Monthly Outlook: November 2022 

Markets had a decent “bear market rally” in October. The S&P500 gained 8.1%, the NASDAQ rebounded 4.0%, and international stocks added 5.9%. These are hopeful signs until you realize that all three markets are still down 17% to 29%, YTD. Much of the rally was sparked by speculation that the Federal Reserve might be ready to “pivot” on their rapid rate-hike program, and move to a slower pace and maybe even a holding pattern.

The Fed has already raised Fed Funds from 0% in March to 3.00% today, and most likely to 3.75% this week. Markets anticipate another 0.75% or 0.50% at the Fed’s last 2022 meeting in mid-December, putting Fed Funds at 4.25% to 4.50% by year end. All of this is baked into the market today. The question is, What then? Will 4.50% be enough to quell inflation and signal “enough?” That’s the hope of this rally.

The data do not support this wishful thinking, at least not yet. Inflation measures continue to show 6% to 8% inflation, which is a long way from the Fed’s stated goal of 2% inflation. The logical bet is that the tightening will continue until there is evidence that it is working, and that could take many months. Savvy investors know to follow the trend, and “don’t fight the Fed.” That’s what we do, and for that reason, we’d recommend investors sell this bear market rally if they haven’t already. The bear market remains intact, for now.

Inflation Might Prove Difficult to Tame

Prices are always the intersection of supply and demand. Inflation occurs from some combination of too little supply and/or too much demand. The challenge is that myriad factors affect supply and demand, some obvious and some subtle. The Fed, however, has limited tools to fight inflation including changes in the Fed Funds rate, as well as quantitative easing and tightening (buying and selling bonds). How does raising rates improve the supply of stuff delayed at our ports? How does quantitative tightening make people want to go back to work, thereby increasing supply of labor? The Fed’s tools are most effective at reducing the demand for money and credit. Higher interest rates make it more expensive to borrow for a house,  car, use credit cards, or to expand a factory. Slowly, but eventually, higher rates and tighter money will hurt the economy. Earnings will fall, debt will rise, and the unemployment rate will rise. Only then will prices come down and inflation recede to the 2% target. It’s a sloppy way to meet a goal.

While most investors focus on the inflation in the price of “stuff,” the bigger challenge is likely to be inflation in the cost of labor. The supply of labor is way down for many reasons, and many workers can demand higher wages and benefits. Because labor is such a huge component of our economy, inflation won’t be reduced to 2% until labor costs decline.

Sixty-nine million people receive Social Security, which amounts to about $95 billion/month. Fully 25% of the adult population receives this benefit and many count on it as their primary income or at least a significant portion of their income. Last month, the Social Security Administration announced an +8.7% inflation adjustment for Social Security payments in 2023. I’m happy for the elders that receive these payments, and they’ll need it to pay higher prices for goods and services. But the important economic and market consideration is that we just locked in 8.7% inflation on $1 trillion of surrogate labor costs. This is counter-productive to the Fed’s fight to lower labor costs. This is just one example of why it’s likely the Fed cannot pivot yet, and why further monetary tightening will continue until a recession is triggered.

Trend Following Strategy in Bear Markets

Most investors want the same thing: make money, don’t lose money, and beat the market while you’re at it. Buy & hold strategies don’t have any mechanism to avoid losing money in downtrends. They just turn your focus to very long-term returns and hope you can muddle through and not panic. That doesn’t work for real-world investors and this weakness in their strategy is revealed in bear markets like today. Our iFolios is a trend-following strategy with built-in rules to sell downtrends to protect from big losses. It’s a better strategy for both good and bad markets. You can count on us to execute our strategy, and help you make it, and keep it!