By: Jeff Anderson, CFA
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||3.489%|
Source: Wall St. Journal
The Fed hiked rates by 50 basis points this week, bringing the rate up to 4.25% – 4.5%. This rate hike cycle has the been the swiftest in decades, sending equity and fixed income markets materially lower year-to-date. It seems like a broken record. Inflation is too high, and the Fed has taken away the punchbowl. No more free money. No more asset purchases. No more cheap mortgage rates. Undoing the massive stimulus that flooded the markets in 2020 and part of 2021 have been replaced by a restrictive stance, where money is more expensive and less plentiful.
The result of this has been a slowing economy. We got more signs that the economy is softening, with the US manufacturing Purchasing Managers Index clocking in at 49. Why is 49 an important number? Anything below 50 signifies a shrinking of the manufacturing economy. The consumer price index for November also came in slightly lower (which is better) than projected. So, with the economic and inflation data softening, shouldn’t it be a clear sign for the Fed to step away from rate hikes and a hawkish stance? You’d think, but no. Why not? The answer is multi-faceted. One reason is employment. It’s still too strong. Unemployment claims remain low, and there are still too many job openings. The other reason is that one or two months of good inflation data isn’t enough to alter the Fed’s path. They have said for months and months that they’ll need convincing evidence that inflation is clearly headed back towards 2%. One or two months of declining rates isn’t enough. What is ironic about this is that at beginning of the year all the economists and Wall Street strategists were arguing that the Fed was behind the curve. The Fed isn’t restricted enough. Fast forward to now and these same experts are saying the Fed is “too” restrictive and that unnecessary damage to the economy will be the end result of the Fed’s current direction.
So, what do we know at this juncture? At the very least, it’s clear that the effects of higher interest rates are taking a bite out of economic activity. Revenues are up in many industries but its from price increases, not volume increases. Many parts of corporate America are selling less stuff but at higher prices. Stocks have been in a bear market for most of 2022, with share losses coming from a decline in the earnings multiple. Call it the “P” Stocks decline because investors are less bullish. They want to pay less for that same dollar of earnings because they believe that earnings have stalled, or maybe declining…. or just not growing as fast as before. So, heading into 2023, it’ll be all about earnings (the “E”). Multiples on earnings typically decline “before” earnings actually decline. It is likely that a recession happens in 2023. Earnings will likely decline. Stock prices will remain volatile. At some point, hopefully in 2023, inflation will back under control and the Fed will be able to stop hiking rates. Earnings will bottom at some point in 2023 or 2024 and the next bull market in stocks could resume. It’s all a cycle. Don’t forget that.