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Investment Improvements are Happening!

It’s hard not to be surprised by the relative strength of the economy and markets as we approach year-end.

Despite 375 basis points of Fed hikes so far this year, the consumer remains unbroken, and the unemployment rate has barely moved. The equity markets have picked themselves off the floor at the end of the third quarter but there’s evidence that the central bank’s work is far from complete.

To be clear, the Fed is seeing considerable evidence that their hikes are affecting economic activity and the rate of inflation. Higher interest rates have delivered a direct hit to home sales, for both new and existing properties. In addition, manufacturing contracted for the first time in 2.5 years in November. And the all-important Consumer Price Index (CPI) is trending in the right direction. The June through October CPI reports were 9.1%, 8.5%, 8.3% 8.2%, and 7.7%.

The problem is that inflation is not declining fast enough for policymakers who maintain a congressionally mandated target of 2% annual inflation. While supply chains, wars, and fiscal stimulus are all valid reasons for the inflation predicament we are in, the strong consumer is the Fed’s target right now.

There have been some interesting developments in China. After four months of market declines Chinese stocks rallied in November as hope for a relaxing of President Xi’s strict Zero Covid policies grew. The unprecedented protests in many parts of the country against the harsh lockdown appear to be pushing Xi to offer greater freedoms. Importantly, word out of Beijing is that officials are stating that infections are not as lethal as they have been, and that more vaccines among the elderly will help to suppress Covid.

The world right now is really hyper focused on the Fed. The rally we saw in October and November was based on hopes of a Fed pivot. While it appears that a pivot to cut rates is still in the future, investors were buoyed by the fact that the pace of interest rate increases should slow somewhat starting this month. However, in addition to comments made by Powell last week no one can know what the effects of the hikes will be because of the lead time involved. Will the blunt force of Fed policy push the economy into recession in 2023? If it does, how deep will the recession be?

Countering the risk of a negative surprise from the Fed, the chance of another pullback, and continued volatility:

  1. Seasonality. December and January are typically good times to be equity investors;

  2. If we have a recession in 2023, it will likely be shallow;

  3. We are seeing sliver of hope for a solution in Ukraine;

  4. Easing of extreme Covid policies in China.


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