Market Commentary – December 2022

The year 2022 may best be described by one word: inflation.  Economies across the globe were influenced by rising inflation, its causes, and the policies aimed at curtailing it. While inflationary pressures began to mount in 2021, they were exacerbated by continuing supply shortages; the ongoing effects of the COVID-19 pandemic, both here and abroad; the Russian invasion of Ukraine; and a global energy crisis.

Early in 2022, the Federal Reserve expected inflation to reach 2.6% by the end of the year, not much above their 2.0% target. Federal officials expected supply bottlenecks to ease, economies to re-open after relaxing COVID-related restrictions, and economic activity to return to something close to normal.  Unfortunately, the Fed underestimated how rising wages, federal aid, and expanded savings would lead to increased consumer spending, which continued to outpace supply, and drive prices higher. Most importantly, Fed officials didn't foresee the impact the Russian invasion of Ukraine would have on world trade in energy, food commodities, and resources such as natural gas and crude oil. And inflation was not just felt in the U.S. but throughout world economies as well. The International Monetary Fund expected worldwide inflation to hit 8.8%, the highest rate since 1996. In response, the Federal Reserve began the most aggressive policy of interest-rate hikes in more than 15 years.

Consumer price indexes in the 19 countries that use the euro currency rose to 10.0% or higher in November from a year earlier, while prices for food rose at a faster pace. Inflationary pressures also impacted world economies in the Middle East, Africa, South America, Canada, and Mexico. Rising inflation made countries' imports more expensive and forced central banks to raise interest rates. The U.S. dollar surged in value against most world currencies, weakening foreign currencies and contributing to rising prices for goods and services.

While overall inflationary pressures may have peaked as we close out 2022, food and energy prices remain elevated. Energy prices led the price surge at the beginning of the year. Crude oil prices rose to more than $110.00 per barrel for the first time since 2011. Energy prices, which were already rising at the end of 2021, were sent soaring following the Russian invasion of Ukraine as Russian refining capacity diminished amidst sanctions and trade restrictions imposed by several countries.However, energy prices have since stabilized somewhat. Helping to stem surging oil prices was a notable retreat in Chinese energy demand amidst COVID-related restrictions; the stabilization of Russian crude output; increased U.S. oil production; and a release of oil from the Strategic Petroleum Reserve.

The U.S. economy saw a slowdown in growth for much of 2022. Gross domestic product contracted in the first two quarters of the year after advancing at an annualized rate of 5.9% in 2021. But GDP rebounded in the third quarter, climbing 3.2%. Although inflation has cut into consumers' purchasing power, they have continued to spend during difficult economic times, supported by rising wages, job growth, and access to savings accumulated during the pandemic.

Industrial production lagged through the summer months, only to rebound during the latter part of 2022, ultimately exceeding its pace from a year earlier. The housing sector was hit particularly hard by rising mortgage rates and diminished inventory. Existing home sales were more than 35.0% below their pace in 2021, while sales of new single-family homes lagged by more than 15.0%.

Inflation also impacted the stock market, both at home and abroad. Several market sectors that had led the bull surge since 2008 suffered notable pullbacks. Information technology and communication services ended up as two of the worst performing sectors in 2022. Retail stocks also took a tumble as inflation drove up nondiscretionary items like food and energy, leaving less for consumers to spend on discretionary products and services. Also plaguing retailers were rising costs associated with products, services, and labor.
This past year was not only a difficult one for stocks and bonds, but also for "alternative assets" such as crypto. Rising interest rates impacted the viability of crypto. Couple this with revelations of fraud and abuse, and crypto assets have fallen precipitously.

Nevertheless, as 2022 draws to a close, there are some positives to consider entering the new year. The GDP expanded for the first time in the third quarter, and crude oil and gas prices reversed course and dipped lower. Primary inflationary indicators, such as the consumer price index and the personal consumption expenditures price index, trended lower at the end of the year. Ultimately, the economic outlook for 2023 will likely depend on the path of inflation and whether the economies of the U.S. and the world can avoid a recession as prices are driven lower.

