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Weekly Update 12/9/2022: China Re-opens as Fed Meeting Looms

  • BorgWarner announces spin-off
  • FTC blocks Microsoft deal after firm inks Call of Duty pact
  • More inflation news
  • Carrier and Stryker increase payouts

With the holiday season now in full swing, many traders are looking forward to end of year parties and closing the books on 2022. Nonetheless, the year is not over yet, and the week highlighted another key inflationary data point for investors to digest, and overseas news garnered headlines. Enjoy the reading! 

International news

In a swift policy pivot, China scrapped most of its national Covid testing and quarantine requirements this week. This was in response to nationwide protests which have unnerved Chinese leader Xi Jinping and other senior officials. Trade data released before the Covid easing measures were announced on Wednesday showed Chinese exports fell at the steepest pace in more than two years in November putting added pressure on the economy among a sluggish recovery in the property sector. Recent Covid-related disruptions at the world’s biggest iPhone assembly plant led Apple Inc. to question using China as its Asian manufacturing base. Other supply-chain commotions put the zero-Covid policy in the crosshairs along with actions by overzealous local officials who were empowered to shut down entire blocks or towns at their discretion curtailing business activity and personal freedoms. The question now is what happens next?  Ironically, the zero-Covid approach created large populations of individuals who were not exposed to the virus and thus have not been able to build any antibodies. Clearly, it was nearly impossible to stop the spread of the disease by merely isolating people from each other, but the situation was potentially made worse by creating an unprotected pool in which the virus can now spread. There will likely be large outbreaks in China in the next few weeks because the apparatus for finding the origins (through testing) will not be in place and people are likely to embrace more mobility as rules are eased. That may lead to significant pressure on the health care system as hospital beds fill. China has fewer than four intensive-care bed spaces for every 100,000 people, China’s National Health Commission said last month, which means the country has about 56,000 ICU beds at present for a population of 1.4 billion. According to Feng Zijian, former deputy director of the Chinese Center for Disease Control and Prevention, about 60% of the Chinese population might be infected when the first wave of large-scale infections reaches its peak, before the infection rate gradually plateaus. Eventually between 80% and 90% of China’s population will be infected, Mr. Feng, a member of the central government’s advisory panel for Covid control, was quoted as saying at a forum on Monday. The extent of any spread may be limited by the uptake in those getting the vaccine and the fact that there will still be testing required for certain restaurants and bars in addition to nursing homes and schools. Currently more than 20% of people over 80 are completely unvaccinated and only 40% have had the three shots deemed necessary for robust protection. Fearing a potential monsoon-like wave of infections, share prices in Hong Kong and mainland China have been mixed in response of the policy pivot as investors are anticipating a messy re-opening with many still fearful of catching the disease and others not sure if lockdowns are indeed gone for good. Might further sickness and death lead to even more anger in the population? Will local leaders under report illness and fatalities to save their positions? Potentially. This remains a fluid situation that will require close monitoring because if it is one thing we have learned about Covid, it’s that it can mutate quickly into new variants creating untold problems for people everywhere. Stay tuned.


Producer Prices and Fed Thoughts

The biggest economic item of note this week was the producer price report from the Labor Department. Headline prices rose 0.3% for the month of November meaning it rose 7.4% from a year earlier. Monthly gains in October and September were also revised higher. The median November estimate called for a 0.2% gain and 7.2% year-over-year advance. A further dive into the numbers shows goods prices rose 0.1% while services prices registered the strongest advance in three months, up 0.4%. Excluding food, energy and trade services, producer prices rose 0.3% from the prior month and 4.9% higher versus a year earlier. A bit of good news came in the fact that the annual core price increase was the smallest since April 2021.

With actual results coming in higher than estimates, there was not much change in the overall expectation of what the Fed will do next week at their Federal Open Market Committee two day meeting which concludes on Wednesday. Attention will now turn to consumer price data for the month of November which will be released next Tuesday morning. Excluding food and energy, a Bloomberg survey of economists is expecting prices to rise 6.1% year-over-year. That would be slightly down from the 6.3% pace in October and constitute further evidence that inflation has indeed peaked. However, that does not mean that it is coming down anytime soon. The markets are expecting the Fed to raise its benchmark federal funds rate by 0.50% bringing the target range to 4.25%-4.50%. According to the futures markets, traders are betting that the terminal rate for federal funds settles just under 5.00% which suggests that the Fed is nearly done with its rate hike cycle. The big question then becomes how long will the Fed keep rates at that maximum rate? History offers some clues, but the range is so wide (from a low of three months to over a year) that it is still anyone’s guess at this point.

Earnings Trends

With third quarter reporting season mostly over, it is informative to take a look at what has transpired and what is anticipated. With 493 of 500 companies in the S&P 500 reporting results, third quarter earnings are 4.6% above the year-ago levels. At the beginning of June, those expectations were for a 9.9% annual growth, so those figures have been cut in half. Earnings per share for the fourth quarter of 2022 are now expected to be down from the fourth quarter of 2021. In a similar fashion, 2023 annual earnings per share estimates went from $247.50 at the start of June to $229.70 now. That is, a 9% growth rate down to 2.7%.

Remember, the S&P 500 hit an all-time high the first week of January this year. Then a combination of headwinds from Fed hikes to Russian invasions to continued supply-chain hiccups sent major averages lower. Earnings cuts are now in vogue as evidenced by the figures in the preceding paragraph. The last “shoes to drop” are headline information about layoffs, slowdowns and the imminent recession which will depress consumer confidence further. This is the process markets go through when bull markets end. It is nothing unprecedented nor particularly surprising. It is not a joyful experience, but one that is necessary to establish a base from which future market gains can be built upon. After a 31% gain in 2019, an 18% rise in 2020 and a 29% increase last year for the S&P 500, it cannot be too astonishing that there would be a down year at some point. As the saying goes: trees do not grow to the sky. This is a process, and the process is going to take time. Markets have a history of climbing a wall of worry and bouncing back so we are hopeful that things will start to turn once the Fed starts downshifting their hike program over the next few months. We will have more to say about earnings and outlook as part of our year-end quarterly write-up that will come to you in January.

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