After posting comfortable gains early in the week, market sentiment reversed course with the release of the US Fed December policy meeting statement and subsequent Fed Chair Jerome Powell’s press conference on Wednesday afternoon. Except for the energy sector, all sectors posted negative returns, with the tech-laden NASDAQ index tumbling 2.7% in the week, bringing the year-to-date total return to a negative 31.57%. The expiration of approximately $4 trillion in options contracts added to Friday’s volatility. European shares fell after several European central banks, including the EU central bank, raised rates and suggested further rate increases were necessary to achieve levels sufficiently restrictive to tame inflation and achieve the central bank’s target of 2%.
Last Tuesday, the National Federation of Independent Business reported the small business optimism index rose to 91.9 in November from 91.3 in October. The reading is the 11th consecutive month below the historical average of 98. The small business economy is improving, but labor shortage, supply chain disruption, and inflation continue to plague the sector. Forty-four percent of small business owners reported job openings that were hard to fill, particularly in the transportation, wholesale, and construction sectors.1 Also on Tuesday, The US Bureau of Labor Statistics reported the headline consumer price index rose 0.1% in November, bringing the rolling 12-month increase to 7.1%. This latest 7.1% increase for the last 12 months is the smallest 12-month increase since the period ending December 2021. The core index for all items less food and energy rose 0.2% in November after increasing 0.3% in October, bringing the rolling 12-month increase ending November to 6%. The most significant contributor to this month’s increase was food rising by 0.5%; shelter increasing by 0.6%; and services less energy services, up 0.4%, while the energy index decreased by 1.6% in the month. Over the last twelve months, energy has increased by 13.1%, and food indexes increased by 10.6%.2 The lower-than-expected inflation data gave the market hope that the Fed might reduce the need for a more restrictive policy longer than initially thought as the inflation rate slows. That hope was dashed by the announcement of an expected 50-basis-point increase in the Fed funds rate and the accompanying statement and press conference.3 Last week the central banks in the UK and the EU also raised rates by 50 basis points and repeated the message that further rate hikes are likely needed to bring inflation back to the target. The Bank of Canada is the only central bank that has openly stated that it is open to pausing rates at the current levels.
On Thursday, the US initial unemployment claims for the week ending December 10 fell 20,000 over the previous week to 211,000. Continuing claims for all benefit programs for the week ending November 26 increased by 302,109 to 1,586,144.4 Weak retail sales falling 0.6% in November sent a shiver through the market on Thursday. Weaker car sales, higher interest rates, and the slowing economy seemed to have contributed to the decline. Stripping out autos and gas receipts, retail sales were down 0.2%. For the rolling twelve months, retail sales have increased by 6.5%; however, as reported above, the inflation rate over the same period is 7.1%.5 Another indication that the consumer is struggling is the savings rate, which fell in October to 2.3%, the second lowest rate since 1959.6 A gauge of regional manufacturing is the Philadelphia and Empire State manufacturing indices. The Philadelphia Fed reported an improvement of 5.6 to negative 13.8 in December, and the Empire State index declined to 11.2 from 4.5 in the month. A negative reading indicates worsening conditions.7 Nationally the Federal Reserve reported industrial production decreased by 0.2 in November. Manufacturing fell 0.6%, mining fell 0.7%, while utilities jumped 3.6%. Capacity utilization slid 0.2% in November but held above the long-run average for the period 1972-2021.8
With evidence that economic activity could be slowing, market participants appear to be ignoring the Fed’s message of higher rates longer. One issue for the Fed is the labor market. Until the unemployment rate increases, the Fed has expressed concern that wage inflation could take hold, further exacerbating the problem and enabling the Fed to continue pushing policy rates higher. As we close Q4, attention will likely be diverted from the Fed, at least temporarily, to earnings and market valuations. If earnings are soft, the result could be an earnings recession for at least the first half of 2023. We expect continued volatility in the coming months fueled by Fed policy, comments, earnings reports, and guidance for the first half of 2023.
*Due to the upcoming holidays, there will be no market commentary for the week of December 26, 2022.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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