Thursday, December 8, 2022

The Six Factors to Expect during the end of 4Q22

By on November 10, 2022

We are deep within the fourth quarter we thought it prudent to offer some thoughts as to what we should expect to end the fourth quarter and the year 2022. As pessimism persists and other questions about all kinds of economic expectations, we wanted to offer a focused and detailed analysis for investors to ponder. In the U.S. and Puerto Rico, we have a robust banking system, vigorous consumer activity, better-than-expected corporate earnings results, and stable job growth with historically low unemployment. 

When navigating the uncertainty of future economic performance with higher than normal market voaltility it creates investors with a deep sense of pesimism and while we canot fix all your concernrs we offer our coomentary to helo you navigate these uncertain times.

There are two quotes that I used often to help investors navigate uncertain times one is from John Maxweel that says ” On the other side of the storm is the strenght that comes from having navigated thru it, so put up you sail and go” The other quote is from The Oracle of Omaha Warren Buffet that says “Be fearful when others are greedy, and greedy when others are fearful”

Choose the one you like best and stick with it’s  important to remember that markets generally surpass in both directions: Extreme and Prudent.

We will look at the six factors at play to end the year; let’s begin.

1. U.S. Economic outlook for the fourth quarter

The GDPNow model predicts a 3.6% GDP increase for the fourth quarter, up from its initial forecast of 2.6%. 

With inflation running at 8.20%, the Federal Reserve is forced to act aggressively to achieve their stated 2% inflation goal for the U.S. this translates into an aggressive 75 basis points campaign that has taken rates from 0.25% in January 2022 to 4% in November 2022. 

Conventional wisdom states that rising rates could damage the economy and take into a recession, this has not happened, and in fact, the GDP for the third quarter was a robust 2.60%. We view that most of the monetary policy increases have been priced into the markets, and we also think inflation has peaked. These facts, as mentioned earlier, have set the stage for a gradual market recovery. 

However, we must also contemplate the effect of higher interest rates, inflation, and the broader impact of the Ukraine conflict continues to add high levels of uncertainty, which could end up taking the U.S. economy into a recession during 2023. 

Image supplied

However, should the roadblocks clear up without any significant economic impact, the recession, should it materialize, could be pretty mild. 

2. Wall Street and Markets live in the future

As we have often stated, Wall Street is always focused on the future, and this year is no exception. Typically stock markets are ahead of the economy by at least six months, and what the results have been telling us since January is a reflection of a mild recession. 

We must consider that this year’s robust job growth, record-low unemployment rate, and more substantial than-expected consumer spending are all incompatible with a recession. But as the Federal Reserve Banks’ aggressive rate increases make their way into the economy, slower job growth is unavoidable. 

3. Inflation is the main culprit 

As we continue to march toward the end of Q422, our biggest concern to sway markets up or down is the inflation number. Following four 75 basis points increases and inflation remains at 8.20%, the FOMC is expected to see no less than three significant inflation decreases before it can pivot its aggressive camping. We predict inflation will subside during Q422, driven by improvements in the supply chain, less pent-up demand, lower housing sales, and improved market dynamics. 

Once the Fed pivots, the broader markets will rally, mounting a solid recovery.

4. The Fed Committed to 2% inflation

We are so much closer to the end of the aggressive interest rate cycle as there are faint indications of inflation slowly easing away, albeit not as quickly as the Fed desires. 

Let’s analyze this further; the Fed preferred inflation benchmark, the U.S. Core Personal Consumption Expenditures, has been above 25 since April 2021, when it hit 3.65%, and the fed waited until 2022 to act upon inflation; below, we share the numbers. 

   U.S. Core PCE:

  • Sep. 22 6.24%
  • Aug. 22 6.22%
  • Jul. 22 6.36%
  • Jun. 22 6.98%
  • May 22 6.52%
  • Apr. 22 6.41%
  • Mar.22 6.77%
  • Feb. 22 6.39%
  • Jan. 22 6.12%
  • Dec. 21 5.97%
  • Nov. 21 5.85%
  • Oct. 21 5.22%
  • Sept.21 4.65%
  • Aug. 21 4.52%
  • Jul. 21 4.28%
  • Jun. 21 4.09%
  • May 21 4.02%
  • Apr. 21 3.65%
Image supplied

The Fed was late to act upon inflation by at least 11 months, and being late to its inflation mandate has cost the Fed credibility; this is why they are committed to achieving 2% inflation. 

