by Alex Harding, CFA
Vice President, Equity Research
Yesterday, we hosted our annual Investment Outlook webinar where we discussed the key themes impacting capital markets and client portfolios in 2023. As we begin the new year, investors remain focused on the Federal Reserve’s inflation-fighting crusade leading us to our title of this year’s outlook, “Slaying the Dragon.” If you were unable to attend the live version, you can access the recording here.
A central theme within our overview is the belief that inflation’s flame will dim in 2023 as the Fed’s aggressive rate hikes take hold. Coincidentally, on the same day as our webinar, the December consumer price index (CPI) report was released by the Bureau of Labor Statistics. While below its June peak of 9.1%, the 6.5% year-over-year print remains well-above the Fed’s 2% inflation target. That said, within the report were many positive details. For the first time since May 2020, the headline inflation number contracted on a month-over-month basis, driven by a large drop in gasoline and used car prices. And, although the Core CPI, which excludes volatile food and energy items, remained stagnant at 5.7%, the shelter component accounted for more than half of the overall increase. This matters, because shelter inflation is known to lag changes in home and rental prices by six to 12 months. As shown in the chart below, home prices and new rents started decelerating in the first half of 2022. We expect shelter costs to follow suit and contribute to the downward trend of inflation in 2023.
The Fed’s Likely Reaction
The improving inflation picture sets the stage for a reduction in the pace of interest rate hikes at the upcoming February 1 meeting, with the likelihood of a more modest 0.25% increase all but certain. Further, investors are anticipating the Fed’s short-term target rate will peak in June of this year with rate cuts expected by year end. Despite the market’s view, central bankers are likely to maintain their hawkish rhetoric until they see a more balanced employment picture and confidence that the “sticky” components of inflation, including shelter, have rolled over.
Earnings Season Begins
As much as investors would like to put 2022 in the rear-view mirror, the fourth-quarter earnings season kicked off Friday morning with financial companies, such as Bank of America and J.P. Morgan, reporting. These large, money center banks provide a comprehensive view into the overall health and outlook of the global economy. Results were encouraging. Despite higher interest rates and a more uncertain economic backdrop, there are no signs of credit quality issues within bank loan portfolios and the consumer remains in great shape.
Takeaways for the Week:
Stocks rallied this week, advancing over 2%, in response to the positive inflation news
Shelter costs should be less of a headwind to overall inflation as we move through 2023