Rate Worries Weigh on Markets (Again)

Performance for Week Ending 12.16.2022:

The Dow Jones Industrial Average (Dow) finished down 1.66%, the Wilshire 5000 Total Market Index^SM (Wilshire 5000^SM) lost 2.04%, the Standard & Poor’s 500 Index (S&P 500) fell 2.08% and the Nasdaq Composite Index (NASDAQ) shed 2.72%. Sector breadth was negative with 10 of the 11 S&P sector groups closing lower. The Consumer Discretionary (-3.63%) was the worst performer followed by Technology (-2.67%) and Financials (-2.49%). The Energy sector bucked the trend to finish up 1.72%.

*See below for Index Definitions

MARKET OBSERVATIONS: 12/12/22  – 12/16/22

The S&P 500 finished lower for a second straight week following a round of global central bank interest rate hikes and indications that rates will continue to be pushed higher. Stocks posted gains early in the week after the year-over-year pace in consumer prices fell and came in better than economists forecasts. On the inflation front, the Labor Department reported that consumer prices in November increased by a lower than expected 0.1%, and by 7.1% from a year ago. While the year-over year pace remains elevated, it is down from 7.7% during October and the peak reading of 9.1% during the month of June. Excluding volatile food and energy prices, the so-called “core” CPI rose 0.2% during the month and by 6% on an annual basis, both were also better than forecast and down from the prior months reading.

Fed Meeting – Higher for Longer: As expected, the Fed hiked its benchmark lending rate by 50 basis points (bps), capping a year of seven hikes that have added 4.25% to the Fed Funds rate. The central bank also indicated that it will likely push the Fed Funds rate above 5%, implying at least another 75 bps in cumulative hikes, before holding at that level for most of next year. "We're into restrictive territory," Fed Chairman Jerome Powell told reporters in Washington. "It's now not so important how fast we go. It's far more important to think what is the ultimate level (and) how long do we remain restrictive." Powell cautioned "there is a strong view on the committee that we'll need to stay there until we're really confident that inflation is coming down in a sustained way and we think that will be some time." The hawkish signaling snuffed out a three-day rally on Wall Street, triggered in part by the softer-than-expected November consumer inflation reading. During the follow-up press conference Powell said there would be no cut in rates until the Fed is confident that inflation is moving down to 2 percent in a sustained way, adding that wage gains right now are running “well above” what would be consistent with 2% inflation. Later in the week, New York Fed President John Williams said that while inflation has showed some signs of slowing, a tight labor market and other factors are likely to keep price pressures elevated and warrant high interest rates for some time.

Summary of Economic Projections: In addition to the FOMC meeting, the Fed also released its updated Summary of Economic Projections (SEP) which showed the forecasted midpoint for the fed funds rate at 5.125% by the end-2023 (vs. 4.625% in the September projections). The SEP showed lower GDP growth and higher unemployment rate and inflation projections over the 2023-2025 forecast horizon. The median projection now shows the unemployment rate rising from its current 3.7% level to 4.6% in 2023 (vs. 4.4% previously), 4.6% in 2024 (vs. 4.4% previously), and 4.5% in 2025 (vs. 4.3% previously). The SEP showed an upgrade to the GDP growth projections in 2022 as participants incorporated Q3 GDP data (up 0.3% to +0.5%) but showed downgrades to growth in 2023 ( down 0.7% to +0.5%) and 2024 (down 0.1% to +1.6%) and left the 2025 growth projection unchanged at +1.8%. The median core inflation forecast was meaningfully revised up for 2022 ( up 0.3% to 4.8%), 2023 (up 0.4% to 3.5%), and 2024 (up 0.2% to 2.5%) but was unchanged in 2025 at 2.1%. While the Fed’s updated projections don't explicitly call for a recession, a rise in the unemployment rate by as much as what they are forecasting has historically been consistent with a recession.

While the equity markets got pummeled due to the higher rate projections, some corners of the markets appeared unfazed with the Fed’s new guidance for over 5% rates in 2023. Traders’ rate expectations for next year barely budged last week with Bloomberg’s World Interest Rate Probability screen showing a peak rate of around 4.84% by May and 4.33% for end of 2023. The 2-year Treasury yield—the most sensitive to changes in monetary policy—finished the week at 4.18%, down by 4 basis points from before the meeting. The reaction to the news is almost always more important than the actual news and the message being sent by the rates market seems to be that Trader’s don’t believe what the Fed is saying. In other words, investors should pay more attention to what they do versus what they say – stay tuned.

Wasn’t Just the Fed: Following the move by the Federal Reserve, both the Bank of England and the European Central Bank (ECB) followed suit and hiked their key policy rates by 50 basis points. While the 50 basis point hike by the ECB was a step down from the 75 basis point move at the prior meeting, ECB President Christine Lagarde made it clear that more rate hikes are coming. Lagarde told reporters that the ECB's smaller half-point increase did not mean its rate-hiking campaign was shifting down a gear. “We have made progress over the course of the last few months, but we have more ground to cover, we have longer to go and we are in for a long game,” she said. “We’re not pivoting, we’re not wavering.” She said rates could go up at a pace of a half-percentage point per meeting “for a period of time."

Bad News is now Bad News: Adding to the negative sentiment was a batch of weaker than expected US economic data. Unlike in recent months, when the market would move higher in the face of weaker than expected economic data—reflecting expectations of an early end to the Fed’s rate hike program—this week’s data spurred concerns that a recession maybe inevitable. Regional manufacturing data from both the Philadelphia and New York Federal Reserve banks showed manufacturing activity contracting during the month of November, while U.S. Retail Sales during November fell for the second time in three months (not a good sign when 70% of US economic growth is fueled by consumer spending).

The Week Ahead: Following last week’s disappointing report on retail sales, the US consumer will be the focal point for investors as recession concerns mount. Among the key data releases will be consumer confidence and personal income data, along with PCE inflation. We'll also see housing market data including new and existing home sales. The earnings calendar will be light with just 9 members of the S&P 500 expected to release results. The Fed speaking calendar will be nonexistent with no formal presentations scheduled.

— By Michael Schwager, Chief Market Strategist, Managing Director

Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market Index^SM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500^© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

This material contains opinions of the author, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC.