Market Update

Market Update

Aaron Soderstrom


January 18, 2023

Market Update


  • Economy continues to slow, but the U.S. Economy is not yet in a recession.
  • Labor market is still tight.
  • Inflation is still high, but shows signs of cooling.

The week in review

  • Headline CPI: 6.4% y/y, -0.1% m/m
  • Core CPI: 5.7% y/y, 0.3% m/m
  • Initial claims edged lower to 205k

The week ahead

  • Retail Sales
  • Industrial Production
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Primary Economic Drivers

The four primary economic factors that can explain roughly 86% of all market deviation continue to fight their trends. This counter-trend movement in the factors is pushing equity markets higher. There are better situations for macro traders in the short run. However, taking a step back, we can see that despite the market direction, the business cycle is still the main economic driver and is still approaching a recession.

Risk Free

The Current economic environment defined by the economic driver does not support equity markets or corporate debt but supports treasuries, specifically long-duration treasuries. Another case for supporting long-duration treasuries is the market when the two-year treasuries yield drops below the Federal Funds Rate. This is likely to occur shortly after the Federal Reserve raises rates today. The only signal we would be looking for would be a confirmation in our trend model, which has been trending down all of 2022.

Domestic Equities Small Value High Yield Investment Grade Treasuries Commodities
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Equity markets continue to fight the macro environment, moving up while the climate suggests that it should be falling. This is because we are in the very late stages of an imminent recession where lower inflation (typically a bad sign) is giving hope that the Federal Reserve will pull off a miracle with a soft landing. A soft landing is highly unlikely to do the long and variable lags in monetary policy and the fact that rates of 4.25% are still not yet at a neutral rate estimated to be higher than 5%.

In the short run, markets trades from emotion, but in the 6-to-12-month range, they trade off fundamentals. Our overall outlook remains on the downside until the macro environment changes.

Economic Growth

Following two consecutive quarters of negative GDP growth, 3Q22 real GDP showed the economy grew by a 2.6% annualized rate, slightly more substantial than the 2.4% consensus expectation. Much of the gains came from an upswing in trade, while beneath the surface, the economy is still losing momentum in growth and inflation. Real consumer spending continued to soften, and construction spending was very weak with the climb in 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.

Our daily growth factor also confirms that growth slowing is not stalling; since November of 2022, growth has started to accelerate despite the pressures added by higher interest rates. Despite the increase in economic growth, our base case is that growth will continue to slow as we enter 2023 inching toward a recession at a methodically slow pace.


The 4Q22 earnings season will likely reveal that companies are continuing to face macroeconomic headwinds. Our current estimate for 4Q22 SP 500 operating earnings per share (EPS) is $52.52, representing a 7.4% y/y decline, driven by tighter monetary policy, geopolitical tensions and a stronger dollar despite the dollar easing. Revenues are expected to be the main driver of EPS this quarter and margins will likely contract due to higher input costs. Operating leverage continues to be key for profitability.


The December Jobs report was strong, with an above-consensus gain for payroll jobs and a decline in the unemployment rate to 3.5%. Notably, wage growth continued to moderate and was revised lower in the prior two months. With sliding wage growth and headline inflation, it is hard to justify the need for overly aggressive action from the Fed to tame inflation, and this report widens the window for a soft landing. The job market remains the strongest aspect of the economy right now.



Last week, December’s CPI came close to expectations, and marked the sixth consecutive decline in the headline CPI on a year-over-year basis and the first monthly decline since June 2020.

While the story last year was about inflation peaking, the 2023 narrative is shifting toward how quickly inflation can cool, and furthermore, how much cooling will be sufficient to get the Fed to pause its rate-hiking campaign. Last week, December’s CPI came close to expectations, and marked the sixth consecutive decline in the headline CPI on a year-over-year basis and the first monthly decline since June 2020. Core CPI on the other hand, which peaked three months after the headline figure, registered an increase of 0.3% m/m.

Turning to the details, energy prices declined by 4.5% relative to November, and there was also a moderation in food price increases to 0.3% m/m. Core goods, helped by abating supply chain bottlenecks, declined by 0.3%. On the other hand, core services came in firm at 0.5%, but were largely boosted by shelter prices (0.8% m/m), which are expected to reflect recent moderation in the rental market with some lag.

The Fed is likely to welcome this much-awaited progress on inflation by slowing the pace of rate hikes in February. However, the Fed will want to see further evidence that inflation is cooling, especially in services, before it will feel comfortable taking a pause.


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 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 the Fed overtightening and inducing a recession remains elevated.

Final Thoughts


  • Fed is likely to 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 the 2022 sell-off, quality fixed income now offers higher yield and more protection against a market correction or economic downturn.

  • Solid profit growth and reasonable valuations will be crucial in determining equity winners in a higher rate environment. Stock pickers beware. We are waiting for the recession before getting back into individual stocks.

  • Long-term growth prospects, a falling dollar and wide valuations discounts support international equities.

Upcoming Risks

Last Friday afternoon, amidst the lengthening shadows of a winter sun, the Treasury Secretary delivered an ominous warning: By this Thursday, the U.S. federal debt will reach its legal limit, requiring her to take extraordinary measures just to keep paying the bills.

Secretary Yellen’s warning was, perhaps, a little premature and she suggested that, with some adjustments, our real rendezvous with disaster might be postponed until June. But even this date is considerably earlier than many assumed in the middle of last year, due, in large part to the budgetary effects of the Federal Reserve’s aggressive tightening.

From both an economic and a financial perspective, a failure to raise the debt ceiling would be an unmitigated disaster. Today, as in the past, attempts to gain political advantage by holding the debt ceiling hostage amount to a juvenile game of chicken and both parties deserve the scorn of voters for not eliminating this fiscal doomsday machine years ago.

Moreover, debt ceiling theater has always acted as an easy distraction for those who minds ought be focused on managing the federal budget in a responsible way. Both parties have contributed to a ballooning of the national debt over the past two decades, eroding future living standards and increasing the risk of an eventual fiscal crisis.

While a failure to increase the debt ceiling is the most immediate fiscal threat to the economy and markets in 2023, damage could also be done either by continuing to neglect deficits altogether or by inflicting very sharp fiscal tightening on an economy which is now thoroughly hooked on the drugs of monetary and fiscal stimulus. Investors can hope that Washington adopts a more sensible middle path. However, they would be well advised to consider how their portfolios might hold up under a messier outcome.

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