The silver lining for investors is that following the end of the Fed’s tightening cycle, market performance has been historically robust from 12 and 24 months after the Fed’s policy rate pivots. While interest rate-driven volatility shall continue, we expect it to subside once inflation is deemed to have been beaten. 

5. What does the recovery will look like, “V” or “U” shape:

We expect markets to recover in a gradual manner more consistent with a “U” shape recovery instead of the v “V” shaped recovery favored and experienced recently. While the complete recovery will take time to show its face, and there will be disruptions along the road ahead, we advise investors to look for these conditions. 

  • Four months of consistently declining inflation.
  • Rising corporate earnings.
  • A rise in market valuations.
  • Widespread Optimism.
  • The leading indices were turning positive YTD.

6. Global outlook

Most global markets have taken a beating, with stock markets lagging, with the U.S. dollar rising to increased levels and a dramatic global growth slowdown to 3.2% GDP from its original projection of 4.5%. 

The Russian and Ukraine war has thrown Europe in a tailspin not seen since WW2, and due to its reliance on Russian Gas and Oil Exports to the tune of 40% for Gas and 25% for Oil, it has made the Eurozone an easy target. Challenges will continue, but solutions are on their way to eradicate Russian Gas and oil supply dependency. With challenges persisting, the IMF has lowered its economic forecast for the Eurozone to 2.6% for 2022 and 1.2% for 2023. Also, China has never been transparent about its homegrown COVID pandemic’s severity. The year 2022 will be recorded as one of its worst economic performances in decades, with the IMF projecting 3.3% GDP for 2022 and 4.65 for 2023. Lastly, Russia will see its GDP fall by at least -6.0% in 2022 and -3.5% in 2023. Being isolated by the western nations in its quest for the domination of Ukraine has dramatic costs to Russia. 

Image supplied

The Week in Markets: U.S. Nonfarm Payrolls fell -17.14% to 261,000, with unemployment increasing to 3.70%, and Wall Street lost for the week

The U.S. stock markets ended the week with gains as stocks rallied during the session, but the gains were not high enough to erase the weekly losses. Investors who had been anticipating the nonfarm payrolls jobs report it finally showed that the economy created 261.000 new jobs or -17.14% less than last month. The results split investors into two views: those that understand that the jobs number will make the Fed more aggressive with its rate increase campaign. The other view is that the labor markets are beginning to soften, and unemployment has risen to 3.70%. The question here is, who will get it right?

As the midterm election is happening Tuesday, how these numbers affect or benefit either party is still being determined.

Wall Street Weekly Summary for the week ending November 4:

  • Dow Jones Industrial Average closed at 32,403.22, down 458.58 points or -1.40%.
  • S&P 500 closed at 3,770.55, down -130.51 points or -3.35%.
  • Nasdaq Composite closed at 10,475.26, down -627.19 points or -5.65%.
  • Birling Capital Puerto Rico Stock index closed at 2,656.20, down 107.34 points or -3.88%.
  • The U.S. Treasury 10-year note closed at 4.17%.
  • The U.S. Treasury 2-year note closed at 4.66%.
Provided by Birling Capital LLC

One last lesson: The time has come to adjust the investment objective from a defensive for inflation one to a growth one.

As we have seen so far, we do not see the Fed modifying its aggressive interest rate campaign. However, given that in terms of inflation we are headed in the right direction, we feel it is appropriate to start adjusting our investment objective from a defensive one to a growth one.

As markets shift into growth mode, we will start to see lower yields on bonds and an increase in yields on most equities, and given the lower prices, we are seeing that create a compelling opportunity for growth. As soon as investors sense that inflation has been tamed, pessimism will dissipate, and corporate earnings misses will become buying opportunities for many; the key is to catch the growth and earnings train early.