Ghost of Christmas Present
In Charles Dickens’ classic novella, A Christmas Carol, the miserly Ebenezer Scrooge is visited by three Christmas spirits who offer him a chance of redemption – the ghosts of Christmas Past, Present and Yet to Come. Each spirit attempts to show Scrooge the errors of his ways and how treating everyone with kindness, generosity and compassion embodies the spirit of Christmas. When it comes to the markets, the events of the past year have been different than any we have experienced in recent memory. As we look back at 2022 and assess the current situation, will we see more of the same in 2023 or will the markets change their ways?
Stocks wrapped up their worst week since September after a worse than expected report on wholesale prices Friday. This comes on the eve of this week’s Federal Reserve policy meeting where expectations are for an increase in the fed funds rate of 50-basis points, or one-half of one percent. For the week the S&P 500 fell 3.3%, while the Dow Jones Industrial Average sank 2.7% and the Nasdaq dropped 4%. Bond markets endured a bumpy week with the yield on 10-year U.S. Treasury bond ending marginally higher. However, longer term yields remain more than a half percent lower than they were in just a month ago.
Falling long- term rates pushed bond prices higher, as prices move inverse to interest rates. November was the best month for U.S. bonds since December 2008. Unfortunately, the US bond market is still lower by double digits year-to-date and remains on pace for one of its worst years in history. The traditional 60/40 stock/bond portfolio, which is supposed to provide diversification, has also suffered one of its worst years in history. Higher interest rates do mean better yields for fixed income investors but the volatility of the bond market, which we think will continue into 2023, has shown that bonds may no longer provide the diversification and protection they have in the past, making this an opportune time to consider alternative strategies for portfolio protection.
Ghost of Christmas Yet to Come
With the volatility we have experienced and the precocious position of the markets and economy, we all might be wondering what the future might hold. Consumer spending, which makes up about two-thirds of GDP, is being monitored closely, especially during this holiday season. Indications are that spending remains strong, but consumers are seeking out more bargains and discounted items than they have in the past. Inflation has outpaced wages for 20 consecutive months, so in order to support higher levels of spending, consumers are saving less and borrowing more. This is a cause for concern, especially if we were to enter a recession and experience job losses, making payments on borrowing, especially credit cards, more difficult and unemployed people having less savings to rely upon. Oddly, the continued strength in consumer spending contradicts the widely followed University of Michigan’s Consumer Sentiment Index, which has been negative for 8 consecutive months; the longest run of extreme negative sentiment that we’ve seen with data going back to 1952.
Despite last week’s higher than expected Producer Price Index (PPI), inflation does seem to be moderating and even falling. The PPI increased 7.40% over the last year, the smallest increase since May 2021. For reference, PPI peaked at 11.66% back in March. (Note this coincides with when the Fed began to raise interest rates, as mentioned earlier.) Supply chain backlogs have improved dramatically and there have been large drops in the prices of lumber, used cars, and rents. Lumber prices are often viewed as a forward indicator of economic conditions since they reflect demand for construction materials. These price drops will eventually be reflected in inflation numbers and we should see at least a pause from the Fed, providing some relief and a tailwind for the stock market.
Currently the stock market is very much dependent upon Fed action, which in turn is dependent upon inflation. With prices of many raw materials dropping, many economists are predicting inflation will fall rapidly back to the Fed’s 2% target. But we remain skeptical since these same economists have been predicting lower levels of inflation over the past two years and historically when inflation reaches the levels it has recently, it takes on average ten (yes, 10!) years for inflation to fall back to the Fed’s comfort zone of 2%. Just as this year has been different than many years in the past, we are not of the belief it will take that long for inflation to subside to that level, but we think it will still take a long time, perhaps years and not months.
The main event of this week will be Wednesday’s Fed meeting and rate decision. As we’ve seen in the past, since the interest rate decision is widely telegraphed beforehand, it often is not the actual rate decision but rather the comments from the Fed afterwards that move the market. The Consumer Price Index (CPI) report on Tuesday is also likely to have an impact on the markets since the focus remains on inflation. After the excitement around these two events in the middle of the week, we are apt to see a much quieter stretch for the markets going into the end of the year. However, we do caution that many institutions and fund managers make big moves at year-end to position portfolios, which may especially be the case this year given the amount of volatility. We may see some moves in the market but we would not put much credence into large market moves since they are likely to be short-lived.
As always, we encourage investors to ignore short-term moves in the market and maintain a long-term perspective. Remember the objective and goals of your investing. For most people this would be to provide protection of purchasing power to maintain your lifestyle and standard of living in retirement. If you are worried about visits from spirits of the past and future and what they might reveal to you, please give us a call to ensure your portfolio is positioned appropriately so you can avoid needing your own chance for redemption.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
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