*Chart reflects price changes, not total return

Last Month’s Economic News

• Employment: Job growth remained strong in November with the addition of 263,000 new jobs after adding 284,000 (revised) new jobs in October. Monthly job growth has averaged 392,000 thus far in 2022, compared with 562,000 per month in 2021. Despite federal interest-rate hikes aimed at slowing the economy and inflation, there is little evidence that the supply of labor is peaking. In November, the unemployment rate was unchanged at 3.7% and has remained in the range of 3.5%-3.7% since March. The number of unemployed persons was essentially unchanged at 6.0 million. Both the unemployment rate and the number of unemployed persons are in line with their levels prior to the coronavirus pandemic (3.5% and 5.7 million, respectively, in February 2020). The labor force participation rate dipped 0.1 percentage point to 62.1% in November (61.9% a year earlier). In November, average hourly earnings increased by $0.18 to $32.82. Over the past 12 months ended in November, average hourly earnings rose by 5.1% (average hourly earnings in November 2021 were $31.23). The average workweek decreased by 0.1 hour to 34.4 hours in November, down from 34.8 hours in November 2021.
• FOMC/interest rates: The Federal Open Market Committee met in December and increased the target range for the federal funds rate 50 basis points to 4.25%-4.50%. In support of its decision, the FOMC noted that inflation levels remain elevated due to supply and demand imbalances related to the pandemic, higher food and energy prices, broader price pressures, and the ongoing Russia/Ukraine war.
• GDP/budget: The economy, as measured by gross domestic product, accelerated at an annual rate of 3.2% in the third quarter. GDP declined in the first and second quarters, 1.6% and 0.6%, respectively. Consumer spending, as measured by the personal consumption expenditures index, rose 2.3% in the third quarter, marginally higher than in the second quarter (2.0%) and the first quarter (1.3%). Spending on services rose 3.7% in the third quarter compared with a 4.6% increase in the second quarter. Consumer spending on goods actually decreased 0.4% in the third quarter. Fixed investment fell 3.5% in the third quarter (-5.0% in the second quarter), pulled lower by a 27.1% drop in residential fixed investment. Nonresidential (business) fixed investment rose 6.2% in the third quarter. Exports rose 14.6% in the third quarter, compared with a 13.8% increase in the previous quarter. Imports, which are a negative in the calculation of GDP, fell 7.3% in the third quarter, after advancing 2.2% in the second quarter. Consumer prices increased 4.3% in the third quarter (6.5% in the second quarter). Excluding food and energy, consumer prices advanced 4.6% in the third quarter (7.1% in the second quarter).
• Inflation/consumer spending:  The Consumer Price Index for November may offer more evidence that inflation may be peaking. The CPI rose 0.1% after advancing 0.4% in October. Over the 12 months ended in November, the CPI rose 7.1%, down from 7.7% in October, falling to its lowest 12-month advance since December 2021. Excluding food and energy prices, the CPI rose 0.2% in November and 6.0% for the year ended in November. Although energy prices fell 1.6% in November, food prices rose 0.5% and prices for shelter rose 0.6%. For the 12 months ended in November, energy prices increased 13.1% (despite the recent decrease), while food prices rose 10.6% (food at home prices increased 12.0%). New vehicle prices advanced 7.2%, prices for transportation services rose 14.2%, and prices for shelter increased 7.1%.
• Prices that producers receive for goods and services rose 0.3% in November following a 0.2% October jump. Producer prices increased 7.4% for the 12 months ended in November. Producer prices less foods, energy, and trade services rose 0.3% in November, while prices excluding foods and energy increased 0.4%. In November, prices for services increased 0.4%, while prices for goods inched up 0.1%. For the 12 months ended in November, prices less foods, energy, and trade services moved up 4.9%, while prices less foods and energy increased 6.2%.
• Housing: Sales of existing homes decreased 7.7% in November, marking the tenth consecutive monthly decline. Existing home sales dropped 35.4% from November 2021. The median existing-home price was $370,700 in November, lower than the October price of $378,800 but 3.5% higher than the November 2021 price of $358,200. Unsold inventory of existing homes represents a 3.3-month supply at the current sales pace, unchanged from October but well above the 2.1-month supply in November. Sales of existing single-family homes dropped 7.6% in November and have not recorded an increase since January 2022. Over the 12 months ended in November, sales of existing single-family homes are down 35.2%. The median existing single-family home price was $376,700 in November, down from $384,600 in October but higher than the November 2021 price of $365,000.
• New single-family home sales advanced in November, climbing 5.8% and marking the second consecutive monthly increase. However, sales are down 15.3% from November 2021. The median sales price of new single-family houses sold in November was $421,700 ($484,700 in October). The November average sales price was $543,600 ($533,400 in October). The inventory of new single-family homes for sale in November represented a supply of 8.6 months at the current sales pace, down from the October estimate of 9.3 months.
• Manufacturing: Industrial production declined 0.2% in November, following a 0.1% decrease in October. Manufacturing decreased 0.6% in November, mining fell 0.7%, while utilities rose 3.6%. Over the past 12 months, total industrial production in November was 2.5% above its year-earlier reading. Although manufacturing fell in November, it remained 1.2% above its November 2021 rate.
• November saw new orders for durable goods decrease 2.1%, after increasing in each of the previous three months. Durable goods orders advanced 0.7% in October. New orders for durable goods rose 10.5% since November 2021. Excluding transportation, new orders increased 0.2% in November. Excluding defense, new orders decreased 2.6%. Transportation equipment, down following three consecutive monthly increases, led the November decrease, falling 6.3%.
• International markets: The impact of inflation was felt throughout much of the world. Most countries saw double-digit increases in prices for goods and services during the year. In 2022, the consumer price index advanced 10.0% in Germany, 10.7% in the United Kingdom, 10.1% in the Eurozone, and 6.8% in Canada. Japan (3.8%) and China (1.6%) were not significantly impacted by rising inflation. However, gross domestic product in both Japan (-0.8%) and China (2.8% through the third quarter) retreated from the prior year. Stock markets of several countries were also hit hard. For 2022, the STOXX Europe 600 Index declined 12.4%; the United Kingdom's FTSE advanced 0.9%; Japan's Nikkei 225 Index fell 9.4%; and China's Shanghai Composite Index lost 15.1%.
• Consumer confidence: The Conference Board Consumer Confidence Index® increased in December following two consecutive monthly declines. The index stands at 108.3, up from 101.4 in November. The Present Situation Index, based on consumers' assessment of current business and labor market conditions, rose to 147.2 in December, up from 138.3 in the previous month. The Expectations Index — based on consumers' short-term outlook for income, business, and labor market conditions — improved to 82.4 in December from 76.7 in November.

Eye on the Month Ahead

The battle against rising inflation will likely continue to dominate much of the economy and stock market in 2023. If and when the Federal Reserve scales back its aggressive interest-rate hikes, investors might be more inclined to return to equities, particularly tech shares. However, the war in Ukraine and new COVID cases will also have an impact. If nothing else, 2023 should be very interesting.