The Navigator | October 2022
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Market volatility reemerged in the second half of September, most notably after the last FOMC meeting. The S&P 500 fell 9.2%, breaking its mid-June lows and returning to November 2020 levels. The Nasdaq tumbled 10.4% while the Dow lost 8.8%. Major macro catalysts for the downward market trend in September were stubbornly high inflation and the Federal Reserve reasserting that monetary policy will be tighter for a longer period. U.S. inflation was surprisingly firm in August despite a sharp decline in gasoline prices and an easing in global supply chains. In particular, the acceleration in the core CPI (up 6.3% on a year-ago basis) and strong wage growth supported by a resilient labor market did not sit well with the central bank. The September FOMC meeting reinforced the Fed’s hawkish tone and sent a strong message that the target rates would be at a restrictive level and remain there for a longer period. The Committee delivered a 75bp hike as expected in the meeting, taking the Fed funds target range to 3.00-3.25%, its highest level in almost 15 years. While there is little change to the policy statement, the upward revision to the policy rate projections (the “dot plot”) made headlines: the median estimate for Fed Funds rates at the end of 2022 was pushed to 4.4%, 1% higher than the projection in June; while the median estimate for 2023 is now 4.6%, up from 3.8% from last quarter. Also, the quarterly Summary of Economic Projects (SEP) indicated a downward revision to real GDP estimates as well as upward revisions to the unemployment rate projections. The market now expects the FOMC to continue hiking into next year and has priced in increased challenges for a soft landing. Hawkish surprises also took the stage internationally, with most major developed market central banks making it clear that they would continue to carry out more restrictive policies over the near term. The Bank of England hiked by 50 basis points to 2.25% and is expected to continue to hike at a sustained pace in coming meetings. The central banks in Indonesia and the Philippines hiked by the same amount, while the South African central bank hiked by 75bps and the Swedish Riksbank hiked by a surprise of 100 basis points. The implications of all of this: our view is that central banks will continue normalizing to bring inflation back to their targets, indicating that economic growth is likely to continue to soften across most developed markets in the near term. Meanwhile, the European energy crisis remains a considerable challenge, and we believe it will profoundly affect growth in Europe. Since Russia invaded Ukraine, soaring energy prices have battered Europe, and its gas prices have now climbed to almost ten times their 10-year historical average. We believe that the energy crisis will exacerbate the weaker growth and higher inflation in the UK and the euro area, with industries across Europe scaling back operations due to higher energy costs. The crisis also has a spillover effect on other economies in the form of higher prices and slower growth. Fuel imports by Asian countries, including China, India, and Pakistan, have declined significantly with the fierce competition for natural gas supplies in Europe. We remain conservative (U.S.) and cautious (International) with equity exposure, which has helped to mitigate the impact of the recent sharp sell-off. We see more volatility in the equity market down the road and believe that a cautious approach, active stock selection, and thoughtful portfolio construction can lead to more resilient portfolios. Although oversold conditions and bearish positioning could lead to a short-term technical bounce, we believe that the balance of risk in the riskier assets is still skewed to the downside. |
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↓ Valuation | The S&P 500 tumbled 9.2% this month, and stock valuation metrics improved but remained negative. P/E decreased from 19.3 at the end of August to 17.6 at the end of September. Forward P/E decreased to 16.1 at the end of September from 17.5 at the end of August. Inflation-adjusted valuation metrics continued to be negative.
↓ Sentiment | The ISM manufacturing index was unchanged in August, remaining at 52.8 (better than consensus expectation). U.S. manufacturing conditions have weakened this year, but the index remains above its recessionary threshold (closer to 48). University of Michigan consumer confidence continued to move slowly higher from its historic low and rose modestly from 58.2 to 58.6 in September, with gasoline prices falling from record highs. The NAHB index fell further below the neutral level in September to 46, with elevated mortgage rates and worsening affordability. The 30-year fixed-rate mortgage rate has soared to 6.8%, more than double the rate at the end of last year.
↔ Technical | Technical indicators were neutral to slightly positive, with the increases in fear indexes and short-term reversal signals offset by declining momentum signals. The S&P 500 was 15% below its 200-day moving average, 10% below the 100- day average, and 11% below the 50-day average. The VIX index increased this month and settled at 31.6 at the end of September (compared with 25.9 at the end of August). With stronger than expected inflation data and a hawkish central bank, market volatility picked up considerably in the second half of September as investors positioned for interest rates to continue to rise sharply and a further slowing of the economy.
↑ Macroeconomic | The U.S. labor market showed signs of cooling in September but remained strong. Nonfarm employment increased by 315,000, modestly higher than the consensus forecast. The four-week moving average of initial jobless claims fell to 207,000 for the week ended September 24. The headline CPI rose 0.1% in August (stronger than consensus) compared with no change in July. On a year-ago basis, the headline and core CPIs were up 8.3% and 6.3%, respectively. Retail sales rose more than expected in August by 0.3%, with a solid gain in vehicle sales offsetting a decline in gasoline sales caused by lower prices. The robust labor market and wage growth overcame lingering low confidence and a shift from goods to service spending. U.S. industrial production declined 0.2% in August.
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As of 9/30/2022
1 Source: Bloomberg, NorthCoast Asset Management.
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