Have interest rates peaked?
The Fed raised rates as expected last week, and the broad consensus among investors and in the markets is that it was the last rate hike for this cycle. (The Fed itself didn’t commit to an end to rate hikes, but it did signal that pausing here is a very real possibility.)
While last week’s hike was broadly expected by markets—just as an end to the hikes at this point is broadly expected—what comes next is more of an open question. According to expectations priced into markets (which, granted, in fact are often wrong), the Fed will start a campaign of cutting rates, as shown below in the blue line. Given how high inflation still is, and how resilient the economy still seems to be, I think that may be wishful thinking.
Why does the market expect the Fed to imminently drop rates back to 3% or below? Perhaps it’s flawed modeling by bond traders. Or perhaps they are just using the average of all cycles. Historically, the Fed more often than not starts easing soon after its final rate hike. In fact, the forward interest-rate curve above looks almost identical to the average easing cycle that typically follows the peak of a rate-hike cycle.
How important is this disconnect? It may depend on where the economy, and inflation, go from here. If inflation continues to improve and the economy stays resilient, rates that are higher for longer could prove benign for markets. On the other hand, if inflation becomes stubborn and the economy weakens, then that disconnect could become significant.
Have rates gone high enough?In very simple terms, the Fed’s new 5% to 5.25% target range for the fed funds rate is the highest it’s been since 2007. But with inflation still elevated, are rates restrictive enough?
Based on my own calculations of what would be a “neutral” fed funds rate (meaning one that is neither restrictive nor accommodative), the Fed is moderately restrictive—with the current fed funds rate about 1 percentage point above neutral.
Another way of looking at it is by comparing the policy rate to the inflation rate. The Fed’s current target rate is now also above the 4.6% annual rate of change in the core Personal Consumption Expenditures Price Index (which measures price inflation felt by consumers, excluding food and energy, which tend to be more volatile). So by that definition the Fed is also moderately restrictive.
But based on the chart below, since the 1970s the Fed has generally raised rates to above the peak in headline inflation. So depending on which exact inflation measure one uses, by that standard the Fed may still be accommodative.
Some signs of a soft landingFirst-quarter earnings season is now heading toward the finish line, and the results have been strong. Out of the 425 companies that had reported by last week, 78% have beaten estimates—beating them by an average of 6.72 percentage points. It’s hard to see this earnings season as a glass half-empty.
The strength in earnings is supported by the fact that revenues continue to march to new highs (at least in nominal, or non-inflation-adjusted, terms).
And with revenues trending higher and earnings growth starting to flatten out, by definition it also means that profit margins are stabilizing.
Yet the market isn’t acting like a bull marketConsensus earnings estimates are suggesting that the US is headed for a soft landing. And this earnings season showed some encouraging signs.
But not all signs are pointing in the same direction. While the S&P® 500 is up more than 8% so far this year (and around double that since the market’s October low), there is uneven participation beneath the surface.
Early-cycle bull markets tend to be driven by segments and styles that are more economically sensitive and more volatile. Small- and microcap indexes are usually in or close to the lead in an early bull market—posting strong performance and usually beating larger-cap indexes like the S&P 500. But not this time.
Relative performance of Russell Microcap index to S&P 500 is taken by dividing the level of the Russell Microcap index by the level of the S&P 500 index. Source: FMRCo., Bloomberg, Haver.
The weakness in small caps and microcaps is not consistent with the idea that an early-cycle bull market is sprouting, and continues to cast at least some doubt on where we go from here.
That—along with expectations for the Fed—is among the key inconsistencies facing this moment in the markets, and why this still doesn’t look like the start of a new bull market.
Source: Fidelity Viewpoints. Timmer, Jurrien. 11 May 2023. https://www.fidelity.com/learning-center/trading-investing/interest-rates-peaked?ccsource=email_weekly_0511_1037578_43_0_CV1
April's Market Outlook 2023
The main factors that affected the market selloffs (a situation in which many investors sell their shares of a stock suddenly, often because of bad news) of equities and bonds during 2022 are still relevant today in 2023. These include high inflation, tightening monetary policy and higher interest rates, slowing U.S. and global economic growth, and geopolitical turmoil. However, it is how these factors evolve that will be critical to the 2023 outlook.
Top Things To Watch in 2023
Fidelity expects inflation rates to decline in 2023 but remain higher than what the market expects. Two key indicators to keep track of to determine when inflation may slow in 2023 are the housing and labor markets. Inflation peaked at above 9% in 2022 -the highest in four decades- the good news is inflation has decelerated to about 7% year-over-year in the second half of 2022 and is expected to be headed toward a further significant slowing in 2023. This has caused supply-chain disruptions to improve, energy prices to drop off their recent highs, and prices for most goods to come down late in 2022. The bad news is that financial markets have priced in a return to low and stable inflation quickly and painlessly, which many analysts and economists believe is not the case. The key to 2023’s outlook is the degree to which disinflation occurs in services industries, which often sees sticky inflation. A weakening housing market could help slow rental inflation rates in 2023. Labor markets will be a main focus for disinflation as well, where employee costs typically have had a heavy influence on the price of services. There have been signs of softening demand for labor, but aging demographics and other structural issues may continue to restrain labor supply and keep wage growth above levels compatible with 2% core inflation. The potential for stickier wages to continue supporting elevated labor costs means inflation could be more persistent than commonly believed. There would need to be a much larger weakness in the labor market and a significant increase in unemployment for the market’s low inflation forecasts to be correct.
Inflation trends are now headed in the right direction and the Fed may be in the final innings of its tightening cycle. Current market pricing indicates a belief that the Fed could stop hiking at around 5% by mid-2023 and possibly begin easing policy by the second half of the year. However, analysts at Fidelity do not expect inflation to come down as quickly as the market expects. They also believe that the fed will be willing to tolerate some economic pain through higher unemployment to make sure core inflation continues downward toward its 2% target.
U.S. Business Cycle
Leading indicators suggest that recession risks could continue to rise in the coming months. Credit conditions have deteriorated as lending standards at banks have tightened, the treasury bond yield curve remains inverted, inventories have risen as sales decreased, while new orders for manufacturing goods have also declined. Company profit margins have fallen, which is typical of the final months of the late-cycle phase. According to consensus estimates, the market expects positive earnings growth of about 3% in 2023. It’s possible that earning growth will hold up better than the 18% average decline during typical recessions, but Fidelity analysts think there is downside risk relative to market expectations.
Economists are also following employment markets and consumer spending in 2023 Consumers’ willingness to spend may be threatened by savings rates that have dropped to near all time lows, the apparent exhaustion of excess savings for low and some middle-income cohorts and falling asset prices. On the upside, labor markets appear structurally tighter and more supportive of medium-term wage growth. Additionally, household balance sheets remain in good shape, the increase of fixed-rate mortgage debt implies a lack of financial stress, and falling inflation may boost real (inflation-adjusted) income growth.
By the end of 2022, long term 10-year Treasury yields dropped well below the shorter term 3-month Treasury bills. This steep inversion of the current US Treasury bonds yield curve –with long term rates higher than short term rates– is historically a leading economic recession indicator and a sign that the financial markets believe that at some point in the future the Fed will have to start cutting rates in reaction to economic weakness. Economists are keeping track of business cycle indicators previously mentioned to monitor whether a U.S. recession becomes the dominant story of 2023.
Overall, Fidelity analysts believe that both inflation and policy rates could remain higher than current consensus investor expectations. The Fed’s latest inflation and interest-rate projections tend to agree, markets are overly optimistic at the moment. Uncertainty around these trends is likely to persist well into 2023, implying high odds of continued market volatility and heightened need for portfolio diversification.
However, this greater market volatility could provide even greater opportunities to purchase assets at discounted prices. Over the past 11 recessions since 1950, a diversified portfolio of stocks and bonds has returned an average of 6% and 11% over the one- and two-year periods after the start of a recession. Valuations are perhaps the most important indicator of expected returns over the medium and long term, and 2023 is a more attractive starting point for valuations than at any time in the past decade.
Excessive Fear of Loss?
