November 3, 2022 | What Went Up Must Come Down

Yesterday, Fed chair Jerome Powell reiterated his commitment to combating inflation (lagging indicator) at the expense of economic growth, employment and asset prices (leading indicator). Stocks didn’t like the message. In an abrupt reversal, every market sector tumbled into the close, with 474 of S&P 500 members ending in the red. There’s a point of financial pain at which the Fed will pause; evidently, we aren’t there yet.

The persistent hawkishness of central banks is a new paradigm for a world of market participants who’ve been trained to presume unending monetary bailouts. Most are incredulous that gambling isn’t winning and lack the discipline to do otherwise.

Meanwhile, the most abrupt tightening cycle on record is moving through the economy faster than average. With interest rates the highest since 2007, home sales are already down 49% year over year in Toronto and 45% in Vancouver. US mortgage applications (a leading indicator) were -40.8% year over year for the week of October 28. Used car prices in October were -10.4%, the weakest since the 2008 recession.

Ex-oil and gas, S&P 500 earnings per share were -5.1% year over year in the third quarter, following a 4% contraction in Q2, registering the first successive quarterly decline since the 2020 recession.

Public company profits benefited from pandemic-era fiscal and monetary support while they were able to pass on higher input costs to consumers. But that is all in the rearview mirror. Now, consumers are tapped out and focused on how to cut spending just as excess inventories, higher borrowing costs and worsening productivity prompt companies to cut overhead/workers.

On the upside, collapsing demand and a profit recession will force liquidation selling and finally help bring inflation back to target. The policy-enabled inflation of 2021 is mean reverting through deflation in 2023.

Danielle Park November 3rd, 2022

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