The markets look to finish the week lower as fears regarding the economy continue to drive both sentiment and near-term activity. With economic data suggesting the economy isn’t slowing to the extent the Federal Reserve wants, it appears further rate hikes are forthcoming. While this is great news for savers, who have suffered the consequences of near-zero interest rates these past thirteen years, it is not such great news for consumers, employees, and employers who are all facing the difficulty of rising costs and diminishing opportunities, earnings, and certainty. What we can absolutely count on is the angst will not subside until the Fed signals it is approaching the end of its tightening cycle. Given speeches this week from several of the Board of Governors, it appears they intend to disregard the markets and push forward in the months ahead.
Marc will recap the third quarter in his upcoming quarterly newsletter, but I’ll just provide the prologue by saying the third quarter has closed below where we were at the end of the second quarter. Despite an attempted rally in August, investor sentiment fizzled as inflation data came in well above expectations, signaling further tightening by the Fed. Among the four heads of Federal Reserve banks that spoke this week were Lael Brainard, Mary Daly, James Bullard, and Loretta Mester. Perhaps the most shocking comment was from Loretta Mester who said she believes the Fed will not give up raising interest rates even if the economy slips into a recession. She sees inflation as more persistent than what the central bank’s latest median projection suggested, hence her hawkish remarks. At this point, analysts expect the Fed Funds rate to top 4% by the end of this year, versus the current rate of 3.00%-3.25%.
Here’s where things get dicey. The very news that the Fed is looking for to slow or end its quantitative tightening path is the same news that investors and analysts will likely see as negative. For example, Jerome Powell made clear in his latest remarks that he expects the unemployment rate to rise from 3.7% to 4.4% due to the intentional economic slowdown. The media will undoubtedly report this news as millions of people hitting the unemployment rolls, with weekly jobless claims potentially spiking. Additionally, as the economy slows we should expect to see Gross Domestic Product (GDP) slow or even fall, which will also be reported as negative news by the mainstream media. The combined effect of the intentional slowdown and it’s being reported on by the media will be a headwind for the stock market in the coming months despite it being the intended result by the Federal Reserve. So, on the one hand, inflation has sparked fear, while on the other hand, the remedy for said inflation is also sparking fear. The medicine, despite it tasting awful, will eventually heal the patient.
I’d like to say that company news will heal the current malaise, however, we should expect earnings season to bring further anxiety. Starting in a few weeks companies will begin reporting their third-quarter earnings. More importantly, some will likely lower expectations for the fourth quarter and perhaps even 2023. We may also begin to see analysts lower their estimates for the third quarter, ahead of the actual announcements. Analysts are predictably late when it comes to their recommendations and this time will be no different. We saw some big “downgrades” this week long after the market has already discounted the economic implications to these companies. I would expect we’ll see further downgrades and negative revisions over the next couple of weeks leading up to the earnings announcements. While this won’t last forever, it will feel uncomfortable while we go through it. The signal we should all be looking for is when the Federal Reserve says it is done raising interest rates. The day that happens, we’ll be off to the races.
In closing, our hearts go out to those who live in Florida, especially those in the path of Hurricane Ian. We have some clients that live in that area and they should know that if there is anything we can do to help, to please let us know. While we would never wish something like this on anyone, it is a reminder that life is precious and despite all our financial goals, sometimes life can throw a wrench into the best-laid plans. It also reminds us that family, friends, and health are the most important asset we have. Our thoughts and prayers are with you. Everyone stay safe and reach out to us if you need anything.Bruce J. Mason, MBA