Consider these strategies to help counter fear of loss so you have the potential to grow your money. Fear of loss is a powerful motivator. But fear, like greed, is a dangerous sentiment for investors. Excessive fear of loss—which behavioral economists call loss aversion—causes many investors to act counterproductively. Fortunately, you don't have to treat growth and protection as mutually exclusive. Certain strategies can help you benefit from market gains, while protecting you on the downside.
No one has ever successfully and consistently predicted stock market returns. The strategy of jumping in and out of the market is known as market timing; investors who try to time the market typically sell after their investments have lost money, and buy only after stocks have recovered—selling low and buying high. Avoiding stocks altogether has major drawbacks too. Stocks provide the potential growth nearly every long-term investor needs to stay ahead of inflation. Cautious investors with long-term saving goals—those who will not need to access a portion of their assets for 5 to 10 years—may benefit from strategies that allow them to protect principal while exposing some of their assets to the stock market's growth potential. If you fit that description, consider the following strategies: the anchor strategy or the protected accumulation strategy.
1) Anchor strategy
An anchor strategy involves dividing your portfolio into 2 parts: a conservative anchor and more growth-oriented investments. The anchor portion of your portfolio uses investments that offer a fixed return, such as certificates of deposit (CDs) or single-premium deferred annuities (SPDAs). These assets have a set lifespan, and the amount you invest is designed to grow back with interest to your original principal. This portion of your portfolio acts as your anchor, while your remaining assets are invested in more volatile, growth-oriented securities such as stock mutual funds or ETFs. The anchor strategy can remove the negative outcomes cautious investors sometimes fear because even if the markets fall, your anchor makes sure you at least have what you started out with.
*Tip: Remember, inflation can erode the purchasing power of your original investment over time and this strategy generates taxes each year in a taxable account.
2) Protected accumulation strategy
Here's how it works: the protected accumulation strategy takes advantage of principal protection features on variable annuities. A guaranteed minimum accumulation benefit (GMAB) rider on an annuity is the most basic of these. Your assets are invested in a portfolio that typically has a larger equity position than the roughly 15% stake outlined in the anchor strategy above. For a fee, the GMAB rider guarantees that at the end of the annuity's investment period—typically 10 years—you'll have at least the same asset value you started with. Another potential benefit is that most GMAB riders let you reset the level of principal protection each year if your investments have grown in value. If you do lock in a higher balance, the investment period resets and your balance is guaranteed for another 10 years. It is possible that your fee may increase if you elect this option and annuity features will vary by the issuing company.
Which loss aversion strategy is right for you? Determining which, if either, strategy may make sense for you will depend on a number of factors, including your investing goal, interest rate environment, fees on your investments, your time horizon, and your tolerance for risk. First consider if you might be better off investing in a diversified portfolio, because either of these strategies (anchor or protected accumulation) may limit your upside growth potential—and the diversified portfolio may offer a greater long-term benefit. You also need to consider when you will need access to these assets, because both strategies might penalize early withdrawals.
Consider working with your financial professional to sort how to protect your principal while keeping a watchful eye on your overall goals, diversification of your portfolio, and exposure to taxes. Questions? Contact us at Brien@TraditionsWealthAdvisors.com
Source: Fidelity Viewpoints. 22 March 2023. https://www.fidelity.com/viewpoints/retirement/fighting-loss-aversion?ccsource=email_weekly_0330_1037579_36_0_CV2
March Market Outlook
The Fed’s Most Recent Rate Hike and Potential Future Rate Hikes
The Federal Reserve raised interest rates again by 0.25% for a Federal funds rate of 5.00%, the highest since 2006 right before the great financial crisis. A main paragraph from Powell’s press conference speech succinctly summarizes the Fed’s current outlook, “Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes. It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond. As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation; instead, we now anticipate that some additional policy firming may be appropriate. We will closely monitor incoming data and carefully assess the actual and expected effects of tighter credit conditions on economic activity, the labor market, and inflation, and our policy decisions will reflect that assessment.”
Jerome Powell’s statement is pretty straightforward, given recent major bank closures the Fed is likely to hike rates less than previously stated due to the economic results of the failed banks. Exactly how much less they are going to raise rates is difficult to pin down. It will depend on the depth and duration of the financial stress and the resulting sustained impact on financial conditions. Lastly, the upcoming Fed policy will be even more data dependent for both macroeconomic data and measures of financial conditions.
