Yesterday morning, the Consumer Price Index (CPI) for All Urban Consumers was reported by the U.S. Bureau of Labor Statistics and the index rose 0.1% in November on a seasonally adjusted basis. Over the last 12 months, the all-items index increased 7.1% before seasonal adjustment. This compares with respective estimates of 0.3% and 7.3% – positive news – inflation may be slowing.

This is the type of data that Chairman Powell and Federal Reserve (FED) are analyzing to determine the next actions they take on interest rates. Right now, the markets are laser focused on guessing what the next interest rate increase will be (the FED meets later today). The hope is that inflation data is softening, and the FED can slow its rate increases.

Why do the investment markets care? If interest rates rise, the stock market becomes less attractive to investors as other investments, such as fixed income, becomes more attractive and it can lure funds away from the stock market. Real estate cares because every interest rate point upwards causes mortgage rates to rise, exponentially raising the long-term cost of buying a home for many buyers.

If equity prices are going to go higher in 2023, an end to the FEDs rate hiking campaign will likely be a key component. The timing of the last rate hike of this cycle is uncertain and won’t be clear for a while, although the above news is encouraging. LPL Research believes that the FED will pause early spring of 2023 amid an improving inflation outlook and loosening job market. Should that occur, stocks would likely move higher, consistent with history. Stocks have tended to produce solid gains after hiking cycles end, including a 10% average gain one year later.

We keep hearing about a potential recession – is it coming? There are three factors for defining a recession: depth, diffusion, and duration – conveniently referred to as the “three Ds”. Depth refers to declining economic activity. Diffusion describes an economy that has experienced a contraction in a wide range of sectors. Duration, likely the least important of the three Ds, measures the time between the previous business cycle following trough. Since World War II, the average recession has lasted just over 10 months.

According to LPL, If the U.S. falls into recession, the chances are that it would occur during the first half of 2023 and will not be as deep as the 2008 recession, which was initiated by a fundamentally flawed financial market.

Lastly, some comments now that the midterm elections are over. The Democrats have held to a slim majority in the Senate and the Republicans gained enough seats to win a narrow majority in in the House. What this means is only legislation with broad bipartisan support will get passed once the new Congress is sworn in on January 3, 2023. The key take away is, it is over (thankfully). Historically, midterm years have been volatile for markets, and 2022 is no exception. But the third year of a presidential cycle has historically been the strongest and a weak 2022 may help set that bullish pattern again. ~ Mark and Elise

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