Economic Monitor: Monotony Amidst Mixed Messages
BY: Mark Drachenberg
Boring! Yes, things are boring in the investment world! I know, I know, some of you are thinking I’m nuts right about now but bear with me and I’ll try my best to explain. Perhaps the better way of putting things, is that they are monotonous right now, and therein lies the first mixed message!
The dictionary defines monotony as having a lack of variety, tedious, repetition, and routine, and that sounds a lot like the economy and markets right now. I’m nuts, I know! But think about it, for much of the last six months or so, the inflation data has remained high, the Fed raises rates, the markets react thinking the Fed is going to slow or reduce the size of their rate hikes only to have those hopes dashed. Rinse and repeat. The whole thing is getting old for everyone. I get it that the potential for the markets to rally is exciting, but the truth is that, for now, there is no basis for them to do so until inflation (and by extension, the economy) show serious signs of slowing without going into a deep recession.
Here is where we get to more of the “mixed messages” part, the Fed needs to quit speaking out of both sides of their mouth. As recent as this week, the Fed raised rates and indicated a slowing in their process of raising them (meaning smaller rate hikes but that they may continue to raise rates for a longer period of time than the markets expect today). The market rallied. Then, Chairman Powell held his press conference and basically dashed the markets hopes by stating that the Fed may slow their hikes but may raise rates higher than the markets expected. The mixed messages sent the markets in a freefall for the rest of the trading session. Sounds exactly like what I described above and has been the same basic scenario that has played out several times this year. Monotony and mixed messages! At some point, the cycle will change but hopefully we won’t regret it when it does.
Financial Markets
October, like July earlier this year, was a stellar month in this monotonous cycle we are in. The Dow Jones Industrial Average rose 14.07% in October, which was its best month since 1976! Other than the EAFE and the NASDAQ, the equity markets overall posted strong results. The S&P 500 gained 8.10% in October while the 400 and 600 indices gained 10.52% and 12.37% respectively. The EAFE posted a 5.33% gain for the month while the NASDAQ brought up the rear by gaining only 3.94% in October. So much for a nasty Halloween! The Bloomberg US Aggregate Bond index continued its losing streak by falling 1.30%.
October has been termed the month that kills bear markets, and October generally came through on that front, although the month will likely turn out to be just another in the relentless cycle of volatility we are in right now and the mixed messages it sends about where things might be headed. What is, perhaps, a bit different is that the markets seem to be finally coming around to the idea of not fighting the Fed as much. If that is the case, volatility might soften a bit, which would help smooth things out until the Fed finishes its tightening and inflation eases. For more market and economic data, please see the end of this commentary.
The Economy
Uncertainty is the issue right now. Are we in a recession? Have the markets bottomed? Will prices ever come back down? And so on. Wait. I said that last month. And probably the month before that. Monotonous, right? The problem is that nothing has changed. Inflation is still high, unemployment is still low, the Fed is still tightening (and sending mixed messages), and the markets go up one month and down the next. Rinse and repeat.
The good news is that GDP did grow in the third quarter, ending the talk, temporarily, of our being in a recession due to two consecutive quarters of negative GDP growth. Oil and gas prices have continued to bounce around, although they were not helped recently as OPEC announced production cuts to keep prices elevated. The consumer continues to spend, and hopes are that the holiday season will be relatively strong – but not too strong, of course, as that would send a mixed message to the Fed. Interest rates on deposits are rising, finally, although lending rates are rising faster and higher dampening some of the enthusiasm. The roller coaster ride continues, and although we will get through this at some point, it will be a rocky ride in the meantime.
GDP (Gross Domestic Product) – GDP rose in the third quarter at an annualized rate of 2.6% after falling 0.6% in the second quarter and 1.6% in the first quarter. The gain was at the higher end of estimates and, for now, stopped talk of the economy being in a recession. All numbers may be revised in coming days as the government evaluates the data further. Full year estimates have been all over the map but are currently running in the positive 1% to 2% range.
