A Body in Motion…
…stays in motion. This is the beginning of Sir Isaac Newton’s First Law of Motion and is the basic premise of inertia. Even though economic events and the stock market are not subject to the laws of physics, it may seem as if they still apply. The example that readily comes to mind is inflation. It is the second part of Newton’s First Law that may be most fitting – …except as compelled to change that state by external forces impressed upon it. The Federal Reserve is trying to be this force; raising interest rates aggressively and decreasing the money supply in an effort to slow inflation.
Last week’s inflation readings, the Consumer Price Index (CPI) and Producer Price Index (PPI), both contained a good deal of underlying data and can be interpreted various ways. Overall they were viewed as being slightly hotter than expected and looking at the headline numbers, it appears inflation remains persistently high. The readings are slowly receding and it may appear as if we have already experienced “peak” inflation. But what is concerning is that as we dig into the numbers further, core inflation, which excludes food and energy, was higher than expected, and remains higher than we have seen it in 40 years, exceeding previous levels seen this year when headline inflation was higher than it is now. Despite the Fed’s efforts, inflation is not slowing as much as hoped, but we also need to acknowledge there is generally a considerable lag time between Fed action and the impact it has on the economy. This lag is what leads to general concern the Fed will overshoot and raise rates higher than needed to tame inflation, pushing the economy into a recession. At some point we expect the Fed to stop raising rates and pause for an extended period of time to determine the effects, before taking further action.
The CPI report not only bolstered expectations that the Fed will raise rates by 75 basis points (0.75%) at their November meeting and at least another 50 basis points (0.50%) at their December meeting, but now the terminal Fed Funds rate is expected to be close to 5%. For reference, it is currently at 3.25% so this implies further rate hikes into 2023. The prediction of the peak in the Fed Funds rate continues to be revised higher, indicating just how stubborn inflation has become as well as how slow it may be for it to substantively abate. But even if inflation is beginning to slow, it will most likely be a long time before we see it within the 2-3% comfort zone of the Fed and to a point where it is no longer front and center in everyday life.
Equal and Opposite Reaction
After the CPI report was released last Thursday, the markets began to plummet but quickly recovered and closed higher, having one of their best days in over two years. There really is no explanation for this except it may be that the CPI report was not a complete disaster or simply that after five days of losses bargain hunters took over and the buyers stepped in. The S&P 500 did drop below the YTD lows seen in June before the sharp reversal and recovery. The lows may be providing some support and we could see the markets bounce around these same levels until we begin to see a larger, more sustained move in either direction.
Current market sentiment is at some of the lowest levels ever. Historically this has been a contrarian indicator and a signal that a market bottom is near. But as we have experienced so far this year, this market cycle is different than most others. Since we think interest rates are going to continue marching higher and we will see a recession in the next year, we do not yet think the stock markets have seen the bottom. Surprisingly, many individual stocks are still trading above their June lows, signaling some strength. Given the amount of negative sentiment and short-selling in the market, once things turn around we could see a rather fast rebound as short-sellers are forced to cover and the markets gain momentum in a positive direction.
The focus of the markets now will shift to third quarter earnings. This week we will see earnings reports ramp up and the majority of S&P 500 companies will report earnings over the next few weeks. With lowered expectations for growth, we do not expect strong earnings to be a catalyst for a move upwards in the market as we have seen most quarters over the past several years. Further, markets do not like uncertainty and the upcoming elections are providing a bit of an overhang on the market. Once we get past the elections, regardless of the outcome, and remove the uncertainty we would not be surprised to see a rally into the end of the year.
It is worth noting that the Social Security Administration announced last week that retirement benefits will increase by 8.7% in 2023, the largest cost-of-living adjustment since 1981. There have only been three times since the start of automatic adjustments in 1975 that it has been higher, all of which were during the high inflation years of 1975 through 1981. This increase will be welcomed by many as it helps maintain purchasing power. But this is also a reminder that any source of income, especially in retirement, should be viewed on a real, or inflation-adjusted, basis.
We would like to thank those of you who came out to hear Becky Swansburg provide her insights into the current tax situation and how it is likely to affect your retirement. If you would like to discuss your individual situation in more detail and implement some of the strategies discussed, please call our office to schedule a time to meet with one of our advisors. Be confident your retirement plan is not adversely affected by external forces and remains in positive motion.
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.
Office phone # 952-460-3260