Fence or Ladder
We see the scene often play out in movies – the hero is being chased by bad guys or maybe a pack of wild animals and then comes to a fence. Does the hero see the fence as being the end of the line and simply give up? Or is the fence used as a ladder to escape danger? In life we often are faced with difficult situations and can choose whether we view such as a fence or ladder. And right now, investors can look at the markets and make a similar decision the same.
Equities finished last week higher, capped by a big rally on Friday after the monthly employment report. The jobs report came in slightly better than expected but there were downward revisions to the previous two months’ reports. What moved markets most was that average hourly earnings posted a smaller than expected monthly increase and the previous month’s surprisingly large spike was revised downward, helping ease concern wages will contribute to higher inflation. The strength of the labor market and continuing upward movement in wages has been bolstering the Federal Reserve’s case for continuing to raise interest rates.
Treasury bond yields moved lower after the employment report with the 10-year US Treasury bond yield now 30 basis points, or 0.30%, below where it was at the end of year. This may not sound like much but since prices move inversely with yields, longer dated bonds, which had a horrible year last year, have enjoyed a slight rally to begin the year. We are not optimistic this is going to last and think inflation will remain elevated with bond yields continuing to move higher, but at a slower pace. The minutes from the last Federal Reserve meeting in December were also released last week. These showed that while policymakers felt it was an appropriate time to dial back the pace of rate increases, they did not want to be seen as wavering in their commitment to the inflation fight. And there were no indications any of the committee members felt a pivot to rate cuts in 2023 would be appropriate. Our expectation is the Fed will raise rates at least twice and then is likely to pause for the remainder of the year to assess the impact rate hikes have had.
Balloon or Rock
There is little doubt economic growth is slowing but the biggest question remains to what extent. Last week’s jobs reports reflected a slight softening in labor conditions but overall the employment situation remains fairly strong. The less than expected wage growth which helped propel the market higher will likely not be enough on its own to convince the Fed to change course. The question remains whether the Fed has tightened too much or not enough. Either case is very likely to lead to more challenges for the stock market. There is the third, “Goldilocks”, option where they have tightened just the right amount and we see what is being termed a “soft landing” in the economy. Odds of this occurring seem to be increasing but are still much lower than the odds of the other two scenarios.
But it isn’t just the Fed that is causing concern, it is also what is happening in Congress. The passage of large spending bills last year could very well lead to more inflation this year. (Yes, there are consequences for actions, for example the inflation that was caused largely in part by pandemic era stimulus payments.) The drama in the House last week electing a Speaker demonstrated the broader discourse between members of Congress, even within parties. This does not bode well for the debt-ceiling debate occurring later this year. And now there is even justified speculation there may be austerity measures, including lower levels of government spending. This could help with the inflation situation but may be harmful if we were to experience a recession, as is being widely anticipated, since government spending generally works to provide stimulus during slow economic times.
The markets continue to be attuned to the same themes that drove it in 2022, including the path of inflation, the state of the labor market, and the Fed’s policy response. The Consumer Price Index (CPI) report for December will be released on Thursday. Current consensus expectations are for a flat reading month-to-month and a drop on the yearly number firmly below 7% for the first time since November 2021. This is still an elevated rate of inflation and well above the Fed’s comfort zone so it is not expected this report will change the expected course of Fed action at their next meeting, unless it happens to surprise strongly to either the downside or upside.
While inflation and the Fed will remain an underlying theme driving markets in 2023, we think the focus is going to shift more towards corporate earnings. Earnings reports for the fourth quarter of last year kick off on Friday with the major banks reporting, along with locally watched heavyweights Delta Airlines and UnitedHealth Group. Markets anxiously await the coming wave of earnings reports for Q4, with thoughts being that current consensus estimates will need to come down. However, the strength of the market last week seemed to possibly indicate there is some comfort in hopes for earnings resilience amid cost cuts and workforce restructuring.
If the up and down string of market sessions over the past few weeks are an early indication, we are likely to see a continuation of challenges in the market this year. Some may view these conditions are being an obstacle, or a fence, standing in their way on the path to a comfortable retirement. We are here to help you in any market conditions so you can turn this into an opportunity, or a ladder, towards realizing your retirement goals.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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