Following the disappointing inflation data reading in the form of the Core PCE Index (excluding food and energy), the third quarter closed with a resounding thud.
The key takeaway from the report is that the inflation the Fed says it can control (prices of goods and services purchased by consumers) ticked higher in August by 0.6% against forecasts of 0.4%. Hence, investors can continue to expect the Fed to continue with tight monetary policy and unabated quantitative tightening.
The latest CME FedWatch Tool has a 56.5% probability of the Fed raising the Fed Funds Rate by a fourth 75-basis point hike at the Nov. 2 Federal Open Market Committee (FOMC) meeting. This will take the short-term overnight lending rate banks charge each other to 3.75-4.00%.
For the Dec. 14 FOMC meeting, there is already a 53.9% probability the Fed will hike by an additional 50 basis points, taking the rate up to 4.25-4.50% where it is presumed the heavy lifting of monetary policy will likely be complete. This future rate meets core inflation where it is, given that housing and wage inflation take time to decline.
The Fed’s dual mandate of maintaining full employment and controlling inflation is under severe testing as the fourth quarter is a time of massive hiring by the retail industry for the holiday season. But these are seasonal jobs, whereas the bigger issue for the Fed is minimum wages in many states will rise in January 2023, based on the 8.3% increase in inflation over the past year, as reported Sept. 13 by the U.S. Bureau of Labor Statistics in its consumer price index (CPI).
This coming Friday, Oct. 7, will bring the employment data for September where Non-Farm Payrolls are forecast to increase by 250,000 and the Unemployment Rate to tick higher to 3.8% from 3.7% in August. The higher rate indicates a rising labor participation rate (people entering the workforce) from the 62.4% reading for August.
This part of the Fed’s mandate is solid gold. The major problem continues to be the upward pressure on the cost of making things and providing professional services that wages and salaries are adjusted for.
The average 30-year fixed rate mortgage closed out the week at 7.53%, according to BankRate.com. It is safe to say 8.0% mortgage rates are dead on the horizon, which one would think would start to really put some downward pressure on home prices. All the housing data for September will be released the week of Oct. 17. Stay tuned.
Next up is third-quarter earnings season, which is set to kick of the week of Oct. 10. That is almost certain to bring about a highly mixed set of sales, profits and forward guidance.
For Q3 2022, the estimated earnings growth rate for the S&P 500 is 2.9%. If 2.9% is the actual growth rate for the quarter, it will mark the lowest earnings growth rate reported by the index since Q3 2020 (-5.7%).
The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 15.4. This P/E ratio is below the five-year average (18.6) and below the 10-year average (17.1). according to latest FactSet Earnings Insight forecast released on Sept. 30.
Analysts have revised third-quarter earnings lower by the largest margins in more than two years. That outlook clearly is reflected in the price action of most stocks.
The big question on most investors’ minds is whether the market has priced in the next one or two rate hikes, the impact of the strong dollar and the lower earnings expectations. It would seem a good deal of these fears is priced in, since they are the most widely discussed topics in financial circles.
What the market doesn’t know, and it’s a biggie, is the outcome of the midterm elections. A win in the House by the GOP is already being factored into most scenarios as surveys show most Americans say the economy and inflation combine to rank as their #1 issue of concern. And Republicans need to pick up a total of just five (out of 435) in the House to grab the majority.
With partisanship so intense these days, it’s gridlock for any new major legislation getting passed. The overturning of Roe v. Wade has stunted Republican momentum to win the Senate, but in the event the GOP does win the House, the market will likely have a reason to start moving higher.
So, there you have it. Mark your calendars for the fireworks of data to explode over the next month.
Oct. 7 — Employment Data
Oct. 10 — Earnings Season Begins
Oct. 12/13 — CPI and PPI Data
Oct. 14 — Retail Sales
Oct. 18/19/20 — Housing Data
Oct. 28 — PCE Prices (Core)
Nov. 2 — FOMC Rate Decision
Nov. 8 — Midterm Elections
In between, the usual releases of industrial production, ISM manufacturing, ISM services, consumer sentiment, energy inventories, durable goods, factory orders and inventories will all be reported, but the market will hang most those key reports noted with their corresponding dates of release.
It should be quite a show and if history is any guide, then there is reason for optimism:
“Interestingly, the stock market in 2022 has generally followed the downward path typical for a midterm election year since 1962,” Dan Clifton, of Strategas, told Forbes magazine. “The S&P 500 is down slightly more than the typical 19% intra-year decline, but the news improves if stocks stick to the script. Stocks have historically bottomed in October and rallied by an average of almost 32% in the next 12 months. Clifton notes that stocks have been positive in the year after every midterm election since 1942!”
That’s an amazing winning streak and would coincide with the near-capitulation price action that has a firm hold in the market sentiment. Investors have been holding out for the Fed to pivot, but just maybe the stock market will pivot first.