Mike Gapen and his analyst team at Bank of America have adjusted their Fed call. They are now predicting one more 0.25% hike in May and no longer a rate hike in June, however, they still don’t see the Fed beginning to cut rates until March 2024. This change to their call is due to the “tighter credit conditions” that Fed Chair Powell stated in his speech. Overall, they are expecting a Federal Funds rate of 5.25% to be reached in May. However, if stronger macroeconomic data comes in after May the Fed may be inclined to raise interest rates higher.
Bank of America Analysts also predict jobless claims to decrease to 190,000 from the previous 192,000. This underscores the tightness of the labor market and how much work the Fed still has to do to cool labor demand. They’re also expecting new home sales to cool to 650,000 at a seasonally adjusted annual rate for February, from 670,000 previously. Median prices of new homes have hit lows of $428,000 as of January, which was down for the first time on a year-over-year basis, at -0.7%. Nevertheless, the housing market remains tight as mortgage rates are still in high territory and months of supply have fallen steadily since September. New home sales should rebalance over time as supply adjusts to demand and mortgage rates cool down further.
Do you want more details about these tips? Click here to read the full article. Questions? Call or e-mail 979-694-9100, Brien@TraditionsWealthAdvisors.com or Sarah@TraditionsWealthAdvisors.com
February Market Update
Recent price data on Consumer Price Index and the Producer Price Index from the U.S. Labor Department came in hot for January, increasing worries for investors that the Federal Reserve may have to keep interest rates elevated for a prolonged period of time.
Consumer Price Index (CPI)
Recent Consumer Price Index data showed that prices for energy, housing, food, and other items increased for the month of January. Compared to January 2022, the CPI inflation measure climbed 6.4%, edging down slightly from 6.5% in December. The good news is that the consumer price index has had 7 consecutive months of easing inflation since peaking at 9.1% in June, which was the highest reading since 1981. The bad news is that this cooling trend is moderating and strong inflation reports are likely to keep Federal Reserve officials on track to raise interest rates in March, with further potential increases after that.
Fed officials in recent public appearances have forewarned of a longer fight than anticipated by many investors, who recently have anticipated faster declines in inflation. Jerome Powell recently stated that the process of reaching the Fed’s goal of 2% inflation “is likely to take quite a bit of time. It’s going to be, we don’t think, smooth. It’s probably going to be bumpy.”
Core CPI rose 5.6% from a year earlier, down from 5.7% in December. Core CPI, which is similar to CPI is an aggregate of prices paid by consumers for a typical basket of goods, excluding typically more volatile food and energy costs.
Underlying data in the CPI report showed that shelter prices have risen by 7.9% from a year earlier, the most since 1982, reflecting the lagged effects of booming demand for houses and apartments and remote working earlier in the pandemic. However, shelter prices are expected to ease later in the year. Grocery prices rose 11.3% in January from a year earlier. While grocery inflation has moderated from highs this past summer, some particular items like eggs and carbonated beverages remain considerably expensive. Prescription drug prices increased by 2.1% for the month while clothing and household furnishings were also more expensive.
Producer Price Index (PPI)
The recent Producer Price Index report, which measures the average change in selling prices received my domestic producers of goods and services, showed that US supplier prices rose 6% in January from a year earlier, a sign of still stubborn inflation pressures in the economy. The January report of 6% is still down from 6.5% in December and the all-time high of 11.7% in March, the most recent peak. PPI increased 0.7% in January from the prior month, compared with a revised 0.2% drop in December, which is significantly faster than the 0.2% average monthly rise in the year before the pandemic.
The recent PPI report just provides further evidence to the Fed to hold interest rates higher and potentially even raise rate at the next FOMC meeting. Dallas Federal Reserve President Lorie Logan stated, “We must remain prepared to continue rate increases for a longer period than previously anticipated if such a path is necessary to respond to changes in the economic outlook or offset any undesired easing in conditions.”
