Economic Reversals – Hints of a Cooling Economy
INVESTMENT COMMITTEE COMMENTARY November 2022
Following comments by Federal Reserve (Fed) Chairman Jerome Powell, stocks and bonds rallied in November. The S&P 500 rose for the second straight month, up 5.6%. Foreign developed equities and emerging markets also rebounded with strong gains of 10.9% and 14.0%, respectively. Emerging markets had their best monthly performance since March 2016 as global money managers, including Morgan Stanley, predicted a peak in the U.S. dollar. U.S. real estate investment trusts (REITs) gained 6.0%.
For the month, the yield on 10-year Treasuries fell from 4.08% to 3.70%. As a result, intermediate investment grade bonds gained 3.7%. Most fixed income categories rose over 1.5% in November. Notably, municipal bonds were up 4.8%.
Currently, the key performance catalyst for stocks and bonds is Fed monetary policy. Powell announced on November 30th that the pace of interest rate hikes can slow as soon as December. This likely means the Fed will raise interest rates by 50 basis points (0.5%) in December, ending a string of 75 basis point hikes. The Fed must balance concerns about inflation with those of slowing economic growth and falling earnings as we move into 2023. The rate of employment and industrial production have both remained strong despite the Fed’s tightening so far, but there are signs of weakness.
Economic Reversals – Hints of a Cooling Economy
The most recent employment reports, while presenting stronger headline numbers, mixed results. The Job Openings and Labor Turnover Survey (JOLTS) presents data on job openings, hires and separations. As illustrated in the chart below, there continues to be more job openings than job seekers which is positive. The trend through the COVID pandemic is displayed and while the ratio recently turned down, job openings remain at a higher level, consistent with late-stage economic expansion.
Source: Bureau of Labor Statistics, J.P. Morgan Asset Management
However, underlying data in the Employment Household Survey was not robust. The labor force has declined for the last three months (and five of the last six months). Also, the number of persons employed has fallen for the last two months. The unemployment rate remains at 3.7% and has been that level through most of 2022. The bottom line from available employment data is that the economy is making forward progress but at a diminishing pace as Fed tightening appears to be impacting job creation.
It has been interesting to see how the labor market has been inversely impacting the investment markets. Negative employment statistic releases help investors gain conviction that inflation is cooling. Positive employment numbers have been catalysts to equity market declines. In both cases the markets are anticipating how the Fed will react regarding interest rate policy.
The strength of the U.S. dollar has also recently reversed direction. The following chart from the Fed shows the U.S. dollar index (DVY) has generally risen for the last two years. However, it has recently weakened as investors see some moderation in inflation. The weaker dollar contributed to stronger foreign and emerging markets performance in November. After a two-year long rally, some believe the dollar has peaked, especially with the recent sharp reversal.
Source: Federal Reserve
In summary, U.S. economic conditions appear to be weakening and while not there yet, an economic cycle peak and recession may be closer. However, the combination of lower stock valuations and higher interest rates mean that portfolio assets are positioned for higher growth for long-term investors.
If you have any questions, please consult your JMG Advisor.
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