Growth
Following two consecutive quarters of negative GDP growth, 3Q22 real GDP showed the economy grew by a 2.9% annualized rate. Much of the gain came from a large upswing in trade, while beneath the surface the economy is still losing momentum in both growth and inflation. Real consumer spending continued to soften and construction spending was very weak with higher interest rates. However, investment spending is still holding up and the GDP price deflator declined markedly to 4.1% from 9% last quarter. Moreover, with pent-up demand for autos and a still very tight labor market, it’s clear the economy is not yet in recession.
Jobs
The November Jobs report was strong at the surface with an above-consensus gain for payroll jobs and rise in average hourly earnings. However, both the details of the payroll report and a broader view of the labor market suggests that moderation is continuing after very strong gains earlier in 2022. In particular, this morning’s report showed a second consecutive monthly decline in employment as measured by the household survey and a fall in temporary workers which often serves as a warning sign of weakness. Unemployment remained constant at 3.7%.
Profits
The 3Q22 earnings season showed a mixed picture of corporate resilience, with pricing power differentiating winners from losers in the face of rising costs. Our current estimate for 3Q22 S&P 500 operating earnings per share (EPS) is $50.28, representing a year-over-year (y/y) decline of 3.4%. 58% of companies beat earnings expectations and 54% beat revenue expectations. Management commentary constantly referenced the impact of higher interest rates, shipping costs and a stronger US dollar on earnings. Looking forward, earnings expectations for 2023 likely have to come down to reflect the slowing growth backdrop, which could lead to further equity market volatility.
Inflation
Inflation came in below expectations for the second consecutive month and reinforced the turning tide on inflation as nearly every major category showed easing price pressures. Headline inflation rose by 0.1% m/m and core inflation rose by 0.2% m/m, bringing the year-over-year rates down to 7.1% and 6.0%, respectively. Prices for energy and core goods contracted, while services ex-shelter inflation decelerated. We expect inflation will continue to trend downwards in the months ahead given easing supply constraints, cooler demand and lower commodity prices.
Rates
Despite a recent inflation moderation, the Fed has maintained its hawkish messaging on monetary policy. At its December meeting, the FOMC hiked rates at a reduced pace of 0.50% to a range of 4.25%-4.50%. Markets were most surprised by the Fed’s updated Summary of Economic Projections, which showed a picture of higher unemployment, higher inflation and slower growth in 2023 and 2024. The median FOMC member now expects a terminal rate at or above 5% next year. Further cooling in inflation data may allow the Fed to pivot before hiking rates above 5%, but the risk of Fed overtightening and inducing a recession remains elevated.
Risks
- The Fed could push the economy into recession if it overtightens policy in response to supply-driven inflation.
- Heightened geopolitical tensions with Russia could result in continued energy shortages, low consumer confidence and dampened growth.
- Markets may remain depressed and volatile until investors receive clarity on inflation and the Fed.
Investment Themes
- After this year’s sell-off, fixed income now offers more protection against a market correction or economic downturn.
- U.S. equity investors may use profits as a guide in a rising rate environment.
- Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.
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Originally Posted December 26, 2022 – Economic Update
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