Stock futures were in positive territory before the start of today’s trading. Earlier in this holiday-shortened week, the major stock market indexes began to weaken, as unfavorable housing sector data rolled in for October and November. Home prices and sales are softening, with borrowing rates now at higher levels. Also, investors are concerned about happenings in China, which has aggressively rescinded COVID-19 precautions. The concerns are that pandemic cases in that country will rise, again disrupting manufacturing and export activity. Starting in January, U.S. officials will require people visiting from China to present negative COVID tests before entering. Today’s release of initial jobless claims showed a further, albeit modest, slackening in domestic employment. Claims in the recent week rose by 9,000, to 225,000. Continuing claims increased 41,000, to 1.17 million. Ongoing wage growth remains a worry for the Federal Reserve.
This year, the Federal Reserve has raised short-term interest rates by 425 basis points, to a range of 4.25%-4.50%. Also, the central bank is reducing bond holdings on its balance sheet at a pace of $95 billion a month, via maturities and fewer purchases, thereby reducing market liquidity. Such actions are having an impact. Aside from a slowing housing sector, domestic manufacturing and industrial production have decreased. Still, the labor market has been stubbornly tight, pressuring employers to keep wages high, or increase pay, to hold on to workers. Fed officials, looking to rein in wage growth, appear intent on lifting interest rates to just over 5% by next spring, and then holding them at that level until 2024. Wall Street is concerned that the Fed’s strategy, along with similar undertakings by other world central banks, soon will push the global economy into a recession. A recent healthy third-quarter gross domestic product reading in the United States, and better-than-expected economic data out of Europe, suggest that any downturn will be relatively mild.
Hopes for a Santa Claus rally have been pretty well dashed as this week draws to a close. Indeed, many investors and institutions have been selling shares for tax-loss purposes, dragging down the major market indexes. Too, market participants are becoming increasingly focused on prospects for 2023, which are not all that encouraging. They are limiting risk exposure, reallocating portfolios in favor of value/defensive stocks and high-quality bonds, rather than growth equities. In 2022, the blue-chip Dow Jones Industrial Average, though so far in the red, has handily outperformed the technology-heavy NASDAQ. This trend may well persist in the first half of 2023.
Upcoming corporate earnings reports may be disappointing. For much of 2022, companies have been able to raise prices on goods and services to offset materials and labor inflation. Higher prices probably won’t be as easy to put in place next year. Net profit margins could suffer. On a positive note, healthy company balance sheets and fairly solid consumer finances should cushion the impact of a slowdown. Credit card balances are rising, but banks have taken care not to become heavily reliant on subprime lending, which would be more likely to default in a recession.
There’s a good deal of economic (e.g., Fed rate hikes) and geopolitical (the war in Ukraine) uncertainty going into the first half of 2023. Share-price volatility may perk up. We would not be surprised to see several brief stock market rallies and pullbacks. Investors should do well to stay with defensive issues over the short run. Once there is some indication that the Fed is nearing an end of its inflation-fighting program, they may begin to raise their exposure to riskier holdings, most prudently via dollar cost averaging (i.e., purchasing shares periodically with more or less equal amounts of money).
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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