This week, Ramesh Poola, Ph.D., CFA®, discusses the latest interest rate hike as well as the forces behind the market selloff.
Welcome to the Weekly Market Update!
Last week, we reported employment and inflation data – two critical economic data points driving the interest rates and market reactions.
This week, I will discuss the interest rate hikes and the forces behind the market selloff
As widely expected, the Fed raised interest rates by 0.75 percentage points this week.
It is the third consecutive 75 basis points rate hike.
After this hike, the federal funds rate increased to 3.25% – a level we have not seen since early 2008.
What is more? Officials project short-term rates will rise above 4.25% by the end of this year.
The underlying message here is: Fed will continue to increase at this pace in their next November and December meetings, and rates will stay higher for longer, well into next year.
As we all know, inflation has been very sticky while the jobs market is strong. These data points have significantly changed the trajectory of target policy rates since the second quarter of this year.
The Fed Chairman repeated his firm and hawkish tone at Jackson Hole.
He was also very candid about the risks that might come with it.
Slowing the economy, increasing unemployment, housing correction, and causing a recession may sound alarming. But these are potentially a few downfalls that come with higher interest rates.
Meanwhile, we are already witnessing the impact of rate hikes on the economy.
Mortgage rates are increasing at a faster cliff over the last five weeks. The average rate on a 30-year fixed mortgage climbed to 6.29%.
The last time rates were this high was October 2008, when we were deep in recession. For comparison, a year ago, mortgage rates were 2.88%.
Higher mortgage rates have cooled the housing market significantly, and this trend will continue for several quarters.
The existing home sales fell in August. Sales dropped nearly 20% from a year ago.
While home prices have fallen from their springtime highs, prices remain above where they stood a year ago. We think prices should eventually trend down once the supply-demand rebalances.
Chairman Powell on Wednesday said the housing market would go through a correction after a period of red hot price increases.
We shall see how much correction will happen in the home prices.
Rising interest rates are squeezing stocks on both sides, corporate profits, and valuations.
A slowing economy can lower pricing power and sales growth, and both are impacting corporate earnings negatively.
We see that the expectations for third-quarter earnings have dropped in recent months.
Analysts now project profit among companies in the S&P 500 will rise a modest 3.5% from a year earlier.
It was down from 9.8% growth forecasts three months ago. Estimates for the entire calendar year have also declined to 7.7%. We won’t be surprised if the earnings growth continues to trend lower into the fourth quarter.
Last week, FedEx issued a profit warning. It slashed its earnings forecast, pulled its outlook for the year, and called for a half a billion dollars shortfall.
This news hit a nerve with global markets that are already jittery over the state of the economy. FedEx stock ended 21% lower on Friday, its worst one-day percentage decline since April 1978.
Several giant companies, including Target and Walmart, have sounded warnings or posted quarterly profits well below Wall Street expectations.
We think early warnings from these bellwether companies paint a picture of a slowing economy and what to expect in the near future.
The rising rates also pressure valuations and stock prices – how much investors are willing to pay for a slice of a company’s profit.
After the steep selloff year-to-date, stocks are commanding lower prices in terms of company profits.
The S&P trades below 16 times its projected earnings over the next 12 months, down from 21.5 at the end of last year and below the 10-year average.
Higher interest rates and growth fears have roiled the global markets.
All three major U.S. stock market indices have poised to post steep losses for the week and the year.
The Dow Jones Industrial Average reached a new low for this year. It has surpassed its lows from June and now trades at levels last seen in late 2020. It would mark a 20% fall from the record close set on January 4. Clearly, it is approaching the bear market territory.
The S&P 500 Index is also approaching its June lows and is looking to test its 3600 support levels.
Commodities like gold and oil also posted steep losses for the week.
The volatility has returned with a resurgence. The VIX index, commonly known as the fear gauge, got closer to the 30 mark, four points shy of its June highs.
So, what does it all mean?
Inflation numbers and rising rates have already inflicted considerable pain on investors. And this downward trend is not over yet.
Though the market is causing considerable short-term pain for investors, it also offers some opportunities. A few companies we liked but didn’t buy before due to their hefty valuations are now on sale. We will continue to look for such opportunities and make changes as appropriate to our portfolios.
Capitan Powell has left the seat belt sign ON. We must fasten our seat belts and remain seated until we cross this turbulent period.
The bottom line, investors must remain patient until we can ride out this volatile period.
Have a great weekend, and join us next time for the weekly market update!