This blog serves as a follow up to our previously released Q4 Investment Themes, as well as an update on what we are seeing and our current outlook.
Here are the top three things we are covering in this month’s quarterly update blog:
- The Fed Pivot dominated market headlines and investor psychology all throughout the fourth quarter. Every job and inflation report was scrutinized under a microscope for some indication of slowing. Panic buying and fear of missing out drove market behavior for much of the quarter.
- The backward-looking jobs data continues to indicate a tight labor market. In addition, the labor market itself is a lagging economic indicator. Basically, the Fed is doubling down on old information to keep its foot on the brakes and tighten while the economy plunges further into recession.
- We are likely entering the next big phase of the bear market. This phase would include economic growth falling back to negative, decelerating but elevated inflation, a worsening of the housing market, more job layoffs, corporate earnings move deeper into recession.
Market
The S&P 500 (SPX). Hope for a Fed pivot bubbled up multiple times in the fourth quarter, which put a bid under the stock market. The SPX finished up 7.08% for the quarter. The Nasdaq lagged the other major indices as earnings warnings continue to weigh on stocks like Apple, Amazon, Tesla, Microsoft, semiconductor companies and others. The Nasdaq finished down -1.03% for the quarter. The Dow Jones 30 significantly outperformed the other major indices as investors bought blue chips and focused on value. In addition, many of the “defensive” or consumer staples stocks in the Dow outperformed.[1] Boeing also came roaring back from deeply oversold conditions and the damage to competitor Airbus because of corruption scandals[2], which was an additional boost to the index. The Dow finished up 13.26% for the quarter. Small Caps (the Russell 2000 or RUT) under performed slightly as investors are still reluctant to add higher risk stocks during the current market uncertainty. The RUT finished up 5.80% for the quarter.[3]
The World Index (MSCI) outperformed slightly. The drop in the dollar during the fourth quarter was one factor that helped some foreign companies, especially emerging markets. The MSCI finished up 9.42% for the quarter.[4]
The commodity index (DBC) under performed in the quarter as the “peak inflation” narrative kept pressure on raw materials. Recession worries may also finally begin to outweigh inflation hand-wringing, which is an additional headwind to commodity prices. The DBC finished up 2.22% for the quarter.[5]
Gold outperformed on the triple positives of dropping real yields, the drop in the dollar, and the flight to safety trade as investors re-position for a recession. Gold finished up 9.22% for the quarter[6]
Longer term interest rates (as measured by the Ten-year Treasury or TNX) were relatively flat in the fourth quarter. The Ten-year yield (TNX) finished the fourth quarter at 3.88%, up from 3.80% at the end of the third Quarter.[7]
Oil prices rolled up and down multiple times in the quarter, but in the end stayed relatively flat. The current administration is continuing to furiously work behind the scenes to manipulate prices through data massaging and draining the SPR.[8] Fortunately for them, they may get a boost to their efforts to suppress prices from a deep recession. Oil finished at 79.45 for the quarter.[9]
Economy
The on again off again “Fed Pivot” dominated market headlines and investor psychology all throughout the fourth quarter. Every jobs and inflation report was scrutinized under a microscope for some indication of slowing. If there was any hint of bad news, traders panic-bought ahead of what they were certain was going to be a Fed pivot. However, the pivot hysteria was dashed over and over again by the Fed throughout the quarter. It turned into a game of Whack-A-Mole between Jerome Powell and the financial markets. Traders may have bid up the stock market in the fourth quarter on Fed Pivot hopes, but the Fed remains steadfastly hawkish…and will likely stay hawkish in the first quarter of 2023.[10][11] And the further we move into recession, the more likely that panic buying will be replaced with panic selling. Our stock market view is that the risks to the downside are greater than the risks to the upside.
Data from the Government still indicates a tight labor market. This includes wage pressure from available workers per job opening.[12] However, the jobs market is a very lagging indicator because of the way the data is measured and reported. For instance, the U.S. still has a low unemployment rate, but that is because many people are being forced to take second jobs. In addition, there has been a decrease in full-time employees and an increase in part-time jobs.[13] There are serious cracks developing in the labor market[14], but those may not be fully manifested until at least April, and by then the Fed may have likely tightened too much to avoid a full-blown recession and a big market sell-off. The problem for the Fed is that they are using backward-looking jobs data, which itself is a lagging economic indicator. Basically, the Fed is doubling down on old information to keep its foot on the brakes and tighten while the economy plunges further into recession.
