The main themes in US markets this year have been inflation and geopolitical tensions caused by Russia’s invasion of Ukraine. Ever since the Federal Reserve’s confab in Jackson Hole in August, investors have been realizing that the Fed means business when it announced its decision to return inflation to its 2% target. (Inflation is currently around 8 percent.) In September, the Fed raised interest rates by 75 more hawkish remarks, leaving investors wondering how much pressure the Fed is willing to put on the economy to reverse inflation. Once we get an answer to this question, the tone in the markets may improve from today’s pessimism. The silver lining for patient investors is that both stocks and bonds can perform well if inflation peaks and is on a plausible downward trajectory. We’re not there yet. In addition, the situation in Ukraine seems to be getting more serious by the day, following Russia’s illegal annexation of four Ukrainian territories and Putin threatening to use whatever means necessary to protect this new “Russian” territory. While cheering Ukraine’s achievements on the ground, Putin seems to have no clear fault for facing the public after this disastrous fiasco.
Additional work can cause pain
The Fed has a lot of work to do, and to paraphrase Chairman Powell, there is no way to bring inflation down without causing pain. Currently, consumer spending is relatively strong and the unemployment rate is at a low of 3.7%, while wages are rising. Some negative economic news that the Fed is trying to force has begun to emerge in recent weeks. The residential real estate market is stagnating. The latest Job Openings and Labor Turnover (JOLTS) data showed that the number of workers fell by one million in August, nearly 10 percent of the total number of jobs gained and the largest decline since the pandemic began. On the corporate side, big earnings misses from FedEx, CarMax and Nike are showing that the Fed’s tough medicine is starting to have the desired effect.
So when should investors expect the markets to improve? We think we need to see two things for both stocks and bonds to find their footing.
First we should see some peak in inflation. Unfortunately, despite signs of a weakening economy and falling commodity prices, core inflation has yet to change. Data released on Friday showed that the Personal Consumption Expenditure (PCE) price index (excluding food and energy) rose 0.6% last month, which was slightly more than expected, the Fed said recently.
Second, we should see investors readjust their expectations for next year’s corporate earnings. Last Thursday, Micron Technology (ticker MU), a Boise-based DRAM (Dynamic Random Access Memory) manufacturing and bellwether company in the semiconductor industry, reported fiscal fourth quarter results. Quarterly numbers were mixed, but the company issued a better-than-expected outlook for next year. Despite the bleak forecast, MU stock rose a fraction that day — a day in which the Dow gained 500 points. It continues to climb this week. Such price action indicates that investors are starting to price in the slower growth expected in the global economy in 2023. We should see similar incidents with many companies. Only when investors truly expect 2023 to be a challenging year overall can we see lower prices for stocks.
Please contact us if there is anything you would like to discuss about your investments or the markets. You can call us at 619-319-0520, email Peter Toms or Schedule a call with us.
