Mid-Quarter Market Update

Markets continue to take their direction from central banks, and we anticipate this will continue well into the new year. While still down double digits year-to-date, equities have rallied 12% and bonds 3% since the end of September.  Central banks’ actions imply a step-down in the size of the rate hikes and, in some cases, even a pause.  This rhetoric has led to the most substantial gain in a quarter since the pandemic rebound in 2020.  Important central bank stances that have changed recently include:

• The U.S. Federal Reserve slowed the pace of rate hikes from 75 basis points (bps) in November to 50 bps in December.  
• The Bank of Canada stepped down from 75 bps to 50 bps in late October.
• Australia and Norway decreased from 50 bps to 25 bps in October/November.
• Brazil and Poland both paused, leaving rates unchanged at their most recent meetings.

While still stubbornly high, the aggressive hikes throughout the year seem to be getting us past peak inflation.


 

• Though the year-over-year change in inflation remains high at about 8% for the Consumer Price Index (CPI) and 7% for Core CPI, the 3-month change shows a better trend.
• 3-month CPI has fallen to 4% from nearly 12% at the peak. 
• Core CPI, which is CPI without food and energy, has fallen to about 6% from a high of over 10%.

Inflation moderating is a good sign; we expect this to continue throughout 2023.  However, it’s also too early to declare that the worst is over for equities. 

The recession is rolling through different parts of the economy at different times, much differently from the everywhere-at-once recessions of 2020 and 2008/2009.  Certain segments of the economy entered recessionary territory in 2022 – notably housing, some goods-oriented segments, consumer confidence, and CEO confidence.  Other areas have grown, such as travel and leisure.  We expect an official recession in early to mid-2023 as the Fed’s stated goal of bringing down aggregate demand will continue slowing the economy.  Earnings and labor market weakness are typically the last dominos to fall before a recession is declared.  We are at the beginning of this stage.

We know a recession is worrying for portfolios.  We would be remiss if we did not again highlight how equity markets behave around them.  In nearly all recessionary markets, equity price declines precede the fall in earnings, growth, and employment during recessions. An example is below:



The bottom in equities occurs even as news on profits, GDP, and payrolls worsen.  The same pattern happened during the 1970’s stagflation, the 1980’s double-dip recession, the S&L crisis of the 1990’s, the Global Financial Crisis, and the COVID pandemic.  Right now, we do not see this cycle ending differently than other recessions. 

We anticipate continued volatility and weakness into the first quarter of 2023, followed by a sustainable recovery towards the middle of the year.  Our focus remains building portfolios of quality companies and bonds that can weather this storm.