Economic Update: November 28, 2022

Growth

Following two consecutive quarters of negative GDP growth, 3Q22 real GDP showed the economy grew by a 2.6% annualized rate, slightly stronger than the 2.4% consensus expectation. Much of the gain came from a large upswing in trade, while beneath the surface the economy is still losing momentum in both growth and inflation. Real consumer spending continued to soften and construction spending was very weak with the climb in interest rates. However, investment spending is still holding up and the GDP price deflator declined markedly to 4.1% from 9% last quarter. Moreover, with pent-up demand for autos and a still very tight labor market, it’s clear the economy is not yet in recession.

Jobs

The October Jobs report showed continued although diminishing job momentum as the economy reaches its limits on the supply of workers. Nonfarm payrolls rose by a solid 261K, above expectations. However, combined with a weaker household survey that showed a loss of 328K, this report still shows a labor market that is cooling down. While supply-demand dynamics remain tight, annual wage inflation has now fallen to 4.7% after peaking at 5.6% in March. Moderating wage growth provides an important signal for the Fed that tightness is not contributing to accelerating wage inflation.

Profits

The 3Q22 earnings season is coming to a close with 90.9% of market cap having reported. Our current estimate for 3Q22 S&P 500 operating earnings per share (EPS) is $51.17, representing a year-over-year (y/y) decline of 1.6%. So far, 57% of companies have beaten earnings expectations and 55% have beaten revenue expectations. Pricing power has differentiated winners and losers, as rising costs rather than deteriorating sales have accounted for weakness in earnings. Management commentary has constantly referenced the impact of higher interest rates, shipping costs and a stronger US dollar on earnings.

Inflation

After many months of upside surprises, hot inflation is finally beginning to cool down. The October CPI report showed a picture of receding inflation pressures across various sectors of the economy. Headline CPI rose 0.4% m/m and core CPI rose 0.3% m/m, translating to annual rates of 7.8% y/y and 6.3% y/y, respectively. While energy prices bounced, this was partially offset by lower utilities prices. Food inflation improved with strength now primarily coming from “food away from home”. Notably, prices for core goods and services ex-shelter are showing promising deceleration. As wages continue to cool and pent-up demand for services softens, we expect services inflation will continue to moderate.

Rates

Persistent inflationary pressures have pushed the Fed to accelerate its rate hiking trajectory. At its November meeting, the FOMC announced another 0.75% increase in the federal funds rate to a range of 3.75%-4.00%. The committee’s tone remained hawkish and inflation-vigilant, but investors took initial relief at new statement language acknowledging the significant amount of tightening the Fed has already delivered and the lags with which it will affect the economy and inflation. However, Chairman Jerome Powell’s rhetoric in the subsequent press conference was increasingly hawkish, suggesting that the risk of Fed overtightening remains.

Risks

  • The Fed could push the economy into recession if it overtightens policy in response to supply-driven inflation.
  • Heightened geopolitical tensions with Russia could result in continued energy shortages, low consumer confidence and dampened growth.
  • Markets may remain depressed and volatile until investors receive clarity on inflation and the Fed.

Investment Themes

  • After this year’s sell-off, fixed income now offers more protection against a market correction or economic downturn.
  • U.S. equity investors may use profits as a guide in a rising rate environment.
  • Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.

This weekly update provides a snapshot of changes in the economy and markets and their implications for investors.

Originally Posted November 28, 2022 – Economic Update

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