October Economic Update
Renewed concerns regarding inflation and another stern message from the Federal Reserve pushed the stock market lower in September to fully retrace the late summer rally and retest the yearly lows set back in June. The Dow Jones Industrial Average retraced lower by 8.84%, the S&P 500 dropped 7.95%, and the Nasdaq 100 Composite fell 9.13%. (1)
Investors came into September optimistic that the monthly inflation report would show a second meaningful decline for in the Consumer Price Index (CPI). But the August report showed a rise of 8.3% in consumer prices from a year ago, which was above consensus. Though the CPI number was incrementally lower from June and July, it was the 6.3% rise in core inflation, which is a measurement that excludes food and energy prices, that unnerved investors. Stocks sagged and bond yields surged on the news. (2)
In response to the CPI report, the Federal Reserve once again raised interest rates in September by 0.75% for the third time in a row. Fed Chair Jerome Powell also emphasized the need to raise interest rates higher and longer than what had initially been priced-in, which further unsettled the market. Guidance suggested interest rates may rise by at least another 1.25% by year-end, with short-term rates potentially reaching as high as 4.6% in 2023 with no interest rate cuts on the table until 2024. The Fed also revised their economic forecasts, including raising their estimates for inflation and unemployment. (3)
The Federal Reserve has increasingly been setting their sights on reducing inflationary pressures from the labor market. Their justification for targeting employment stems back to the late 70s and early 80s when we last experienced inflationary pressures at the levels we have today. During that period, businesses had to compete with one another to attract workers and did so by exponentially increasing wages in anticipation that inflation would continue to rise into the future. In turn, these expectations of higher inflation continued to drive costs higher, causing a “feedback loop”. For this reason, the Federal Reserve seeks to curb labor market demand and will likely continue to raise interest rates until a notable rise in unemployment is achieved.
We have noted several times during the past few months that the price valuations of the S&P 500 index have come back down to historical norms after the excesses experienced in 2021. We are now approaching another quarterly earnings season which will likely be the most pivotal of the year. Last quarter, analysts braced for lower earnings reports in response to higher interest rates and the strength of the U.S. dollar relative to other world currencies. While earnings did contract during that period, it was less than expected which sparked optimism about the strength of the underlying economy.
During this next earnings season which begins toward the end of October, the market will need to see similar results in order to sustain the current market valuations at this time. Several companies, including a major global shipping company and several semiconductor businesses, have already lowered forward guidance due to decelerating demand, citing global economic pressures. If the broader S&P 500 companies report similar trends, the price-to-earnings ratio could once again experience a revaluation.
As we look at economic conditions month-to-month, it is clear we still need inflationary pressures to decline substantially in order for the Federal Reserve to cease interest rate increases and relieve monetary constraints which have caused a global economic slowdown. The October CPI report will once again be closely watched and scrutinized for any signs of relief as we approach the end of the year. Until that happens, we would expect to see more price volatility – both to the upside and downside – as the market attempts to forecast future growth expectations into 2023.
Monthly Financial Tip:
Keep your tax documents organized throughout the year with W-2s, assorted 1099s, and necessary receipts reflecting business and health care expenses and charitable gifts.
1. WSJ.com, September 30, 2022
2. WSJ.com, September 13, 2022
3. WSJ.com, September 21, 2022
This post has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. Bob Lawson is not engaged in rendering legal or accounting services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.