October 2022 By Arthur Swalley, CIMA® Partner
Few times in recent history have presented such a dramatic difference between the real economy and the behavior of markets. Let’s examine the data to figure out if the widely predicted (and in some quarters, declared) recession is actually here.
September economic reports show that on the job front, nonfarm payrolls rose 263,000 while the unemployment rate fell back to 3.5%, tying the lowest level since 1969. Payrolls are up at an average monthly pace of 420,000 so far this year. Data shows the share of voluntary job leavers (often called “quitters”) among the unemployed reached 15.9%, the highest since 1990. Workers don’t quit their jobs unless they have optimism about their job and earning prospects.
Meanwhile, the ISM Services index came in at a robust 56.7 for September. A growing economy is north of 50 and the services portion of the economy is much larger than manufacturing, which came in at a solid 50.7. Auto sales were the fastest since April. Putting it all together, The Atlanta Fed’s GDPNow model is tracking a 2.9% real GDP growth rate for the third quarter. Clearly, none of this data indicates a recessionary environment.
Tell that to investors who see their accounts down in value! Stock investors should expect volatility, especially in the context of strong upside results post-pandemic and over the last decade. Still, seeing the S&P 500 down over 20% in 2022 is not a pleasant experience while living in what appears to be a solid economy.
Even more disconcerting is the performance of the bond market. The Vanguard Total Bond Market Index is down a stunning 15.75%, the bond market’s worst performance since… 1788! (To be fair, US debt default was a real possibility that year and led to the Constitutional Congress of 1789.) Returns on “safe” assets like US Treasury and municipal bonds sure haven’t been very safe this year.
The culprit, as we are sure you have guessed, is the inflation caused by rapid post Covid demand increases and supply chain constraints, on the back of effectively 0% interest rates spanning the prior decade. The Federal Reserve (and many of its global counterparts) have raised interest rates to combat inflation more quickly than any other time since its formation, explaining 2022’s terrible bond returns. What’s coming next? More hikes, but with a likely end in sight.
On October 19 in a Bloomberg TV interview, Federal Reserve Bank of St. Louis President James Bullard said he expects the central bank to end its ‘’front-loading” of aggressive interest-rate hikes by early next year and shift to keeping policy sufficiently restrictive, with small adjustments as inflation cools. The goal is to move to “some meaningfully restrictive level” that will push inflation down. “But it doesn’t mean that you go up forever,” he said.
The Federal Open Market Committee in September forecast raising rates to 4.5%-4.75% next year, which Bullard said could put downward pressure on inflation. Bullard, who’s been an aggressive inflation hawk, said he’s looking forward to switch to a more normal policy. “In 2023 I think we’ll be closer to the point where we can run what I would call ordinary monetary policy. Now you’re at the right level of the policy rate, you’re putting downward pressure on inflation, but you can adjust as the data come in in 2023.”
Market performance this year has clearly projected that the Fed’s interest rate moves this year will slow economic activity, and inflation, in 2023. Will there be a recession as a result? One prediction we can make is that no one, even at the Fed, knows how 2023 will play out. The result of this uncertainty is heightened short term market volatility, and a slowdown in corporate spending as profit margins are impacted by the effects of higher costs due to inflation and higher interest rates. In other words, the “quitters” should find their new jobs quickly!
All the short-term economic and market concerns and speculations we are witnessing have a very important effect on investors: scaring them into make emotional decisions, transferring wealth into the hands of patient investors. We prefer the patient approach and its proven long-term success.