed as a net positive for global markets. 

What to Watch 

As mentioned above, FTX, previously one of the world’s largest cryptocurrency exchange platforms, collapsed into bankruptcy wiping out a $32 billion company overnight. When we have discussed cryptocurrencies and we have always told investors to understand and research what you are buying. FTX is only one company in the swiftly growing world of cryptocurrencies but the old Wall Street adage “there’s never just one cockroach” rings true right now and we implore our readers to continue to exercise caution in this market. One thing for sure is that regulators and law makers will take a much greater interest in the crypto market.

RELATED VIDEO: CIO Bill Henderson on Cryptocurrency

Last week we saw some great news around the Fed, Russia/Ukraine War and China. Softening inflation data gives the Fed some room to slow down its interest rate hiking cycle, which growth stocks (NASDAQ) view favorably. We are cautiously optimistic that we have seen the peak in inflation. Remain vigilant nonetheless and watch events unfold around the cryptocurrency markets, the Russia/Ukraine war and whether President Biden and Xi Jinping announce any actual results of their meeting. 

Current Market Observations  

Markets reacted negatively to Fed Chairman Jay Powell’s press conference, which occurred after the Federal Open Markets Committee announced an added 0.75% hike in the Fed Funds Rate, bringing the range to 3.75% to 4.00%. While the 0.75% rate hike was expected, Chair Powell’s “hawkish” comments at the press conference, where he noted that the pace of added hikes is not slowing, were not expected. Stock markets immediately sold off and bond yields rose because of a similar sell-off in the fixed income markets (See Weekly Markets below). Unemployment moved slightly higher during October, but it is important to note that the labor market still is robust. Additionally, midterm elections are this week and, regardless of what happens, market results tend to be agnostic to party over the long-term. 

Global Economy 
As noted above, the Fed hiked interest rates 0.75% last week. Chair Powell noted that this year’s interest rate hikes have affected the economy, the Federal Open Markets Committee believes that further tightening is necessary to slow the economy enough to deal with the decades-high hot inflation currently weighing on the markets, economy, and the consumer. According to the Chicago Mercantile Exchange, futures on Fed Funds Rate are now pricing in three added hikes with a final terminal level near 5.25%. (See Chart 1 below)

Higher interest rates weigh heavily on consumers (loans, mortgages, credit card interest rates) and directly affect areas of the economy that rely on loans and loan demand (housing). Higher rates also affect those companies that rely on loans for growth such as high-tech, and impact less so on well established companies such in the industrial segment. We saw the divergence of returns last week with the NASDAQ down -5.65% while the Dow Jones Industrial Average was down -1.4%. The labor market remains healthy and last week we saw that 261,000 new non-farm jobs were created during October while the unemployment rate ticked up to 3.7% from 3.5. (See Chart 2 below)

Policy and Politics 
U.S. midterm elections happen this week and historically the party in power (currently the Democrats) loses seats in both the House and the Senate. This is expected to happen this week as well, what to watch will be the extent of the losses that the Democrats suffer. From a markets perspective, results are historically agnostic to election results over the long-term and neither really shows an edge on the other for markets returns to investors. 

What to Watch 

  • U.S. Retail Gas Price on Nov. 7th @ 4:30 PM EST (Prior: $3.857/gal) 
  • U.S. Consumer Price Index (Year over Year) on Nov. 10th @ 8:30 AM EST (Prior: 8.20%) 
  • U.S. Inflation Rate on Nov. 10th @ 8:30 AM EST (Prior: 8.20%) 
  • 30 Year Mortgage Rate on Nov. 10th @ 10:00 AM EST (Prior: 6.95%) 
  • U.S. Index of Consumer Sentiment on Nov. 11th @ 10:00 AM EST (Prior: 59.90) 

Current Market Observations

Last week, we saw diverging pressures on the markets resulting in diverging results on equity indexing. Hopes of a FED slowing their aggressive interest rate hikes moved equity markets higher across the board and bond yields lower, but weak earnings releases from “Big Tech” equities (AMZN, GOOG, META) weighed heavily on the tech-heavy NASDAQ. Still, all major indexes moved higher for the week (see details below) and the 10-Year US Treasury ended the week at 4.02%, 23 basis points lower than the previous week. 

Weekly Markets (as of 10/28/2022; change since 10/24/2022) 

Global Markets 

As noted above, weekly returns were favorable across all major indexes and returns for the full month of October 2022 are shaping up to be some of the best monthly returns in decades. Solid consumer spending, as evidenced by earnings releases from Visa and American Express, continue to fuel economic growth. Last week, U.S. Real GDP (Gross Domestic Product) for the 3rd quarter was released and the number came in at +2.60%, compared to -0.60% for the 2nd quarter of 2022 and +2.70% for the full year 2021. (See Chart 1 below from Valley National Financial Advisors & Y Charts). What we found telling was how GDP has now normalized moving closer to recent historical averages compared to wild pandemic-related swings we saw previously. 

