It’s that special time of the year, and we will all hear and read a great deal about Black Friday, Thanksgiving Weekend, and Cyber Monday during the next few days. Many pundits are going to make sweeping conclusions about the economy based on these very limited reports.
. Christmas-time spending is a marathon, not a sprint. Slow sales early could be bad news, or it could just mean shoppers are waiting to pounce later; fast sales early could be good news, or it could mean consumers get tapped out sooner. Past patterns are no indication of this year’s results. Even more important: it’s not how much consumers are spending that matters, but how much the economy is producing, which is the ultimate source of future purchasing power.
Instead, focus on fundamentals, like monetary policy and corporate profits. It’s these fundamentals that determine the path of markets in the next year or so. And in that regard, the near future is flashing many warning signs. My opinion is that the corporate earnings will suffer for a quarter or two and then show signs of recovery which will be welcomed by the stock market in the second half of next year.
With results from 97% of S&P companies for the third quarter, according to FactSet, it looks like corporate profits are up only 2% from a year ago. We would not be surprised at all if the GDP report (due Wednesday morning) shows economy-wide corporate profits fell in Q3 and, given bottom-up earnings estimates so far, continue to decline in Q4.
The stock market depends on two important factors. Profits and interest rates. As the Federal Reserve has lifted short rates, the entire yield curve has risen, and higher interest rates have been a big drag on stocks. Now stocks look like they’ll also have to grapple with stagnant to declining earnings. This is why I think the recent rally does not signal the end of a bear market, just like the rally from mid-June through mid-August, which ended with the S&P 500 peaking just north of 4300. This is why we have made major changes in the mix of stocks and funds that we are in.
The lowest close so far this year is 3577. We think the market will test that low and likely go lower before the next recession is through. (I will provide more clarity on what to expect in 2023 before year-end.)
The only way the recent rally turns out to signal that the worst is behind us is if the US somehow avoids a recession. But with monetary tightening (highlighted by a significant slowdown in M2), avoiding a recession is unlikely. This is especially true when we add in the fact that much of the economy, especially in the goods sector, has to get back to normal after being artificially supported by trillions in temporary stimulus in 2020-21.
Yes, some recent economic reports have been solid, including retail sales, manufacturing output, and new home sales. Meanwhile, jobs have kept growing. But the link between tighter money and less economic growth is long and variable.
As a result, the near term is going to be a slowdown in corporate profits, with value/dividend stocks outperforming. We can only dampen the effect of this volatility in stocks and position for the growth to come. Next year will be much better than this year as we are at the end of the tight money policy. Stay patient for now and enjoy the season.
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