By Kelvin Lee, Alonso Munoz
It’s been a long and difficult year for markets. Investors have had to endure several peak to trough falls, bear rallies, elevated volatility, and high correlation across asset classes. And now, a disappointing growth outlook has spooked analysts into cutting valuations for next year, with CFOs even anticipating negative YoY growth for the first quarter. But there is reason to be optimistic despite all the downward risk re-pricing. It’s the holiday season, after all, and we’ve earned some good news.
It’s been 75 basis hikes after 75 basis hikes since June. We’re up to 4% of the fed funds rate and we certainly did not get here slowly. We still remember the calls for a 2% terminal rate, a laughable idea now. But, the aggressive quantitative tightening is starting to tame inflation. The November print was a nice surprise with CPI finally beating expectations. We anticipate this trend to follow with next Tuesday’s headline number coming in at around 7%. Of course, still an unbearable number for the consumer, but on a downward trajectory. Even with the stickiness from service and rent prices, core CPI (the feds preferred measure) has also shown signs of falling. The inflation pivot story, coupled with a more dovish Powell, means we’re expecting a 50-bps hike in Wednesday’s meeting, not another 75. We’re seeing a decent bull trend in fixed income as a result and anticipate that the yields in longer duration bonds last month were the peak for this cycle. The current drastic 80 plus bps inversion in yields on the 2- and 10-year treasuries curve is supporting the case that the Fed’s medicine is taking effect and justifies a central bank decision to back off by year end 2023.
Companies are positioned defensively to maintain some of their margins next year in anticipation of revenue declines across the board. By reducing headcount, R&D, and non-core departments, most every major constituent in the S&P is planning to keep profits up for wall street. Also, the supply chain disruption and inventory glut stories that have been plaguing firms have improved from a few months ago. Quality firms were able to offload discounted inventory during this year’s historic end of year spending season. We’ve also seen the pandemic semiconductor shortage ameliorated and overall foreign covid sentiment ease. In this regard, China could be a major headwind for multinational companies if they can remain on their reopening plans next year, just look at east Asian casino stocks. Given the citizen protests over the last two weeks and the GDP goals, Chinese government officials finally have an actionable incentive to withdraw from a zero covid policy.
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