Dear Clients and Friends:
Since the beginning of this year’s fourth quarter, the S&P 500 has enjoyed a double-digit percentage move upward. With market-moving topics featured prominently in the recent news cycle, we thought we would share our thoughts on what we see as the key current issues.
Post-election thoughts. On balance, analyses of the relationships between U.S. election outcomes and equity markets suggest that markets tend to do better under democratic presidencies and with split government, both of which now obtain. However, the results of such studies are dependent upon time periods analyzed and are highly subject to alternative explanations. In our view, the most reliable observations on this matter are first, that markets tend to get a bounce following elections. In fact, the S&P 500 has been positive in the six months following every mid-term election since 1950.¹ Second, many investors overreact to election outcomes.
Basing significant market calls on an election outcome rarely works out well in our experience. In studies of U.S. equity market returns covering more than 200 years, the market has had a remarkably consistent long-term real (net of inflation) return (6.9% as of 12-31-21)². Recessions, wars, and changes in political control have had limited impact on the long-term return which seems determined by fundamental attributes of the U.S. economy. With this year’s election’s turning more on political as opposed to economic issues, and with the split-government result, investors now post-election are quickly turning their attention back to other matters.
Inflation and the Federal Reserve’s response thereto continue to top market concerns. On November 10, markets responded favorably when the CPI (Consumer Price Index) for October came in below expectations. The 7.7% year-over-year increase was the lowest reading since January 2022. Core inflation (the Fed’s preferred measure) also slowed. Employment data which showed rises in new unemployment claims and in total claimants further added to hopes that the Fed might moderate its inflation fight. But in response to these data and the market’s reaction thereto, Fed speakers came out emphasizing the need to continue raising rates and with an expectation that rates will need to remain elevated for longer than the market expects.
On November 15, PPI (Producer Price Index) numbers came in significantly lower than expectations leading to a decline in rates across the curve. While we doubt that we are even close to a Fed “pivot” to lower rates, these most recent data raise the odds for a slowing in the pace of rate rises in the next couple of months, and for a pause in rate rises by the end of Q1, both of which would be well-received by markets.
Recent economic resilience is likely to weaken – which may not be all bad for equities. U.S. GDP (Gross Domestic Product) for Q3 came in at a stronger than expected 2.6% real growth. However, forward estimates are declining, with 38 forecasters surveyed by the Federal Reserve Bank of Philadelphia predicting the economy will expand at an annual rate of 1.0 percent in Q4 and rising only 0.7% in 2023. And it is not hard to find forecasts for GDP declines over the next three quarters, with support from indicators including the yield curve and the Leading Economic Indicators index. However, even the more negative forecasts foresee only a mild recession. Due to their impact on inflation and Fed policy, indications of economic softening are likely to be taken in stride by equity markets in the period ahead.
Corporate profits are weakening. With Q3 earnings season complete, 69% of reporting companies have matched or beaten their estimates, modestly below the 10-year average of 73%.³ Aggregate S&P 500 earnings registered a 2.2% year-over increase. However, since September 30 estimates for Q4 have fallen by 4.7% on a year-over-year basis, and now show an expected 1% decline. Even if the economy can manage to escape recession, the prospect of a profits recession in 2023 has grown increasingly likely and will be a significant market headwind moving forward. In this environment, stocks of companies that can maintain pricing power should benefit, a view that will continue to shape our portfolio strategy.
Geopolitical events are always a wildcard, and ones which tend to skew negatively in their market impact. However, in the present situation, the prospects for market friendly developments should be recognized. If China’s zero-Covid policy winds down because of a deal for the BioNTech vaccine which is now under discussion, the boost to global growth could be significant. As to the war in Ukraine, the next several months should bring a weather-induced slowdown. While it is likely that the conflict escalates thereafter, there is also the prospect that Russia’s war-making capability could be significantly weakened by spring.
Crypto collapse. On the day on which the potential rescue of crypto trading firm FXT collapsed, equity markets dropped sharply after the news broke. However, over the succeeding days as the news about FXT worsened, the market moved higher. The consensus view to which we subscribe is that the risk of contagion from collapsing values in the crypto space is small. While there will be some prominent victims, the overall size of the asset class is small. We are pleased to have completely avoided the space and plan to continue doing so.
We hope the above comments provide helpful context for the current news flow impacting markets. Please do not hesitate to reach out about how any of these topics affect your personal situation, or about any other items to be addressed prior to the end of 2022.
Thanks,
Kevin Barlow and Kevin O’Grady
Sources:
1Jeff Sommer, “The Market Usually Rises After Midterms,” The New York Times, October 28, 2022.
2Jeremy Siegel, “Stocks for The Long Run,” New York: McGraw Hill, 2022.
³ Factset, “Market Rewarding Positive EPS Surprises More than Average,” November 11, 2022.
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This piece is limited to the dissemination of general information pertaining to MPS’ investment advisory services and general economic market conditions. The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. As such, the information contained herein is not intended to be personal legal, investment or tax advice or a solicitation to buy or sell any security or engage in a particular investment strategy. Nothing herein should be relied upon as such, and there is no guarantee that any claims made will come to pass. Any opinions and forecasts contained herein are based on the information and sources of information deemed to be reliable, but MPS does not warrant the accuracy of the information that this opinion and forecast is based upon. You should note that the materials are provided “as is” without any express or implied warranties. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
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