Inflation – Inflation moderated slightly to 8.2% in September, but the dip was not enough to cause the Fed to back off on raising rates as high or as fast, but it did help fuel a bit of the rally in the markets in October. The core reading rose 0.6% in September, or 6.6% over the past year. While expectations are that inflation will begin to taper, the impact of a higher level (than desired) for longer is a reality that is setting in for many now. That “setting in” is what the Fed is afraid of, as that would likely cause further hikes in wages and prices, ultimately causing further pain down the road.
Unemployment – The labor market remains strong as October saw another healthy jump in employment. Nonfarm payrolls increased by 261,000 during the month while the unemployment rate bumped up slightly to 3.7%. Wages continue to bump higher, although they continue to run below the rate of inflation. The healthy jobs market is a large part of why we haven’t “officially” entered into a recession.
The Fed Watch
When it comes to the Fed, the message gets confusing at times (mixed messages) but ultimately seems to stay the same (monotony). That held true this past week as the Fed raised rates by 75 basis points again but gave off mixed signals between when they announced the rate hike and when Chairman Powell spoke at his press conference afterwards.
The 75 basis point rate hike was the fourth time at that level this year and the sixth overall rate hike in 2022. When announcing the rate hike, the Fed indicated a slowing of further hikes was likely, which caused the markets to rally sharply only to see that rally crash back to Earth when Chairman Powell indicated in his comments that while the Fed may slow their pace of raising interest rates, they may have to find an end point that is at a rate higher than what the markets expect.
So, the Fed accomplished both the monotony of the level of rate hikes, the mixed messages that they are so good at, and the monotony of basically doing and saying the same basic things for the third or fourth time this year. This is really where the expression “don’t fight the Fed” comes from because it doesn’t pay to try and outguess them.
Perhaps, however, there was some good news in the comments Chairman Powell made and that is that the tone now seems to be less on the number of rate hikes we may see but rather on the endpoint of those rate hikes. That endpoint now may be above 5%, whereas it was previously expected to be in the mid- to upper 4% range.
Outlook/Summary
The story just doesn’t change, and neither will this outlook. Opportunities always present themselves in times of major market movements and this time is no different. New opportunities exist in the fixed income markets due to the rise in interest rates and the ability to start enjoying some yield again. Soon, it will be time to extend durations a bit to enjoy that yield and to take advantage of potentially falling rates (not dramatically) once things settle down.
On the equity side, it still pays to be defensive with a value tilt, although many traditional growth investments are trading at valuations not seen in quite some time. We will remain diversified but keep a focus on some downside protection as it avails itself. Our eyes, like everyone else’s, are on the Fed, the economy, and other news, to make informed decisions.
To discuss your portfolio, please call the Wealth Management department of the Lake Ridge Bank at (608) 826-3570. We look forward to speaking with you soon.
Market/Economic Data
As of October 31st, 2022…. (Unemployment data is through October for national, September (preliminary) for both Wisconsin and Madison, inflation data through September):
Index | Month Return | YTD Return | Index | Month Return | YTD Return or Current |
---|---|---|---|---|---|
DJIA Industrials | 14.07 | -8.42 | EAFE | 5.33 | -25.09 |
S&P 500 | 8.10 | -17.70 | Bloom US Agg | -1.30 | -15.72 |
S&P 500 Equal Weight | 9.80 | -12.91 | Inflation (CPI All-items) | 0.40 | 8.20% annual |
S&P 400 | 10.52 | -13.27 | U.S. Unemp. | n/a | 3.7% |
S&P 600 | 12.37 | -13.66 | Wisconsin Unem. | n/a | 3.2% |
NASDAQ | 3.94 | -29.32 | Madison Unemp. | n/a | 2.6% |
Thank you for your business – we look forward to speaking with you soon. (Note – this commentary used various articles from JP Morgan, Morningstar, the Wall Street Journal, Investor’s Business Daily, Northern Trust, CNNMoney.com, msn.com, Kiplingers.com, nytimes.com, Fidelity Investments, American Funds, LPL Financial and other tools as sources of information)