Despite the recent inflation data, the broader economy has shown signs of resilience. The unemployment rate last month fell to 3.4%, the lowest level since 1969, and retail sales jumped 3% in January as consumers broadly boosted spending on vehicles, furniture, clothing, and dining out. However, Jerome Powell and the Federal Reserve have maintained their viewpoint that taming inflation is their #1 priority, and they will keep interest rates elevated until there is clear evidence that inflation is coming down. The recent CPI and PPI reports have provided additional evidence that the Fed still has a ways to go on bringing inflation down.
Tax Pitfalls to Avoid
Most people are worried about making mistakes on their taxes that will get them in trouble with the IRS. In reality, most mistakes are simple human errors or missed opportunities that would reduced taxes owed. Last year, 9.4 million 'math-error' notices were sent out. Other mistakes involved forgetting to report invested income, getting bank or social security numbers incorrect, or forgetting to sign your return. In all of these circumstances, a little extra time or paying a tax professional can help save you money and give you peace of mind. Below are 8 common tax pitfalls to avoid:
1. Missing investment income
2. Selling too soon
3. Poor record keeping
4. Forgetting losses
5. Waiting too long to strategize
6. Engaging in wash sales
7. Not taking advantage of tax breaks
8. Forgetting deadlines
Tax Mistakes do happen, but the more you understand your situation and tax rules, the less impact they can have on your wallet. Don't forget, this year's tax deadline is April 18, 2023. If you want more details on tax pitfalls, click on the article here or contact us at Brien@TraditionsWealthAdvisors.com or
Economic Update: Jan 2023
Looking into the new year we have researched economic trends and the possible impact of an upcoming recession. Overall, for 2023 we expect GDP growth to be slim, inflation decelerating, and a shallow recession.
Economic Growth Rates
In the U.S., after two consecutive quarters of negative gross domestic product (GDP) growth followed by a third quarter of modest economic growth, overall growth for all of 2022 is expected to be positive over the course of the full year — the consensus estimate among analysts is 1.5% – 2.0%.
Growth expectations for 2023 are less sanguine. According to the Wall Street Journal Economic Forecasting Survey, there is a rising consensus opinion that the U.S. will fall into recession within the next 12 months. This translates to a consensus estimate for 2023 GDP growth of only 0.4%
Small business owners and consumers represent the bulk of economic activity in the U.S., and we see a distinct downward trend in both groups, driven by fears over inflation, rising interest rates and a potential recession in 2023. These trends may prove to be dominating factors in overall economic activity as consumers, business owners and investors take a “seek shelter” approach in their behavior.
Despite lower GDP growth the U.S. employment situation remains strong. The “headline” U-3 employment rate suggests that we remain in a tight labor market, and even the less-followed “U-6” partial employment level (workers who are involuntarily working at less than full employment) suggests the continuation of a positive employment market. In addition, weekly jobless claims (one of the leading economic indicators) remain at historically low levels.
An interesting occurrence during the Covid-19 pandemic was that there was a higher-than-expected increase in retirements, known as “The Great Retirement Boom”. This number remains elevated and has not yet come down as much as expected, this makes the labor force participation rate look much higher, since retired people are not actively looking for a job, they are not included in the labor force participation rate. The real question is if these retired people have enough savings to remain retired or if they will have to return to the workforce, which would decrease the labor force participation rate. “The Great Retirement Boom” offers a different perspective on how “strong” the current labor market really is.
A main concern of the Fed continues to be the inflation rate, and Fed Chairman Jerome Powell has made clear that his current goal is to bring down inflation rates. Luckily many analysts are estimating that inflation in the U.S. has more than likely reached its zenith and is poised to continue to decelerate in 2023. According to Consumer Price Index (CPI) data, commodities less food and energy commodities have seen its annualized rate of increase plummet over the last nine months, falling from +12.3% to +3.7% in November.
Federal Funds rate hikes in 2022 have resulted in the Fed Funds target range going from a zero-interest rate policy (ZIRP) as recently as March to 4.50% in December, a total of 425 basis points in rate hikes. The graph below highlights how the current aggressive tightening cycle has compared to the previous two more methodical rate hike episodes. It is still unclear if the Federal Reserve will go into “raise and hold” mode in 2023 or entertains rate cuts during the second half of next year. The next Fed decision on interest rates is February 1st, and the interest-rate move is currently expected to be smaller than past hikes at 0.25 percentage-points. There is still significant economic data to come in ahead of the Fed’s decision and this could change the Feds view.
