A common phrase among market watchers in the past several weeks is that macroeconomic-based investing is becoming even tougher than normal. Then again, company-specific investing has also been viewed as more problematic. The reason is that equity markets have continued to climb despite the fact that a recession is anticipated in the new year, alongside weaker or negative earnings growth. Since stocks are supposed to be forward-looking, it is somewhat confusing that share prices can head higher even though the factors that typically drive them are arguing for a pullback.

 

The recovery in equities has indeed been impressive and November marked the second consecutive gain in most indices since the summer of 2021. The S&P500 has broken well above the 4,000 level and the TSX is trading north of 20,500. On Wednesday, markets halted a two-day decline because the Chair of the Federal Reserve, Jerome Powell, indicated that it was unlikely the Fed would raise rates another 75 basis points at its December meeting. Ignoring the fact that this was already priced into the market, it does highlight how traders appear to be picking and choosing those things that support a bullish market and ignoring features that might point to weakness. On Thursday, the latest ISM manufacturing sentiment data showed contraction in overall activity, as well as in prices paid, new orders and employment. Auto sales for November also came in weaker than expected, but instead of these recession-like numbers causing distress in the equity market, we saw a massive surge instead – the notion that bad news on the economy is good news for bonds and stocks because it points to lower inflation.

 

 

Last week, I discussed the US retail picture and whether or not the Black Friday weekend would point to a retreating or recovering consumer. Well, the 10.4% gain in retail sales last week versus the same period last year was much stronger than expected and was the best annual sales growth since the start of October. Then there was this morning’s November jobs report. Market participants were counting on a weak headline payrolls number, based primarily on news that a number of large tech companies are cutting staff and that jobless claims applications have been trending higher. Instead, non-farm payrolls came in hotter than predicted, with a gain of 265,000 and an acceleration in average hourly earnings, rising 0.6% on the month. Note, Canadian employment figures for November were more subdued with a gain of only 10,100 (a 40,600 drop in part-time offset a 50,700 gain in full-time payrolls).

 

If investors thought that the economic environment had cooled off enough to generate a major drop in inflation, such that we didn’t have to worry about protracted interest rate hikes and a harder landing in 2023, they are now having to re-think that view. Powell did validate expectations of a half-point increase in rates at the next FOMC meeting, but nowhere in his comments was there a prediction that there would be an imminent pause in hikes, nor that the ultimate peak in rates would somehow be lower. This morning’s jobs report, and especially the wages and salaries components, will push back on the notion of an imminent pause.

 

 

It is no surprise then that US stocks and bonds went into reverse after the employment report. If the consumer is going to be resilient this holiday shopping season and if wage inflation in the service sector is going to remain sticky, then it is doubtful that Federal Reserve officials are going to feel that dovish in the days leading up to the next FOMC meeting on December 14^th. Even if the market gets its half-point rate hike, it probably isn’t prepared for language suggesting the need for similar hikes into the first quarter, as opposed to the implied expectation that the next move would be maybe a quarter point and then possibly a pause. Note, the next CPI report is released on the day before the Fed announcement and if the recent improvement in retail sales has come more from prices than volumes, that report is also a potential tripping point for markets.

 

In our opinion, nothing has materially changed in the last number of weeks. Inflation remains high, but is on a declining trajectory. That trajectory is not steep enough to cause the Federal Reserve to suddenly release the brake lever, no matter what participants read into Powell’s speech this week. The odds of an economic recession in 2023 remain high, even though the latest data would suggest that it hasn’t started yet. And, as I have discussed before, it is rare to see a bottom in the equity market before the start of a recession. Until we see evidence that run counter to these fundamentals, the game plan remains the same and that is maintain a healthy dose of defense.

 

On behalf of the Pyle Group, have a wonderful weekend.   

Andrew Pyle

 

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These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.