So far in the fourth quarter, markets have bounced nicely from the drubbing they took from mid-August through September. One key economic number, in our view, was responsible for much of this bounce. On November 9, when the Bureau of Labor Statistics (BLS) reported that inflation rose (only) 7.7% year-over-year during October, markets celebrated by powering both the S&P 500 index and the Dow 30 to their largest single-day percentage gains in two years. While obviously still very high on an absolute basis, October’s 7.7% was not only lower than the 8% that was widely expected, but also a significant step down from September’s 8.2%.
Fed Dampens Expectations
The Fed, of course, was quick to downplay the significance of the October inflation report. It was, after all, just a single number in what can be a pretty choppy data series. The last thing the Fed wants is for everyone to celebrate the vanquishing of inflation—especially if it is not yet vanquished. For inflation to fall all the way down to the Fed’s 2% target, there will likely be plenty of economic pain in the coming quarters.
According to FactSet, a data provider, more than 90% of companies in the S&P 500 Index have reported their earnings for the third quarter. On balance, companies have performed relatively well, having grown their earnings at a mere 2.2% year-over-year, but doing about 2% better than analysts expected, on average. Many are, however, using their earnings conference calls to pour cold water on their growth expectations for next year. Now many analysts are expecting corporate earnings to be flat to slightly down next year. With inflation still likely to remain high through next year amid a weakening consumer segment, flattish corporate earnings in 2023 would seem reasonable.
Geopolitical Risks Remain High
While most investors are focused on when the Fed begins to intimate that is has done enough rate hiking, it bears mentioning that geopolitical risks continue to increase, not recede. The retaking of Kherson by Ukrainian forces was certainly an embarrassment for the Russians, who, at least for the moment, seem unlikely to have the stamina or morale to launch any sort of meaningful counteroffensive. Meanwhile, Russian missiles continue to rain down on Ukrainian infrastructure and random civilian areas. If Putin continues to lose on the ground, as seems likely, he may resort to more desperate measures. Also, something that does not get as much airtime is a potential Chinese invasion of Taiwan, which, with Xi Jinping having just secured a third term as China’s leader, seems increasingly realistic. If this were to happen, and the U.S. got into the fight to defend Taiwan, it would be an economic disruption orders of magnitude more damaging to the global economy than the Russian invasion of Ukraine.
Elections and Crypto Have Little Impact
There have been two other noteworthy events so far in the quarter, the midterm elections and the collapse of cryptocurrency exchange FTX. The midterms often give a boost to markets once they are over if only because they are a source of uncertainty. With the results in, investors can cross any potential risks from them off their lists. In our view, domestic politics do not play a major role in determining the path of markets. Interest rates and the business cycle exert much more influence over stocks and bonds, in our opinion.
The collapse of cryptocurrency exchange FTX has also been in the headlines for the past couple of weeks. Despite the amount of money lost by investors in this debacle, there does not seem to have been much, if any, spillover into the equity markets. Let’s hope it stays that way.
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