Unresolved Policy Issues Leave Markets with More Questions

Unresolved Policy Issues Leave Markets with More Questions

December 14, 2022

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Predicting market values in 2023 is tougher than normal. To give a brief recap; COVID declines led to a substantial bounce in the markets following the March 2020 low, this was then followed by an additionally strong market in 2021, this was then capped by a Fed rate hike cycle induced decline for the entirety of 2022. Now we sit with still unfinished international and domestic policy issues that are very difficult to measure the potential outcomes for. In this week’s note I try and put a coral (not a bow) around these items and give some insights as to what we expect moving into 2023.

China Syndrome

The two biggest economies of the world are the US and China. According to the media, we are continuously at odds, yet our economies have become intertwined based on consumption, labor practices, goods and services and financial exchanges. The COVID occurrence has taken all of these and thrown them into a sort of time warp. We can’t get what we need from the supply chain, fears of China taking over Taiwan and taking over control of semiconductor manufacture, stories of continued lockdown of employees in factories due to zero-tolerance COVID policies, and inconsistent shipping of consumable goods of all types have led to greater distrust and a need for the US and the rest of the world to go elsewhere for labor, goods, and services.

As 2023 approaches we don’t see a let up in many of these points, yet we are seeing labor moving to other parts of Southeast Asia and India. Goods are coming from Mexico and other locals. Semiconductor plants are quickly being built to create another location other than Taiwan for semis. As Felix Zulauf and others in Barron’s have been saying this year; we are moving from a globalized world to a deglobalized world. Clearly in an effort to not have as great a dependency upon foreign providers.

Russia / Ukraine Conflict

This conflict, although far from our boarders, has created additional inflationary pressures for us. At the end of 2021 the price of wheat and oil were up dramatically, and this had an immediate and measurable effect on the US economy and consumer. Throughout the year the conflict between Russia and Ukraine rages on but the prices of wheat and oil have backed off and are now not the impediment they initially were.

I don’t mean to discount the human suffering and genocide that is going on, but rather am looking at the structural pricing issues. This conflict will end at some point, yet fears of Russian nuclear weapons and a continued disruption to food and oil in the region is continuing to have an effect on Europe and the US. Since March 2022, the FOMC has alluded to the war as a primary factor putting additional upward pressure on domestic, US, inflation. The war rages on, yet as seen above, the prices have reversed and normalized.

US Inflation and expected 2023 Recession

So here we sit. We have a Fed that has aggressively raised interest rates in an effort to burn off the excess cash that was dropped on the US economy in numerous Quantitative Easing efforts culminated by the stimulus in 2020. Rates have gone from near zero to current levels- approaching 5% on short-term costs of funds. This has devastated the mortgage industry, brought used car sales to a screeching halt and basically put new and pre-owned home sales and commercial real estate in a stand still. As can be seen in the chart below, CPI, PPI and other inflation measures rose, spiked hard and as a result of Fed action have begun to trail off:

I could go into greater detail on the components, but I will leave you to your own research on the points you feel are most important. What IS important is what next? And this is where we are currently. The equity and bond markets of the world are all held hostage to action of the US Fed. Has the Fed raised rates too far and too fast to create a recession? Or has the Fed raised rates as needed and we will experience a slowdown or “soft landing” as it is often termed and then build a new base from which our economy will grow and flourish once again?

The above chart, I believe, gives us the best depiction of what the markets think about the action out of the US Fed, but cannot give us an answer as to whether we recess or have a soft landing. According to Transamerica Asset Management’s Chief Investment Officer, Thomas Wald, I think he puts it in very easily digestible bites below:

I believe that his last point is really the most important. 2023 could be a year where our equity markets have already digested the economic slowdowns that will result from the actions of the Fed. The chart above that shows the action of Fed Funds and the 10-year US Treasury Yield is saying that the economy is slowing as evidenced by the decline that has begun in the 10-year yield. The market should reward some industries that have either already suffered declines and industries that the current administration’s policies support. The industries that could suffer would be those that still need to contract as they became way too extended during the last economic upswing, and they still have room to digest these gains. We will remain focused on the US, international, commodity and fixed income markets to find opportunities that appear to have runways.

As always, please feel free to contact us with any questions you may have and as always, if you have any personal questions you would like us to provide input on, we are always here to help.


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