Winter Cold Snap

Telemus Weekly Market Review December 12th - December 16th, 2022

It was an eventful week for markets as investors reset expectations around inflation, the economy, and interest rates. Stocks had a challenging back half of the week after a sharp drop on Thursday and continued sell off on Friday resulted in the S&P 500 finishing the week down -2.1%.

Oddly, Treasury yields, particularly intermediate and longer maturities, finished the week lower. This reflected a selloff in rates following Tuesday’s November CPI report, as investors initially interpreted the data as a sign the Fed might begin to take a more dovish, or less restrictive stance. While rates backed up slightly during the back half of the week, they remain at a level that is counter to what the Fed is presently guiding to. 

On Tuesday markets were given fresh inflation data as the Consumer Price Index (CPI) for the month of November came in with a tepid reading of +0.1%. This was the lowest reading in over a year (August of 2021). Gasoline and natural gas prices helped to push the CPI index lower, although the more stable Core CPI index, which includes more volatile food and energy categories, rose only +0.2%. The one-year inflation rate now sits at 7.1%, down from 9.1% back in June. The moderation in inflation was a welcome sign as it signals that the Fed’s efforts to cool inflation are taking hold. Moreover, when looking at the data more granularly the pace of price increases was generally lower across categories. However, this month’s low reading was accentuated by much lower gasoline, natural gas and used car prices which each fell -2% or more, a drastic move in just a single month. These items are more cyclical and the deflationary trend will eventually run out of steam.

On Wednesday the Federal Reserve Open Market Committee (FOMC) concluded a two-day meeting where they agreed to raise the Federal funds rate by a half of a percentage point. This was a deceleration from the past four meetings where they had hiked rates by three-quarters of a percent. The Federal funds rate now sits between a range of 4.25% and 4.50%, a 4.25% increase from where it stood at the beginning of the year. In addition to the rate hike, members of the FOMC updated their individual economic forecasts, with projections implying interest rates might go another three quarters of a percent higher over the course of 2023. Moreover, committee members indicated interest rates were unlikely to go lower until 2024, a point further emphasized by Fed Chairman Jerome Powell in his press conference. 

Treasury yields remain defiant of the message the Federal Reserve is sending, with intermediate and long-term Treasuries pricing in quicker and more aggressive rate cuts than the Fed has expressed. In our view this follows the old playbook that has existed since the Great Financial Crisis when zero interest rate targets were first used. Under this playbook bad economic news could be followed by support of the Fed, whether that be lower interest rates, more dovish (less restrictive) guidance, or quantitative easing. These pivots by the Fed ultimately led to a rebound in asset prices. Given the highly inflationary environment we have been through, the Fed seems to be less accommodating in order to ensure inflation is out of the economy. We take them at their word as thus far this cycle they have followed through on the expectations they have set. This week’s lower than expected inflation reading for November is a welcome sign and indication the Fed may not have to go much higher with rates. However, they will need to stay the course in keeping rates elevated to ensure that the inflation fire smolders rather than reignites. The most recent data around producer prices (industrial input prices) and average hourly wages both experienced an uptick in trend and demonstrate that inflationary flames still exist. 

From an investment perspective, until the market is able to come to a greater consensus around expectations for inflation, interest rates and the economy, we expect there will be episodes of sharp moves in asset prices. These don’t have to be to the downside, as evidenced by the welcome equity rally that began in mid-October. The increase in shorter-term trading strategies that have more speculative investment philosophies has, in our view, lead to exaggerated moves both to the upside and the downside. Due to this we recommend one look at investing in today’s market with a wide-angle lens rather than a zoom lens. Using the long-term, wide-angle perspective, this week’s data in our view was a positive. Evidence that the Fed’s efforts are working could lead to fewer and smaller interest rate hikes from here. That only improves the probability of potentially achieving a softer landing for the economy. Moreover, taming inflation now rather than risk letting it rear back a couple years down the line may be more painful in the present climate, but for long-term investors is a positive as it should create a smoother road ahead. Lastly, while bond returns have been a challenge in 2022, we believe a slower cadence with rate increases will put less pressure on bond prices going forward. With bond yields now at attractive levels, we are becoming more optimistic about the return potential for the bond market in the years ahead. 

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