Mortgage rates continue to move higher in response to higher interest rates overall. This has had a drastic impact on the housing market. Last week, the National Association of Realtors released U.S. Pending Home Sales data that was significantly below expectations (-10.17% vs expected of –4.0%) (See Chart 2 below from Valley National Financial Advisors and Y Charts showing the 30 Year Mortgage Rate vs U.S. Pending Home Sales). 

While not a devastating impact on the economy, housing is a key component of economic growth especially given the knock-on effects of home sales – additional purchases of appliances, home improvements made, sales of replacement furniture and fixtures all contribute to or detract from economic activity. 

This week the Federal Reserve meets, and expectations are for another +0.75% rate hike. This is expected so any move higher or lower will have an impact on the markets because, as we all know, markets hate uncertainty. Additionally, about 1/3 of the S&P 500 Index Companies report earnings this week, which will also have a corresponding impact on the markets if the data is more positive or negative compared to Wall Street analysts’ predictions. 

What to Watch 

  • U.S. Job Openings: Total Nonfarm for September 2022, released 11/01/22 (Prior +10.05m) 
  • Target Federal Funds Rate by Federal Open Markets Committee released 11/02/22, current upper range 3.25% 
  • U.S. Initial Claims for Unemployment Ins. for week of 10/29/22, released 11/3/11 (prior 217k) 

There has been a modest turnaround in equities and the month of October has rewarded patient investors handsomely. 10-Year US Treasury yields have come off their recent highs (4.33%), moving lower to 4.02% but markets have yet to express optimism that yields have peaked. The FED meets this week and markets have priced in a +0.75% bump in the Fed Funds Target. The language around that move and additional directional information from Fed Chair Jay Powell is what we are really waiting for with Wednesday’s announcement. Global uncertainty is focused on the Russian/Ukraine war and Covid related lockdowns in China – thankfully, these are not new uncertainties, and the markets continue to accurately price in the story. Watch for impactful data this week while also remaining focused on the long-term trends. Reach out to us at Valley National Financial Advisors for any additional information. 

The Numbers & “Heat Map”

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.

US ECONOMY

CONSUMER HEALTH

NEUTRAL According to the second estimate, 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 advance estimate for Q3 2022 shows Real GDP to have increased by an annual rate of 2.6%.

CORPORATE EARNINGS

NEUTRAL The estimated growth rate for Q3 2022 is 2.2%, which was adjusted downward from 9.8% in June and 2.4% two weeks ago. So far, with 52% of S&P500 companies reporting actual results, 71% of them reported a positive EPS surprise and 68% beat revenue expectations.

EMPLOYMENT

NEUTRAL U.S. Nonfarm Payrolls for September 2022 increased by 263,000 and the unemployment rate fell back to the June and July level of 3.5% after spiking slightly in August to 3.7%. Professional and business services, health care, and leisure and hospitality were among the sectors with the most notable job gains.
INFLATION NEGATIVE The annual inflation rate in the U.S. increased by 8.2% for September 2022 — down slightly from 8.3% in August but still a stubbornly high result and above expectations. Core CPI increased by 6.6% year-over-year marking the highest gain since August 1982. Food and shelter were the main contributors to the increase in CPI, gasoline index fell slightly but overall energy prices are expected to rebound again. Used car prices are also not declining as much as expected.

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. Last week, President Biden announced student loan forgiveness of up to $20,000 subject to income limitations.

MONETARY POLICY

NEGATIVE With inflation still running hot, Fed Chairman Jay Powell is clear on his path to slow the economy enough to cool inflation. The Fed raised rates by 0.75% in September, bringing its target rate to 3.00-3.25%, and suggesting that additional 75bps rate hikes are likely in the coming months. The next Fed meeting will be taking place this week.

GLOBAL CONSIDERATIONS

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.

ECONOMIC RISKS

NEGATIVE COVID-19 lockdowns in China are persistent and the ongoing Russian-Ukraine war is causing a major energy crisis in Europe. Putin shut down the pipeline that supplies Europe with natural gas indefinitely until all sanctions affecting Russia are lifted. 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 “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.

Current Market Observations  

Equity markets reacted favorably across all major indexes to end the week nearly +5% higher. Favorable corporate earnings and FED commentary pushed markets higher. About a fifth of the S&P 500 companies have reported their earnings thus far, with 73% of reported earnings beating estimates. The road to FED hikes remains steady as tightening assumptions dropped at the end of week, but the market is still pricing in a +75bp hike for next week. In the absence of poor information equity markets enjoyed the rally. Bond markets, however, continued to weaken with the 10-Year U.S. Treasury ending the week at 4.21%, 19 basis points higher than the previous week. 

U.S. Economy
The chart below from Valley National Financial Advisors and Y Charts shows U.S. Investor Sentiment (% Bull-Bear Spread), which measures investors’ overall feelings about the markets. October 14 hit a multi-year low, which some market prognosticators believe is a point that markets are oversold. This is the point which equities become reasonably priced and often signal a ‘BUY.’  

