Yesterday’s Federal Reserve announcement (reviewed below) was followed this morning by a number of important reports on the U.S. economy, which has been a big focus of investors in recent weeks, as Wall Street considers what impact the Federal Reserve’s increasingly restrictive monetary policies this year will have on growth in 2023. At 8:30 A.M. (EST), the Department of Commerce reported that retail sales for the month of November declined 0.6%, which was a stark contrast to the 1.3% gain registered in the previous month, and the weakest reading since last December. Conversely, a Labor Department report showed that initial unemployment claims for the week ending December 10th fell to 211,000.
In general, the retail sales report and the decline in manufacturing activity for the greater New York region in November (Empire State Survey fell 11.2%) suggest that economic growth is slowing. Later this morning, we will get data on November industrial production and capacity utilization. The equity futures, which were notably lower on yesterday’s Fed news and heading into the economic releases, took another step down on the weak economic data and the still strong reading on employment, the latter of which will make the Fed’s fight to lower inflation more difficult.
The attention of Wall Street this morning remains on the Federal Reserve and its ongoing battle to tame inflation, which the November reading on consumer prices (released on Tuesday morning) showed is starting to moderate. That is because yesterday afternoon, the central bank announced its final monetary policy decision of 2022, a half-point increase to the benchmark short-term interest rate that pushed the federal funds rate to a range of 4.25% to 4.50%. This marked the highest level since 2007. The Fed also said that it is continuing its monthly asset sales of $95 billion. These moves are designed to reduce the money supply, which, in turn, should lower demand for goods and services, and ultimately put downward pressure on prices.
The U.S. equity market, in a volatile session yesterday, sold off on the Federal Open Market Committee’s decision and, more so, on the hawkish commentary in the Fed’s monetary policy statement and from Chairman Jerome Powell in his post-decision press conference. With regard to the statement, it showed that 17 of the 19 Fed members see the federal funds rate moving above 5.00% in 2023, and maybe remaining at that rate for longer than many market pundits were expecting leading into the decision. The federal funds target rate for 2023 was increased to 5.10%. That, along with comments, which were echoed by Mr. Powell, that “ongoing” rates hikes are appropriate, put upward pressure on Treasury yields and the value of the U.S. dollar against a basket of international currencies. In the pattern we have seen throughout this year, equities, particularly those of higher growth stocks, sold off in response.
In addition to the hawkish commentary, Chairman Powell said that our central bank will not reconsider its long-term inflation target of 2%, which seemed to suggest that the Fed will continue raising the federal funds rate in 2023, albeit at a likely slower pace than this year. Investors appear to be worried that the Fed continuing to raise rates in a slowing growth environment, may make it harder for the central bank to orchestrate a soft landing for the U.S. economy. Leading into yesterday’s Fed decision, concerns about a recession down the road were gaining steam.
The recent drop in oil prices on concerns about global demand, and the continued inversion of the Treasury yield curve (where rates on short-term Treasuries exceed those of longer durations), suggest the United States may be headed into a recession next year. The last time the spread between the two- and 10-year Treasury notes was this wide (75 basis points this morning) was in the early 1980s. The housing market appears to already be in recession and with consumers’ savings accounts decreasing and credit card debt increasing rapidly (up 15% year-over-year in the third quarter), the health of the consumer sector may be more compromised heading into the new year than recent economic data, some of which of course speak of the past, not the future, may be indicating.
So what is an investor to do in an environment where the central bank is tightening the monetary reins into a slowing growth environment? We continue to recommend that investors keep a heavy concentration of stocks and cash in their portfolios, and start adding some bonds to round out the asset allocation. With regard to the equities component, investors may want to focus on the stocks of high-quality companies that have a proven track record of delivering steady earnings growth and maintaining sufficient cash flow in periods of economic weakness. A healthy dividend payout would also sweeten the appeal in an environment where price gains may be harder to secure.
In volatile times for the equity market, stocks ranked 1 (Highest) or 2 (Above Average) for Safety™ by Value Line have relatively outperformed the broader market and should be given a close look by subscribers. Value Line’s stock screening capabilities make targeting these high-quality companies quick and easy. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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