October 2022 | Equity Commentary
Published on November 8th, 2022
The stage was set for an equity rally in October, in our view, given that negative sentiment and oversold conditions had both moved to extremes. The S&P 500 index rebounded a stout 8.1% for the month, and the Dow Jones Industrial Average notably posted its best month (+13.95%) since 1976.1 Equity markets may also have experienced an early benefit from seasonal forces, in which stocks have historically performed relatively well in the November to January timeframe – especially when there is a US midterm election. In the 18 midterm elections that have taken place since 1950, stocks have risen in the 12 months following the election 100% of the time, with an average 12-month forward return of +18.6%.2 In the fixed income markets, the 10-year US Treasury bond finally ended a 12-week streak of negative price returns, with yields falling 0.20% to finish the month at 4.02%.3
As financial markets expected, the Federal Reserve raised the benchmark fed-funds rate by 0.75 percentage points at the November 2 FOMC meeting. Chairman Powell reiterated that the Federal Reserve would rather go too far in hiking rates than not go far enough, as the central bank would more readily accept an economic recession versus entrenched inflation.4 Powell added that if the Federal Reserve had released new federal funds rate projections, they would have likely been higher given ongoing strength in the labor markets and another elevated inflation print in September.
In Chairman Powell’s press conference following the Federal Reserve’s announcement, the message was clear to financial markets that while the size of fed-funds rate increases may shrink at future meetings, the terminal rate – which is the end target for the Federal Reserve’s interest rate – would likely need to move higher. In Powell’s words, “the question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive.”5In other words, investors should not see a 50-basis point increase in December or smaller rate hikes in 2023 as a sign the Federal Reserve’s monetary tightening efforts are nearing an end. The Federal Reserve may go slower with rates, but they also may go longer and, ultimately, higher.
In our view, the macroeconomic picture influencing the Federal Reserve’s decision-making continues to be stubborn (US labor market) and sticky (inflation). The Labor Department reported that demand for workers continues to far outstrip the number of unemployed Americans seeking work. Total job openings unexpectedly climbed from 10.3 million in August to 10.7 million in September, which is slightly more than double the number of unemployed Americans seeking work (5.8 million). The September uptick may ultimately just be an anomaly, however, as the number of job openings has been in steady decline since its March 2022 peak of 11.9 million.6
On the plus side, we believe wages have been moving more favorably for the Federal Reserve, with average hourly earnings increasing by 4.7% year-over-year in October, a slightly slower pace than September’s 5%, and August’s 5.2%. The Atlanta Fed’s wage growth tracker, which measures the “nominal wage growth of individuals,” also fell in September from August – an early sign that wage pressures may have peaked.7 Additional data helpful to the Fed’s goals was the slight uptick in unemployment reported in early November, to 3.7% from the prior 3.5%.8
US GDP grew at an annual rate of 2.6% in Q3, according to the Commerce Department. Better-than-expected GDP growth runs counter to the Federal Reserve’s goal of cooling the economy, but a closer look at GDP’s components shows that overall demand in the economy is indeed falling. Final sales to private domestic purchasers –which measures underlying demand in the economy – moved up by just 0.1% from Q2 to Q3, which while positive indicates a significant downshift in activity. Final sales to private domestic purchasers had moved 2.1% higher in Q1 and 0.5% higher in Q2. A major factor in GDP’s strong Q3 print was a 2.8% increase in net external trade, a reversal from earlier in the year when imports detracted from GDP as companies rushed to restock inventories. Consumer spending edged higher in the quarter.9
Services and Manufacturing activity in the US both slowed from September to October but remain in expansion mode. The October PMI for Manufacturing was 50.2 percent, which was 70 basis points lower than the September reading. New orders eased over the summer months and companies are largely preparing for lower demand in the future, according to the survey. The ISM report showed that supplier deliveries were moving faster, raw materials prices had declined, and supply chain bottlenecks were all but gone, all of which point in a favorable direction with respect to inflationary trends. On the services side, the PMI registered at 54.4 percent, which remains firmly in expansionary territory but slowed considerably from September’s 56.7 percent reading.10
Finally, the US housing market continues to show material signs of weakness as the average 30-year fixed mortgage rate now hovers around 7%. Pending home sales declined 10.2% in September from August, pulling sales back to levels seen at the outset of the pandemic. With the exception of May, pending home sales have fallen every month in 2022, a sign that rising interest rates are denting demand and also that pandemic-driven migration trends are fading. Home prices are also showing signs of plateauing, with the S&P CoreLogic Case-Shiller National Home Price Index falling 1.1% from July to August, the biggest monthly decline since December 2011. With shelter making up approximately one-third of the Consumer Price Index (CPI) measure of inflation, easing home price pressures register as a good sign for the data- dependent Federal Reserve.11
As of October 31st, 2022