October 11, 2022,
The stock market is an anticipatory vehicle. In other words, stock prices move in reaction to investors’ expectations and therefore are considered a leading indicator of economic activity. Recently those of us who watch the markets closely are suffering from acute whiplash as stocks optimistically jump up 2-3% in a day, only to plunge back down the next. The obvious conclusion is that investors do not know what is coming next. When we encounter this level of uncertainty, it is helpful to look at the key segments of the economy individually and consider how our current and prospective investments react to each.
Housing is a strong predictor of consumer spending. As rising home prices give owners a feeling of greater wealth and security, consumer spending increases. The inverse is also true. Home prices are pulling back as mortgage rates increase, but the underlying trend of low supply relative to the growth in new household formations remains intact. We expect prices to continue to moderate but do not see a significant correction as demand stays elevated.
Oil and other commodities have climbed due to geopolitical events and high demand versus supply. Consumers who must pay more for gas will spend less elsewhere. We expect that this inflationary trend has peaked but prices will remain uncomfortably high a while longer, particularly in Europe.
Employment remains a focus of the Federal Reserve. Job openings fell by more than 1.1 million in August, which is great news for the Fed. Their goal is to reduce job openings without significantly raising the unemployment rate. They would also like to see increased job force participation and more moderate wage gains. Unfortunately, the most recent jobs report did not deliver in either of those two areas.
The dollar is strong relative to other currencies. This is a good time to travel to Europe because your dollar will buy more than it has in a long time. It is not, however, a good time for U.S. companies to be selling their products overseas, because the strong dollar makes their goods more expensive than their foreign competitors’ comparable products.
Interest rates and the plans of the Federal Reserve are the focal point right now. Vacillating expectations of how high rates will go and how long the Fed will remain in tightening mode are a primary cause of market turbulence. The U.S. is not alone in this; central banks globally are raising interest rates to fight inflation despite the increased risks of recession. As a global recession becomes more likely, we are at least optimistic that the U.S. will lead the field in returning to growth.
Finally, corporate earnings are about to become a front-burner topic as companies issue their quarterly earnings reports. Expectations are muted, and we fully expect companies to reduce their estimates for future gains. The good news? Everyone anticipates this. Hopefully the already depressed stock prices reflect this reality and further declines will be minimal.
Computing the sum of these parts of the financial system, we anticipate continued economic weakness through at least year-end. As mentioned in the beginning, however, the stock market trades on future expectations. Market history shows many examples of stocks appreciating during periods of weak economic activity. The phrase “climbing a wall of worry” is used to explain this phenomenon. The fourth quarter could bring such a reprieve.
We have included the Strategas Research chart showing the S&P 500 returns for the past year. As you can see, the fourth quarter of 2021 provided the last positive return, and each quarter of 2022 has declined so far. The index fell -4.9% in the third quarter, bringing the year-to-date result to -23.9%. It has been a rough year that will hopefully end on a better note. Yields on bonds have increased sharply this year, driving bond prices down as well. We have been able to buy short-term, high-quality corporate bonds at attractive yields where appropriate.