November 2022 | Equity Commentary
Published on December 13th, 2022
U.S. stocks and bonds performed well in November. The S&P 500 finished 5.6% higher for the month and the 10-year U.S. Treasury bond yield retreated by 44 basis points to end the month at 3.6%.1 Positive performance was driven early in the month by what appears to be encouraging inflation data. The Labor Department reported that the Consumer Price Index (CPI) rose 7.7% in October, a meaningful decline from June’s 9.1% report (which may mark the peak) and the 8.2% reading in September. Core CPI rose 6.3% year-over-year in October which also marked an improvement from September’s 6.6% reading2. On the day of the inflation data release, the S&P 500 jumped +5.6% and the tech-heavy Nasdaq posted a sharp +7.4% rally.3 There are many factors that ultimately drive stock prices, but recent price action suggests the current market continues to be very sensitive to how inflation data may influence Federal Reserve policy. Softer inflation readings suggest the Federal Reserve can slow its pace of monetary tightening, which is a likely tailwind for asset prices.
During November, speeches by Federal Reserve officials and eventually Federal Reserve Chairman Jerome Powell, in our view, appeared to indicate the Federal Reserve may be ready to reduce the magnitude of its rate hikes to 50 basis point increases. In a speech at the Brookings Institute, Powell said that “the time for moderating the pace of rate increases may come as soon as the December meeting,” but also that “wage growth remains well above levels that would be consistent with 2% inflation.” 4Powell also acknowledged that rate increases take time to work their way through the economy, an indication of the Fed’s sensitivity to potentially over-tightening in this cycle. Though the Federal Reserve may downshift in terms of the size of rate increases, we believe the central bank has also tried to stress that the terminal fed funds rate may wind up higher than investors are currently anticipating.
Our perspective is that the labor market is a key reason the Federal Reserve continues to push the “long road ahead” narrative for monetary tightening. The U.S. economy added 261,000 jobs in October, and average hourly earnings rose 4.7% from October 2021. There were also 10.3 million job openings in the US as of the end of the month. A closer look at this labor market data offers some silver linings for the Federal Reserve, however. Though job openings remain too high, they did edge down from the previous month. Ditto for hourly earnings growth in October, which was still well outside of the Federal Reserve’s comfort zone but also marked an improvement from September’s 5.0% year-over-year growth rate.5
We believe the strong labor market has been helping US consumers navigate higher prices. Consumer spending rose 0.6% in September from August, and retail sales rose a seasonally adjusted 1.3% in October compared to September. These figures are not adjusted for inflation, so higher prices can result in higher levels of spending. But it is worth noting that consumers increased spending in non-essential categories, like outings at restaurants, home furnishings, and clothing.6 Anecdotally, the average Thanksgiving week airfare was up 46% year-over-year, but it did not stop Americans from making trips. Overall air travel still went up. 7
Wages are rising but have not kept up with inflation, and as a result Americans’ savings stockpile is starting to shrink – according to government data, somewhere between $1.2 and $1.8 trillion savings remain, which is a notable retreat from the $6+ trillion level reached in the months following the pandemic (when the first stimulus checks started to arrive). The runway for remaining savings may be as little as nine months, which could impact consumer spending particularly if inflation remains elevated. Worth noting is that the Federal Reserve Bank of New York said credit-card balances have risen by 15% year-over-year in Q3 2022, the fastest pace of increase in 20+ years. Consumers have been holding up remarkably well, but it remains to be seen how long the strength can keep up.8
Q3 2022 earnings season has wrapped up, and the latest estimates show earnings-per-share growth of 4.3% on 11.0% higher revenues. These results were largely seen as disappointing by financial markets particularly compared to previous periods, but they were not altogether surprising. Earnings estimates have been coming down all year, and Q4 estimates have already declined by 5.3% since September 30. 9Lower earnings estimates should not be viewed as a major negative, however. Falling expectations often mean a lower bar that corporations need to clear to deliver a positive surprise.
Overseas, China’s economic and socio-political woes joined the war in Ukraine as the biggest stories impacting the global economy. China’s years-long “zero Covid” strategy has reduced death and infection rates, but has also stifled economic growth and, most recently, contributed to citizen unrest and protests across major cities. On the economic front, November activity in China’s manufacturing sector measured by the purchasing managers’ index fell to 48 from 49.2 in October, marking two consecutive months of contraction. Another index that measures activity in the services and construction sector in China also fell month-over-month in November, to a notably weak 46.7.10
Part of the justification for communist rule in China is supposed to be steady economic growth and plentiful opportunity for employment, both of which have been severely compromised by the zero Covid strategy. China’s youth unemployment rate reached 17.9% in November,11 and a sputtering economy beset by strict lockdowns has diminished quality of life. The very rare show of defiance by protestors sent a strong message, however, with the state now scrapping rules for mass testing, ending mandatory hospitalization for people who test positive, and reconfiguring how lockdowns are imposed, among other changes. China is now belatedly shifting some of its focus to vaccinating a larger percentage of the population, particularly among the elderly, who currently have low vaccination rates. Only about 40% of those over 80 have received a two-shot vaccine plus a booster.12 China’s pivot comes as winter months approach, so there is good reason to be cautious about the short-term impact of infection spread, even as reopening is likely to support the economy over the medium term.
1 – Bloomberg: SPX Index; CT10 Govt functions
11 – http://www.stats.gov.cn/english/PressRelease/202211/t20221115_1890234.html
As of November 30th, 2022