Equity Markets: Corporate Earnings and Macro Outlook
A primary concern with regard to the S&P 500’s earnings outlook for 2023 is that banks are indicating a buttoning up of their lending standards, an occurrence that sometimes indicates corporate profit trouble. The fourth quarter marked the fifth in a row in which banks’ total loan books witnessed a tightening in the Fed’s Senior Loan Officers Survey, to a net 31.33%. That reading matches levels seen in 2001, 2007, and 2020, each of which witnessed a fall in S&P 500 earnings thereafter.
The global sovereign debt markets have arguably experienced their worst year on record. However, an interesting development has occurred in the process; the era of negative rates has seemingly drawn to a close. With the exception of Japan, government bond markets in the developed world have now seen yield levels move into positive territory for the key 2-, 5-, and 10-year maturity sectors.
This development has created an interesting phenomenon: there’s “income back in fixed income.” The recent rise in U.S. Treasury rates has brought yields to levels not seen since 2007-2008. The natural question becomes: is there more to come? In other words, can U.S. Treasury yields continue rising from here? In context of future Fed policy, if the expectation for a 5% Fed Funds terminal rate does not come to fruition, Treasury Yields will more than likely continue to rise, especially along the front end of the curve, as yields need to adjust to this potential higher Fed Funds Rate. Analysts are estimating that the Fed will continue to raise rates in the first half of 2023, around the end of the second quarter. We expect the Fed to pause, which could lead to a modest rally in rates along with a steeper curve. Rate volatility will remain elevated; however, we believe we will not experience the rise that we witnessed this year.
Real Assets And Alternatives
Global supply shortages driven by the Russian invasion of Ukraine, combined with relative restrictive U.S. domestic energy policies, would normally provide a solid macroeconomic backdrop of support for global commodity prices. But a global economic slowdown, particularly in China, provides an offsetting counterbalance. Copper is often viewed as a leading indicator of expected future economic growth-in which case, we are in for a week global economy in 2023.
Potential Government Shutdown
Another current event with potential economic implications is a potential government shutdown due to the inability to raise the government debt ceiling. If Democrats and Republicans cannot agree on a number than we may have another government shutdown. This has happened three times in the past 10 years, a 16-day shutdown in October 2013 over healthcare, a 3-day shutdown in January 2018 over immigration, and a 35-day shutdown between December 2018 and January 2019. According to the Congressional Budget Office, the 2018–2019 shutdown reduced economic activity by about $11 billion while it was underway, but much of that lost growth was recovered when government activity resumed. Overall, the shutdown cost the economy about $3 billion, equal to 0.02 of GDP, CBO found.
Treasury Secretary Janet Yellen said on Jan. 19 that the United States has reached its current $31.4 trillion borrowing cap but can continue paying its bills until June by shuffling money between various accounts. At that point, when the so-called extraordinary measures are exhausted, the Treasury would not have enough money coming in from tax receipts to cover bond payments, workers’ salaries, Social Security checks and other bills.
It would be catastrophic if the U.S. government was unable to pay its bills. A missed debt payment would likely send shockwaves through the global financial markets, as investors would lose confidence in Treasury’s ability to pay its bonds, which are seen as among the safest investments and serve as building blocks for the world’s financial system. The U.S. economy could face a severe contraction if the 69 million people enrolled in social security don’t get their monthly retirement and disability benefits, or hospitals and doctors don’t get paid for treating patients through government programs like Medicare.
In conclusion, we expect the Fed to pause rate hikes sometime in the second half of 2023, possibly in to 2024, when there are sure signs that inflation is coming down. Until then, we should encounter a shallower and shorter recession than previously seen in previous recessions due to labor and workforce statistics as well as strong corporate balance sheets. It would be best for the global economy if the Russia–Ukraine war concluded, and the U.S. could agree to raise the debt ceiling.