The goal across Washington is to avoid a recession at all costs. The Fed is at the forefront of this and continues to gauge the pace/amount of rate hikes according to the economic and financial data released prior to FOMC (Federal Open Markets Committee) meetings. Bond yields and broader markets are driven by the Fed’s narrative and actions that follow, so the Fed may not want to push too hard on markets that are recovering after a tough September. 

While bond markets continue to post negative returns for the year, the outlook (1-3 years) remains favorable once bond yields peak. (See the Chart below from Edward Jones and FactSet.) This makes clear sense to us when the FED’s path to interest rates and the economy is considered. 

Policy and Politics 

Political uncertainty continues to affect the United Kingdom as Prime Minister Liz Truss resigned after only 44 days in office. Her replacement is to be determined, with former Prime Minister Boris Johnson taking himself out of the race and former Chancellor of the Exchequer, Rishi Sunak, currently in the lead. 

China is on the global radar as anticipated economic data was released last week that showed signs of a mixed economy. While GDP grew in September, retail sales slumped, and the housing market is failing to recover. President Xi was reelected for an unprecedented third term, tightening his grip on China and reinforcing his potential plans for reunification with Taiwan.  

What to Watch 

  • U.S. Initial Claims for Unemployment Insurance; released 10/27 (Prior 214k) 
  • U.S. Real 3rd Quarter Gross Domestic Product Quarter over Quarter; released 10/27 (Prior –0.60%) 
  • U.S. Core Personal Consumption Expenditures Price Index Year over Year; released 10/28, (Prior 6.25%)  

There is a lot going on globally with China, Ukraine/Russia, the United Kingdom all adding uncertainty to the markets, and we hate uncertainty. However, here in the United States we have our own issues with inflation and the FED understands this and is aggressively raising interest rates to slow the economy down and thereby halt inflation pressures. This will take time as a lot of stimulus has to be let out of the economy and consumers’ pockets but the path to lower inflation has been set. Last week, we saw the FED start to whisper that the end is near for rate hikes. It may not be in 2022, but 2023 should be a pivotal year in all aspects. Investors should remain focused on the long-term economic viability of the U.S. Economy, and it remains favorable.

Current Market Observations

Last week we saw major markets diverge for the first time this year. The Dow Jones Industrial Average notched out a +1.15% return while the S&P 500 Index (-1.55%) and the NASDAQ (-3.11%) each posted negative returns. This divergence of returns is emblematic of the market and economy themselves with economists calling a pending recession while real data – jobs, bank balance sheets, Earnings Per Share (EPS) releases and consumer health – remains healthy if not growing in strength. 

Global Economy 
U.S. economists are beginning to increasingly predict a recession within the next 12 months. On average, economists put the probability of a coming recession at 63%, up from 49% in July. This is the first time since July 2020 that the survey has yielded a result above 50%. Additionally, the survey suggests that GDP (Gross Domestic Product) will contract at

-0.2% on an annual basis during Q1 2023 and -0.1% in Q2 2023. These predictions come as doubts heighten over the Fed’s ability to tame inflation without inducing increased unemployment. Two-thirds of those surveyed believe the Federal Reserve will pivot in either Q4 2023 or Q1 2024.  

European Union leaders are meeting on October 20 and 21 to discuss potential implementation options for a cap on gas prices. After Russia’s invasion of Ukraine, the Kremlin vastly reduced gas exports to Europe as retaliation for the economic sanctions the country received. Energy in the EU is becoming prohibitively expensive, raising concerns for a rough winter over the next few months. The annual inflation rate for energy is currently standing at 37.5%, with electricity at 35.7%, gas at 62.5%, and liquid fuels at 78.9%. 

What to Watch 

Monday, October 17th  

  • 4:30PM: US Retail Gas Price (Prior: $4.034/gal.) 

Wednesday, October 19th  

  • 8:30AM: US Housing Starts (Prior: 1.575M) 
  • 8:30AM: US Housing Starts MoM (Prior: 12.18%) 
  • 10:00AM: US Job Openings, Total Nonfarm (Prior: 10.05M) 

Thursday, October 20th 

  • 10:00AM: 30-Year Mortgage Rate (Prior: 6.92%) 
  • 10:00AM: US Existing Home Sales (Prior: 4.80M) 
  • 10:00AM: US Existing Home Sales MoM (Prior: -0.41%) 

While calls for a recession mount mostly on economist’s note pads and TV prognosticator’s teleprompters, the underlying fundamentals of the U.S. economy remain solid as we stated above. If we get a recession, the economy starts with a real safety net that did not exist in the 2008-09 recession, thereby guaranteeing said recession is neither deep nor lengthy. Opportunities mount in fixed income (now offering yields north of 4.00%) and equities (now trading ~19x forward EPS & yields ~2.00% on the S&P 500 Index) offering investors good entry points for continued long-term wealth creation.