Weekly Market Update: January 2, 2023

Both the stock and bond markets performed poorly in 2022. This is a rare occurrence, as equities and bonds typically have an inverse relationship. But against the backdrop of highly restrictive monetary policies from the Federal Reserve, both suffered notable losses in the same year for the first time since the late 1960s. Historically, stocks don’t perform well when the central bank is tightening the monetary reins, as it removes liquidity from the financial system. Meantime, the high inflation this year and the restrictive monetary policies implemented by the Fed to try to cool the economy, which have included monthly bond sales, had a detrimental effect on the price of bonds.

The elevated interest rates put significant pressure on the higher-growth sectors. That is because many of the companies in those sectors are not profitable and their valuations are based on the potential of future cash flows, which, when discounted back to present value terms at higher rates, are reduced and look less attractive to investors.

The central bank’s aggressive moves to fight inflation are starting to produce results. The Personal Consumption Expenditures (PCE) price index, the gauge of inflation most closely watched by the Fed, rose 5.5% year over year in November. Although a still strong advance, the PCE showed moderation from October (+6.1%) and followed declines in both the November Consumer and Producer Price Indexes.

Wall Street, though, is worried that the Fed’s battle to tame inflation may come at the expense of the economy. The continued inversion of the Treasury market yield curve suggests a recession is possible in 2023. The sharp spike in borrowing costs has started to filter through the economy, with demand for real estate suffering. Likewise, new orders for manufactured goods tumbled 2.1% in November, the biggest monthly drop since the onset of the pandemic, and the pace of both personal income and spending growth slowed.

Conclusion: The new year begins with many of the same headwinds that hurt the market in 2022, including concerns about whether the Federal Reserve will be able to orchestrate a “soft landing” for the U.S. economy as it fights inflation, still in place.

Source: ValueLine.com