Negative sentiment has taken hold this week, and stock market futures suggest an open in the red again today. Early this week, the Dow Jones Industrial Average, Standard & Poor’s 500, and NASDAQ indexes were all up. Consumer Price Index readings for November showed a further easing of inflation, visibly boosting investor enthusiasm on Tuesday morning. The following afternoon, however, share-price gains evaporated. In a press conference, Federal Reserve Chairman Jerome Powell provided an updated outlook on the central bank’s inflation-fighting strategy. The Fed concluded the two-day December meeting of its Federal Open Market Committee (FOMC), announcing a one-half-percentage-point increase in short-term interest rates, to the 4.25%-4.50% range, as most on Wall Street had been expecting. What the Street did not anticipate was Mr. Powell stating that the benchmark Fed Funds rates would continue to rise well into 2023, and were not likely to decline until 2024.
This morning, Standard & Poor’s will release its U.S. manufacturing and services indexes for December. Those indexes seem likely to show contractions in both segments of the economy. That might lend some support to stock prices, since it would be two more data points toward convincing the Fed to throttle back its aggressive strategy for bringing product and services pricing under control. Evidence is mounting that this strategy is indeed working. Yesterday, investors learned that retail sales are measurably slowing, manufacturing activity is pulling back (as per the Philadelphia Fed and New York Empire State data), industrial production is slowing, business inventories are coming down, and capacity utilization remains at a modest level (below 80%). The latest data add on to previous measures showing a softening of the key housing market.
Notwithstanding all of the evidence that the Federal Reserve is achieving the effect on inflation that it desires, there is one major area that remains a concern. That is the employment situation. More than 10 million jobs are currently available, and only a little more than four million people are actively seeking positions. The unemployment rate is at a multi-decade low, and wage growth persists. We note that, on Thursday, initial jobless claims for the week ending December 10th were quite modest. The Fed wants to conquer this important driver of inflation. Chairman Powell’s recent commentary implies that short-term rates could peak at just over 5% by mid-2023, and then hold steady into 2024. Wall Street is concerned this could result in a harsh recession (a scenario we don’t expect).
Corporate managers have voiced caution about next year’s sales and earnings prospects and, in turn, an increasing number of analysts have reduced their estimates on revenues and corporate earnings for the coming quarters. As a result, if one estimates what the ratio of stock prices to corresponding earnings per share will look like over the coming year, the ratio (or “multiple”) stands to rise if stock prices remain where they are. Given the fact that the typical multiple is already above the historical average, the concern is that stock prices will fall further if indeed earnings come down noticeably.
There is a minority on Wall Street saying the gloomy consensus outlook is too pessimistic, and that a “soft landing,” that is, a mild recession, is still possible. All considered, the situation is uncertain, and as a result market volatility could well step up, going forward. We believe the U.S. economy (and the stock market) will prove fairly resilient. Corporate and consumer finances are in decent shape, and total capital and household spending, though slowing, is reasonably healthy. The Fed’s intentions are not to cause a severe downturn.
Since the end of September, blue chip Dow Jones stocks have been increasingly outperforming the broader market. Investors are playing it safe and are currently focused on established consumer staples marketers, industrials, and healthcare firms. – David M. Reimer
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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