Gill Capital Partners Mid-October 2022 Update
While October means stacks of pumpkins, Halloween, and all things pumpkin spice, for markets and investors it also means another round of inflation data, a break from regularly scheduled Federal Reserve meetings, and earnings announcements. And while it is not Halloween yet, markets have been doing their best to scare investors in recent weeks. All eyes are once again on the Federal Reserve and inflation numbers as investors look longingly for data that will convince the Federal Reserve to soften their tone. This week brought another much-anticipated report on inflation and markets reacted in a volatile manner. The dollar is the strongest it has been in approximately 20 years, and that has big impacts globally. We will get into all of this and more, but first, the interesting factoid of the month:
The Saxons had a different name for the month of October: Wyn Monath, which directly translates to “wine month” because it was the time of the year for making wine. Between that and pumpkin spice, it is understandable if October is now your favorite month!
Inflation Update
We don’t know about you, but the monthly CPI report announcement has become must see T.V. for us at 6:30 AM, popcorn and a cup of coffee in hand. It is okay to admit if you have become an economic data nerd like us! This month’s report showed that consumer prices rose 0.4% in the month of September, slightly higher than the 0.3% estimate. On a year-over-year basis, inflation declined this month from 8.3% to 8.2%, compared to expectations of 8.1%. Core inflation (excluding food and energy) moved higher this month, up 6.6% on a year over year basis. The chart below shows the trend in inflation over the last year, along with a breakdown of its major components.
A few key takeaways:
Though the market was hoping for more progress, inflation is certainly trending lower.
Food prices jumped again, rising 0.8% for the month and 11.3% from a year ago.
Shelter costs rose 0.7% for the month and are up 6.6% over a year ago (more on this below).
Energy prices posted another steep decline, dropping 2.1% for the month.
Wages were weaker this month, falling 0.1% for the month and 3% year-over-year. This is one of the key areas where the Fed is looking for progress.
The market initially reacted negatively to this report citing “sticky” inflation. However, it went on to rally strongly as investors digested the report and began to anticipate lower inflation on the horizon and analysts called for significant deceleration in the months to come.
Our view – Meh. Everyone was hoping to see a more pronounced deceleration in the formal inflation numbers. This report was neither particularly good nor bad. Food prices are really proving to be sticky, as is housing. However, the calculations that are used to arrive at a monthly shelter inflation number are significantly flawed and backward looking. Without getting into the boring details, shelter costs, specifically the rental component, rely on data that is 6-9 months delayed. So, while this week’s inflation data reflects rising rental rates, real time rental market data is showing month-over-month declines in rental rates at the national level.
The chart below will be a welcome surprise for all the shoppers out there... discounts are coming (yes, you heard us right, discounts)! Inventories are building and sales are slowing. This means that retailers are going to need to start enticing shoppers with lower prices.
This week’s inflation report is not exactly what we hoped for, but it does tell us that inflation is moving in the right direction. We anticipate that this trend will continue and very well may accelerate.
Update on the Federal Reserve, Interest Rates & the Dollar
The Federal Reserve meets next in early November, and then again in December. After the last meeting, they announced that they are planning on increasing rates by 0.75% in November and then by another 0.50% in December, which would bring rates to their target range of approximately 4.5%.
Our view –Interest rate markets moved swiftly following that announcement to price this new forecast into credit markets. As of this writing, the 2-year treasury rate sits at approximately 4.5%, showing us that bond markets have already priced in the latest Fed forecast. Unless the Fed comes out at the next meeting and announces a more aggressive stance or inflation begins to move higher again, there is a decent chance that we are seeing peak yields, at least for now.
Federal Reserve policy has led to the strongest dollar we have seen in two decades. Why? Currencies move relative to one another based on two main inputs: interest rate differentials and current account deficits. The former is the main factor at play currently. Quite simply, the Federal Reserve is more aggressively increasing our interest rates relative to other central banks. This is creating a significant interest rate “differential,” which pushes our currency higher. There is much more that goes into currency movements, but from a high level this is the big input moving currency markets today. The significant dollar strength that we are currently seeing is creating headwinds for those who have dollar denominated debt or need to purchase goods and services in dollars.
Market Update
Markets briefly touched their lows of the year following the CPI report this week, and then rallied strongly, with the Dow up approximately 1,300 points from its intra-day lows. Why did markets rally so aggressively following a not-so-good inflation report?
Our view – Stocks have been down a lot lately, maybe too much. There is a lot of bad news already priced into this market. Sentiment is historically bad and often times that is when we see the largest stock rallies. Furthermore, sometimes in the world of economics, bad news can be good news. The market is beginning to anticipate lower inflation and slower economic growth and is hopeful that will lead to less restrictive monetary policy (i.e., lower rates). We recognize that market downturns like this are stressful, exhausting and frustrating. But, we also firmly believe that this too shall pass. While we do not know exactly where things are going in the short-term, we do know that stocks have always been a good bet over the long term. Further, fourth quarter has historically been particularly strong for financial markets, and, as the last couple of weeks have shown us, some of the largest gains come quickly when things look their worst. We remain confident in the long-term growth potential and innovation of the U.S. economy, and believe it is a matter of when, not if, the markets bounce back.
Enjoy your weekend and treat yourself to a glass of wine or a pumpkin spiced something. You deserve it!
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.