The dominant themes in U.S. markets this year have been the relentless rise in inflation and the geopolitical tension the Russian invasion of Ukraine has wrought. Since the Federal Reserve’s confab in Jackson Hole in August, investors are coming to realize that the Fed means business when it says it is determined to push inflation back down to its 2% target. (Right now inflation is about 8%.) The Fed hiked interest rates another 75 basis points in September amid more hawkish rhetoric, leaving investors to wonder just how much pressure the Fed is willing to put on the economy to quell inflation. Once we have the answer to this question, the tone in markets is likely to improve from the dismal sentiment that exists today. The silver lining for patient investors is that both stocks and bonds tend to do quite well once inflation has peaked and is on a convincing downward trajectory. We’re just not there yet. Additionally, the situation in Ukraine seems to become more worrisome by the day, with Russia following through on its illegal annexation of four Ukrainian provinces and Putin threatening to use all means necessary to protect this new “Russian” territory. While we are cheering Ukrainian gains on the ground, there does not appear to be an obvious offramp for Putin to save face with his own people after this ghastly fiasco.
More Work May Bring Pain
The Fed has plenty of work to do, and to paraphrase Chairman Powell, there is no way to bring down inflation without some pain. Right now consumer spending remains relatively strong and the unemployment rate is near a record low of 3.7% while wages continue to rise. Some negative economic news, which is what the Fed is trying to force, has started to come out in recent weeks however. The residential real estate market is grinding to a halt. Recent Job Openings and Labor Turnover (JOLTS) data showed that the number of available jobs plunged by one million in August, which is nearly 10% of all available jobs and the largest drop since the beginning of the pandemic. On the corporate side, massive earnings misses from FedEx, CarMax and Nike are demonstrating that the Fed’s tough medicine is beginning to have its desired effects.
So, when can investors expect markets to improve? We think that for both stocks and bonds to find their footing, we really need to see two things:
First, we need to see a definitive peak in inflation. Unfortunately, despite indications of a weakening economy and collapsing commodity prices, the main inflation measures have not yet started to turn. Friday’s release of data showing the personal consumption expenditures (PCE) price index rose 0.6% (excluding food and energy) last month, which was slightly more than expected, did not give investors any hope that the Fed will be considering a course correction in the near future.
Second, we need to see investors reset their corporate earnings expectations for the year ahead. Last Thursday, Micron Technology (Ticker MU), the Boise-based world leader in DRAM (Dynamic Random Access Memory) manufacturing and a bellwether company in the semiconductor industry, reported results for its fiscal fourth quarter. The numbers for the quarter were mixed, but the company issued a worse-than-expected outlook for the coming year. Despite the bleak projection, MU stock finished fractionally higher on the day—a day that the Dow tumbled 500 points. It has continued to climb this week as well. Price action like this indicates that investors are beginning to price in the slower growth that awaits the global economy in 2023. We need to see similar events with many more companies. Only when investors, in aggregate, truly expect 2023 to be a challenging year can we find a bottom for stocks.