October 31, 2022

Nolte Notes

October 31, 2022

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness”. That quote from a Tale of Two Cities is rather apt for the coming few weeks as we hit the mid-term elections and the Fed meeting. The financial markets have already reacted by going from the outhouse to the penthouse, as the SP500 has gained nearly 9% for the month of October. This week will be loaded with scary stuff, from the Fed meeting and press conference to employment data on Friday. Market expectations are for the Fed to begin signaling that their very aggressive rate hiking cycle will begin slowing down beginning with the December meeting and into 2023. Last week’s data showed inflation still lofty, real estate struggling and spending still outstripping income. Mortgage rates have touched 7% and housing has slowed dramatically in many parts of the country. Purchase and refinancing activity are the lowest in over 20 years. Employment remains robust as does inflation. The weekly jobless report points to another 200,000+ gains in jobs come Friday’s report. Inflation remains above expectations. However, the Fed may signal that their aggressive policy of hiking rates 0.75% could back off some as the calendar flips to 2023. The markets could react positively to the news.

Inflation will be the most discussed issue at the press conference after the Fed’s decision to hike rates on Wednesday. Inflation continues to be the classic too much money chasing too few goods. Retail sales rose at an annual rate of just over 4% from 1992 to 2020. For the two years following August 2020, retail sales rose more than double that rate. The amount of money floating around in money market accounts and small CDs rose at an annual 5.5% clip from 1992 to 2020. The last two years it rose by an annual rate of just over 7.5%. The Fed’s charge has been to rein in the excess money, to reduce inflation. However, it will likely result in a recession, which has been the “base case” for Wall Street for 2023. The financial markets are not reacting to what is expected, but rather the likelihood that the Fed blinks and pauses their rate increasing path during 2023. It could be the pause that refreshes the equity markets. Wednesday could be an interesting day.

Interest rates fell for the week. It was the first weekly increase in bond prices in twelve weeks! Spurred by talk about the Fed easing off the brakes, not only did treasuries rise, but also corporates and high yield. Both are indications that investors are willing to take on more risk. It is way too early to say the bond bear market is over, but the jump in corporates is encouraging. One part of the bond market that continues to struggle is municipal bonds. Tax-exempt at the Federal level, these bonds are currently yielding nearly as much as treasury bonds, without the benefit of tax exemption. It could be that the belief in a Republican sweep of Congress will forestall any potential for tax increases, one reason these bonds are purchased. The easing in the dollar over the last few weeks may have also helped the yield market. Again, the Fed meeting on Wednesday will be instrumental for bond yields through yearend.

The Dow could put in the best October ever if Monday’s trading is not too negative. It is also on pace for one of the best months in decades. The same can’t be said for the SP500 and the OTC markets, both are heavily weighted toward technology stocks which have struggled as earnings have come in well below estimates. Key stocks from Meta and Amazon saw more than 10% declines as their earnings were disappointing. The huge difference in performance disappears when looking at the smaller stocks in the market. In fact, small cap growth is doing better than small cap value during October. International has been hurt by the stronger dollar during October, and emerging markets have suffered. The election of President Xi to a third term and his consolidation of power is seen as a shift away from freer markets and a more pro-growth policy. The long-term impact of his election may be seen as Chinese stocks react during the fourth quarter.

All eyes will be on the Fed Wednesday. A three-quarter point increase in the Fed funds rate is a given, but guidance about future increases in the face of weaker economic data will likely drive stocks toward the end of the week. Unemployment and wage growth will be watched for signs of job weakness and wage inflation. Oh, and earnings reports continue too!

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

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