We are likely entering the next big phase of the bear market. This phase would include economic growth falling back to negative, decelerating but elevated inflation, a worsening of the housing market, more job layoffs, corporate earnings move deeper into recession, and serious corporate credit issues as the profit recession collides with higher interest rates.[15]
A credit crisis could end up being one of the biggest economic stories of 2023. Consumers are racking up historic levels of debt as rates hit multi-decade highs[16], while personal savings plunge to multi-decade lows.[17] And as noted, the confluence of plunging corporate sales and higher interest rates could cause a number of companies significant credit issues.[18]
The fourth quarter GDP report (for Q3) held slightly positive, which, as noted last month, was helped by the export of weapons, shrinking imports, higher government spending, and exports of oil and gas to Europe.[19] Projecting forward, our analysis is that GDP will fall back to negative in the first quarter of 2023.[20] In addition, we forecast GDP to continue to decelerate on a year over year (YoY) basis.[21] Peak inflation is yesterday’s news, and our analysis is that the Consumer Price Index will continue to decelerate on a YoY basis throughout 2023.[22] The issue continues to be that “peak” is different from “elevated.” We may have come down off the peak of Mt. Everest, but as long as we are stuck at 10,000 feet the economy will continue to experience altitude sickness. All this adds up to a forecast for the U.S. and much of the global economy for at least three straight quarters of Quad 4. As a reminder, Quad 4 means a period of decelerating growth along with decelerating inflation.
The housing market continues to implode. Pending Home Sales collapsed 38.60% in November, the largest annual drop ever[23] [24]. This, along with the bear market, is turning the Wealth Effect into a Wealth Dissipation as has been noted in this blog for several months. As consumers rack up more debt from inflation and lost jobs, they will spend less money on less things, which means companies will make less money…a lot less. A sharp drop in corporate earnings[25] is starting to collide with a sharp rise in interest rates. Corporate debt default rates are expected to be above historical averages in 2023.[26] There is very little in the macro outlook over the next 1-2 quarters that is positive for the economy. And with a high likelihood of a corporate profit recession hitting in the first quarter, it will be very difficult for the stock market to gain any kind of lasting traction in the first half of 2023.
Summary
- The Fed Pivot dominated market headlines and investor psychology all throughout the fourth quarter. Every jobs and inflation report was scrutinized under a microscope for some indication of slowing. Panic buying and fear of missing out drove market behavior for much of the quarter. However, the further we move into recession, the more likely that panic buying will be replaced with panic selling. Our stock market view is that the risks to the downside are greater than the risks to the upside.
- The backward-looking jobs data continues to indicate a tight labor market. In addition, the labor market itself is a lagging economic indicator. Basically, the Fed is doubling down on old information to keep its foot on the brakes and tighten while the economy plunges further into recession. The Fed may also be concerned about a repeat of the late 1978-79 when they thought they had stamped out high inflation and eased too soon, which only re-ignited inflation in 1980.
- We are likely entering the next big phase of the bear market. This phase would include economic growth falling back to negative, decelerating but elevated inflation, a worsening of the housing market, more job layoffs, corporate earnings move deeper into recession. In addition, we may see more serious corporate credit issues as the profit recession collides with higher interest rates.
We hope you have enjoyed getting a deeper look into our investment research and look forward to providing this to you each quarter going forward. Thank you from the entire Konvergent Team!
[1] https://ycharts.com/companies/XLP/performance
[2] https://www.americanthinker.com/blog/2022/12/airbuss_unfriendly_skies.html
[3] Slide – Major Indexes
[4] Slide – Global vs Emerging Market Equities
[5] Slide – Commodities
[6] Slide – Precious Metals
[7] Slide – 10 Year Treasury Rate
[8] https://www.zerohedge.com/energy/wti-extends-gains-after-small-crude-build-spr-1983-lows
[9] Slide – WTI Oil Price Change
[10] https://www.zerohedge.com/markets/stunned-wall-street-reacts-unexpectedly-hawkish-fed
[11] https://www.cnbc.com/2023/01/04/fed-minutes-december-2022-.html
[12] Slide – Labor Market
[13] https://www.zerohedge.com/markets/something-rigged-unexplained-record-27-million-jobs-gap-emerges-broken-payrolls-report
[14] Slide – Temp Labor Market
[15] https://www.zerohedge.com/markets/corporate-defaults-would-more-double-even-mild-recession-sp-global-warns
https://www.bloomberg.com/news/articles/2022-12-28/credit-market-cracks-widen-as-distressed-debt-nears-650-billion?leadSource=uverify%20wall).
[16] Slide – Credit
[17] Slide – Savings
[18] https://www.nytimes.com/2022/11/10/business/economy/corporate-bonds-fed-interest-rates.html
[19] https://www.bea.gov/data/gdp/gross-domestic-product
[20] Slide – GDP QoQ
[21] Slide – GDP YoY
[22] Slide – Consumer Price Index
[23] https://www.zerohedge.com/markets/us-pending-home-sales-crash-most-record
[24] Slide – Housing
[25] Slide – S&P 500 YoY Growth
[26] https://www.fitchratings.com/research/corporate-finance/us-euro-corporate-default-rates-to-continue-ascent-in-2023-2024-15-12-2022
https://www.wsj.com/articles/junk-rated-companies-face-greater-downgrade-risks-as-economy-slows-11669263665