- December is historically a pretty good month for equities but coming off a significant rally in October and November, December couldn’t maintain the momentum with the S&P 500 down 5.8%. Bringing the 2022 S&P 500’s -18.11% return to its worst yearly performance since 2008. Add this to the NASDAQ being down nearly 33% and the bond market having one of its worst years ever, and you get a (terrible) year for the record books with almost no place to hide.
- The Fed raised rates by a highly expected 50 basis points bringing the Fed Funds Rate to 4.25% to 4.50%. However, the release of the Summary of Economic Projections showed that Fed officials raised their terminal rate projections up to an average of 5.25% with many showing an even higher rate. Even more importantly it showed that they expect that they will need to keep them higher for longer, with the median funds rate for 2024 and 2025 rising to 4.1% and 3.1% respectively. They are projecting the unemployment rate to rise to 4.6% next year, versus their previous 4.4% forecast. The markets still seem to be pricing in the Fed cutting rates in the second half of 2023 despite the Fed continuously suggesting otherwise.
- With the Fed raising rates 4.25% in 2022, economic data continues to slow with most economists and analysts predicting a recession in 2023. If they are correct this would be one of the most telegraphed recessions in history and with the stock market being a forward looking/leading indicator, the question becomes how much of this is already priced in.
- The U.S. labor market remains as one of the last bright spots that may be able to stave off a recession. However, there are signs that it is beginning to weaken. Payrolls rose by 263k. This was higher than the 200k expected but still the smallest gain in 2 ½ yrs. Average hourly earnings rose 0.6% above expectations for a 0.3% gain. The unemployment rate was unchanged at 3.7%.
- Inflation continued to cool in November dropping to 7.1% vs 7.4% expected.
- November retail sales fell 0.6% vs 0.2% decline expected.
Why It Could Keep Going Higher
- The primary driver of U.S. economic growth is the U.S consumer and Americans still have excess savings they are able to spend.
- Employment is still strong and that has always begun to slip before a recession.
- Several fear indexes such as the University of Michigan Consumer Sentiment Index and American Association of Individual Investors survey, have shown extreme bearishness which is usually a pretty good contrarian and bullish indicator for the markets.
- The S&P 500 has already priced in a severe economic decline and has fallen to a much more attractive valuation, significantly improving the future return potential.
- Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes, let alone future rate hikes.
- Most foreign central banks are tightening policy at the same time, which may further amplify a global contraction. While a strong US dollar certainly does not help the situation overseas.
- Employers are forced to lay off part of their labor force to maintain margins in a slowing economy.
- Further Geopolitical tensions.
- The Unknown.
- CPI was up 7.7% in October.
- PPI was up 8% in October.
- 261k jobs were added in October. While still a strong number, it’s the smallest monthly gain since December 2021. The unemployment rate edged up to 3.7% from 3.5%. September’s reading was revised to 315k jobs added versus the 263k previously reported.
- Retail sales rose 1.3% in October beating expectations of 1%.
- ISM Manufacturing PMI slipped for the sixth straight month to 49, marking the first time it fell into contraction territory (below 50) since May 2020.
- S&P 500 companies with less than 25% of sales outside of the U.S. have had 5.1% earnings growth, while those with over 50% have seen earnings decline 7.5%.
- Q4 earnings are now projected to drop .39% year over year, down from +6% in August.
- Bank of England raised rates 75 basis points.
- U.K. inflation rose 11.1% year over year.
What We Are Doing
We have continued to maintain a well-diversified allocation. Our tilts towards defensive sectors such as healthcare, consumer staples, as well as low-duration fixed income have helped us limit some of the damage and outperform our benchmarks. We believe that the rally in October and November may be overdone and reduced risk slightly in November. For the time being we believe it is best to maintain our diversified yet slightly more protective tilts as we continue to monitor the markets closely.