On Thursday, October 13, 2022, the Bureau of Labor Statistics announced that the Consumer Price Index (CPI) increased by 0.4 percent in September, surpassing the expectation of 0.3 percent. The so-called headline inflation, the year-over-year measure, was up 8.2 percent. That is off its June peak of 9.1 percent, but still near its highest levels since the early 1980s.
Inflation just won’t stop—for now. But give it six months. Moody’s Analytics’ Mark Zandi calculates that the CPI will be cut in half by the second quarter of 2023. For that to happen, oil prices need to remain roughly where they are, the supply chain needs to maintain improvement, and vehicle prices must continue to roll over. None of which are unreasonable.
The Dow Jones Industrials futures whipsawed from positive 300 points to negative 500 on the CPI release. The drop in stock market prices in 2022 has been brutal. Perhaps it’s because the U.S. economy will likely tip into recession in six to nine months, according to JPMorgan Chase CEO Jamie Dimon. Mr. Dimon shared his concerns on October 10, 2022, during a CNBC interview. He also shared that the S&P 500 could fall by “another easy 20 percent.” Yikes!
Some have argued that the market’s final low won’t occur until things get so bad that public companies begin to see their earnings drop. Corporate profits have held up nicely thus far this year. But that could change this earnings season. Throughout this period of rising inflation, companies were able to increase prices for their goods and services faster than their costs. That widening spread between revenues and expenses pushed corporate profit margins to record highs in recent quarters. That will persist for some companies, but others are struggling from waning customer demand caused by the Federal Reserve’s war on 40-year high inflation. The Fed has been slowing the economy by rapidly raising its key interest rate from effectively zero to a range of 3 percent to 3.25 percent.
Companies in the S&P 500 have begun to release earnings reports for the third quarter (Q3) of 2022. So far, fewer are beating estimates than during the previous quarter. Those that do beat estimates are doing so by smaller amounts.
Aggregate earnings for S&P 500 companies are expected to rise in Q3, but it’s primarily an energy story. Refinitiv expects Q3 earnings to increase by 4.1 percent. Excluding energy, however, the estimate is a negative 2.6 percent. That’s a 6.7 percentage point swing without the oomph from energy companies. Fourth quarter (Q4) 2022 earnings also look bad. S&P 500 Q4 earnings for the Communications Services sector are expected to be down 9.5 percent. Financials, Consumer Discretionary, and Materials earnings are expected to be down between 2 percent and 3 percent. Technology earnings growth is expected to barely be positive at 0.2 percent. This, unfortunately, supports my concern that 2023 will make 2022 look like a walk in the park. However, it does not help my expectation for a solid year-end rally that extends into early 2023. For that, we need to look elsewhere.
I don’t have a lot of positive news about things like the Federal Reserve, inflation, the war in Europe, the economy, earnings, or much else on the fundamental side. But, at the very least, seasonal factories are turning favorable. The stock market is finishing what has historically been the weakest three-month period for stocks and entering the most substantial. Oppenheimer found that the average bottom date was October 9 for the last eight mid-term elections, going back to 1990.
Bespoke found that since 1990, even in non-mid-term election years, the S&P 500’s median three-month gain from the close of October 10 has been 6.96 percent. That may not sound like much given the market’s precipitous drop, but (a) it’s more potent than any other three-month period, and (b) a gain of 6.96 percent is close to what the historical averages are for entire calendar years.
Three-month returns after October 10 are consistently positive, with gains 81 percent of the time. That is the second most positive streak on the calendar. (The most positive 3-month stretch is the 88 percent success rate that follows the close of October 4). The Technology sector historically had the most significant gains, at 9.5 percent. Then Industrials and Materials rallied 8 percent. No sectors have a historical median loss, but Real Estate and Utilities (classically defensive sectors) typically lag.
Investing based on seasonals is only one part of this crazy investment puzzle. I’d never invest based on only one indicator. Still, it supports my overall investment thesis that there will be a rally before the bear market resumes. Another piece of the puzzle arguing for a rally from here is the Crash Confidence Index (CCI).
Since 2001, Yale University professor Robert Shiller has asked, “what do you think is the probability of a catastrophic stock market crash in the U.S., like that of October 28, 1929, or October 19, 1987, in the next six months?” Currently, the Crash Confidence Index is at 28.8 percent. It was only more pessimistic at the bottom of the 2007-2009 and 2011 bear markets and the 2020 COVID Crash.
The findings are expressed in a rather wonky way, which I’ll avoid describing so that I can clarify the point.)
Because of research conducted by Harvard finance professor Xavier Gabaix, we know that people get it wrong when it comes to calling a crash. (Often, people have what’s called “retroactive prescience,” which is when after the stock market drops, they “knew” it was going to happen…uh-huh…) The CCI is a contrarian indicator. The fear of a crash is high, which suggests stock market gains for the next 12-month, 2-year, and 5-year periods.
That is some promising history. But, as Jamie Dimon reminds us, we must keep the future in mind. Apparently, this 2022 “recession” is only a recession by my standards. Most people believe the “real” recession will come next year. Those people are probably right. According to Moody’s, U.S. business confidence was at 2 percent last week. For context, historically, readings of 20 percent to 30 percent are consistent with an economy expanding at its potential. The all-time low was -30 percent in December 2008, and the peak was 46 percent in April 2015. When responses are negative, the economy is in a recession. The last time I checked, 2 percent was close to negative. The Fed seems determined to push that survey into the negative, put the economy in a headlock, force corporate earnings into the dirt, and kick the stock market in the face.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
