BY: RYAN P. JOHNSON, CFA, CFP® - MANAGING DIRECTOR OF INVESTMENTS
The continued stock rally from the fourth quarter into early 2023 seems to be signaling “mission accomplished” for the Fed on the inflation front and reflects the sentiment that they will soon be done raising short-term interest rates. Employment has remained strong so far, volatility has fallen, but oil is a wildcard. Company updates in the coming weeks may help decide where stock markets go next.
Currently, the market expects 0.25% increases on February 1st and again on March 22nd, which would keep the effective rate just below 5% at its peak. Expectations for months further out should not be trusted but are pricing in possible rate cuts by year-end. A quick reminder, a year ago expectations were for 4 Fed rate hikes of only 0.25% each and instead we saw 7 hikes totaling 4.25%.
The CPI report (Consumer Price Index) for the month of December was 6.5%, down from 7.1% and 7.7% in the prior months. Core CPI, which excludes food and energy, was 5.7%, down from 6.0% and 6.3% in the prior months. The price of oil is influenced by many factors including domestic production, dollar strength or weakness, the Ukraine war, and demand from China as it continues to navigate COVID. Oil could continue to be a big swing factor in inflation readings not only because of the direct cost to consumers but also its effects on transportation costs, goods, and more.
Since our last Insights, interest rates have not moved too much. 3-month Treasury yields have ticked up slightly to reflect the coming Fed rate hikes while 2-, 5-, and 10-year yields have declined slightly. Short-term interest rates remain higher than long-term interest rates, which is known as an inverted yield curve. Historically, this has presaged a recession, but the timing has been inconsistent. Investor caution is still warranted, as the effects of the Fed’s rate hikes take months or quarters to be fully felt.
Volatility, as measured by the VIX index, recently reached a 1-year low. For the next few weeks, we will be closely monitoring fourth quarter results and first quarter outlooks. Analysts had been lowering estimates/expectations headed into this earnings season, which may help support stock prices. Historically, negative sentiment headed into earnings season has often led to gains during earnings season. For 2023, expectations point to 3-4% sales and earnings growth after an estimated 10% sales and 5% earnings growth year in 2022.
Other economic updates are mixed:
The most recent ISM Services report was below expectations and slipped into contraction territory for the first time since mid-2020. Weekly unemployment claims remain low and the monthly jobs report in early January showed a dip in national unemployment to 3.5%. However, we are seeing more companies, particularly large Tech companies, announce layoffs. On the plus side, the most recent survey on consumer sentiment improved.
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Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.