After a light day of economic releases today, the news will heat up tomorrow morning with a report on housing starts and building permits from the Commerce Department. The housing market will be in focus all week long with reports on November existing home sales (due out Wednesday) and new home sales (Friday). We will also get some more insight on the health of the U.S. consumer sector, with the final consumer confidence reading of 2022 from the Conference Board tomorrow and data on personal consumption and expenditures on Friday. In particular, investors will be focused on the Personal Consumption Expenditures (PCE) price index, which is the most closely watched gauge of inflation by the Federal Reserve. The consensus is that the PCE Price Index is expected to show some moderation in prices. If it does not, it may result in some more selling to close out what has been a very volatile year for stocks. This week will also bring the final revision to third-quarter Gross Domestic Product (GDP) on Thursday.
The penultimate trading week of 2022 begins with the major equity averages looking to rebound from a volatile five-day stretch last week. The indexes rose sharply to start last week on what was viewed as a more benign report on November consumer prices, but that move higher quickly faded, and the averages fell sharply in the second half of the week prompted by the Federal Reserve’s still hawkish stance on monetary policy, which included a half-point hike to the benchmark short-term interest rate during the final Federal Open Market Committee meeting of 2022 last Wednesday. That news drove both the value of the U.S. dollar and Treasury market yields higher, and sparked another selloff in the equity market. The equity futures, which were higher earlier today, are now presaging a relatively flat start to the trading day stateside.
The market was not expecting the Federal Reserve to be quite as hawkish as it was during this stage of the monetary policy tightening cycle, which pushed the federal-funds rate to a range of 4.25%–4.50%. Indeed, 17 of the 19 senior Fed officials believe that the federal-funds rate will need to go above 5.00% and stay at that level for a longer duration to sufficiently fight inflation. That, along with the continuation of the central bank’s $95 billion monthly bond-selling program, which is designed to reduce the money supply and remove liquidity from the financial system, is not a great backdrop for equities and, hence, the sharp selloff on Wall Street during the second half of last week. In a nutshell, the era of easy money is clearly in the rearview mirror and that is causing both businesses and consumers to reexamine their spending budgets.
Meantime, the housing market appears to be in the midst of a recession, thanks to the higher borrowing costs resulting from the Fed’s restrictive monetary policies. The recent performances of the housing and homebuilding sectors have been weak, and the aforementioned data to be released this week is not expected show much improvement in building fundamentals. Homebuilding giant Lennar (LEN) noted in its fiscal fourth-quarter earnings report (released last week) that the near-term operating environment is likely to be challenging, given the higher mortgage rates. The housing market struggles, combined with the continued inversion of the Treasury market yield curve and the drop in the price of oil on possible demand concerns, continue to suggest that the U.S. is headed toward a recession next year. The specter of the central bank continuing to raise interest rates to fight inflation into a period of slowing growth has added to the concerns about a recession.
If the economy were to struggle in 2023, it could further exacerbate what is already expected to be a weaker year for Corporate America. Indeed, the Wall Street consensus is calling for negative earnings growth for S&P 500 companies next year, and this will probably put downward pressure on valuations. In this environment, we think a portfolio consisting of mostly high-quality stocks and cash is the best investment strategy. We would recommend taking a closer look at the equities of companies that have demonstrated a history of producing steady earnings and cash flow during periods of economic weakness, while maintaining their dividends. — 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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