By James Lane/ Brien L. Smith, CFP®
II. Source: Wisdom Tree Investments and Dr. Jeremy Siegel, Professor of Economics Wharton School of Business, University of Pennsylvania
Market Update: Dec 2022
2022 was an interesting year to say the least. We saw rampant inflation from increased COVID spending and a decade of low interest rates finally come full circle, hurting the markets this past year. It appears that the Federal Reserve’s policy is starting to help the economy, but many analysts and economists believe that the worst is yet to come. Luckily, the upcoming recession is expected to be much shallower and “easier” than previous recessions. Federal Reserve Chairman Jerome Powell has been very transparent with the public on his goal of taming inflation, and analysts expect him to continue his course of action through interest rate hikes to achieve this goal.
I know that 2022 was a challenging year for the financial markets in general. We saw a large decline in the value of stocks, bonds, and most other assets. Pair this with high inflation, supply chain issues, and other socioeconomic issues with Russia and Ukraine and it is easy to see why this year has been particularly stressful for Americans. Based on a macroeconomic perspective our economy is currently in the late cycle of the Business /economic cycle. This is the period before a recession where GDP growth moderates, credit tightens, the government uses contractionary policy to slow growth, and business inventories grow while sales growth falls.
Other signs of a looming recession are seen in The Chicago PMI (a measure of manufacturing activity) which has only been this low in the past recession (last in 2009, before that in 2008-2009).
The inverted yield curve in the bond market has also signaled a recession as the yield curve continues to fall deeper into territory, with the 3-Month Treasury bill yield now 0.83% higher than the 10-year Treasury bond. In the last 60 years, the only periods with equal or greater inversion include 2000 (recession in 2001), 1979-1982 (recessions in 1980,1981-1982), 1974 (recession in 1973-1975).
It is hard to forecast exactly when Jerome Powell will ease monetary policy and lower interest rate hikes because it takes time for interest-rate changes to slow the economy and even longer to influence inflation. Jerome Powell stated himself, “if you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to over-tighten. We think that slowing down at this point is a good way to balance the risks.” Policymakers expect price pressures to ease meaningfully next year, but brisk wage growth or higher inflation in labor-intensive service sectors of the economy could lead more of them to support raising their benchmark rate next year above the 5% currently anticipated by investors. A 50-basis point rise this month would bring the benchmark federal-funds rate to a range between 4.25%-4.5%, the highest level since December 2007. Most officials in September penciled in rates rising to between 4.5% and 5% next year. That landing zone could rise to between 4.75% and 5.25% in new projections. According to New York Fed President John Williams this is due to “Stronger demand for labor, stronger demand in the economy than I previously thought, and then somewhat higher underlying inflation suggest a modestly higher path for policy relative to inflation. Not a massive change, but somewhat higher.” As of now, Jerome Powell has stated that we will see a rate hike of 50 basis points at the next FOMC meeting in December. This is a good sign as rate hikes have been 75 basis points for every meeting since June.
Expectations For 2023:
Looking forward into 2023, we expect the Fed to continue with its interest rate hikes in February. If inflation slows but the labor market stays tight, they could be more divided over how to proceed. As of now the, Fed has stated that it is lowering interest rate hikes from 75 basis points to 50 basis points on the evidence that its monetary policy is starting to work. Inflation come down moderately so far.
We’ve seen most asset prices drop, as interest rates and the dollar moved sharply upward. Looking to the future, most analysts and economists agree that the markets will continue to be affected by slower liquidity growth, persistent inflation risk, slowing growth momentum, and greater monetary policy uncertainty which will cause continued elevated volatility. Researchers from Bank of America / Merrill Lynch have a year-end target for the S&P 500 at around 4000, as of 12/6/2022 it is trading around 3960. However, the market typically bottoms out 6 months before the end of a recession so there is likely more room for stocks to fall. Luckily, this recession is expected to be shallower due to companies and consumers strong balance sheets so it shouldn’t be comparable to harsher previous recessions such as the great financial crisis and the recession of the 1970s. It is important to remember that Bull markets last much longer and produce much higher returns than bear market length and losses. Therefore, keeping your money invested for the long term is the most efficient form of investing compared to trying to time the market.