Wentz Weekly: Midterms Result in Split Congress, While Inflation Cools in October

Wentz Weekly Insights
Midterms Result in Split Congress, While Inflation Cools in October

For all of last week, the race for control of Congress remained undecided after Tuesday’s Midterm elections. Republicans have an advantage in the House and are still expected to take control, while the Senate was a tossup, where majority was thought to be decided by a runoff election in Georgia on December 6 again. Incumbent Democrat Raphael Warnock won the Senate seat in the 2020 Midterms after the race went to a runoff election that was won January 2021, securing a majority in the Senate for Democrats. However, this all changed yesterday, when Catherine Cortez Masto was declared winner in the Nevada Senate race, which secured 50 seats for Democrats and a majority (as Vice President Harris breaks a tie).

Republicans are still favored to gain majority in the House as of Monday morning with 212 seats confirmed and just six away from the 218 seats that gives the party majority. An interesting takeaway from this Midterm election is that more voters split their tickets – for example, voting for a republican Governor but a democratic Senator. However, this year’s votes resulted in a divided Congress, which historically the markets have preferred.

Despite this uncertainty that is now out of the way, we still have a bigger issue at hand – the highest inflation in decades. Last week’s consumer price index came in softer than expected, rising 0.4% in October but below the 0.7% increase expected. Over the past 12 months the index was up 7.7%, below the 8.0% increase expected. With inflation lower than expected for the first time in months, we questioned what the cause was. Looking at the details, medical services, which make up a chunk of the index, declined 0.6% due to a 4.0% decline in health insurance costs. The core index, which excludes volatile categories like food and energy prices, rose 0.3% and was up 6.3% from a year earlier, still well above the Fed’s 2% target.

The softer inflation numbers were welcoming for investors, with the tech heavy and more growth-oriented NASDAQ rising 7.4% and the S&P 500 rising 5.5% on the day of the release (Thursday) for the best day since April 2020, when stocks were recovering from the dramatic Covid lows. While the numbers were a step in the right direction, we have to remember there is still a lot of work to do.

While market participants will focus on a divided government being the reason for a short-term market rally, it is important to keep in mind that longer-term markets are driven on fundamentals, with profits being the major factor by far. Higher interest rates are another factor, which has been a major headwind in 2022. However, as we have seen over the past several weeks, earnings forecasts have come down and are at risk of coming down further as the economy and stocks move past the artificial boost they got from federal stimulus over the past two years. This is a headwind we are watching as we near the end of 2022 and prepare for our 2023 forecasts. Markets may see bounce from the Midterms resulting in a divided government, and even from the Fed slowing its pace of rate hikes, but lower earnings forecasts may push any sustained rally further down the road.

Week in Review:

It was a more uneventful day to open the week last Monday. Stocks had a slow start but ended up closer higher, just off the highs of the day. China reiterated its “unswervingly” adherence to its zero Covid policy while the government was reported to have told cities to correct excessive measures as the public pushes back against the zero Covid policy. Apple said overnight Sunday its shipments of higher-end iPhones would be lower than expected due to Covid restrictions in its largest assembly site. Not much news from U.S. markets as investors continue to digest the Fed meeting and look forward to the elections on Tuesday. Stocks closed 0.96% higher.

From a market perspective, it was another relatively quiet day, with no economic data, but several lower-profile earnings releases. Cryptos received increased attention after solvency concerns at crypto exchange FTX led to it being acquired by Binance, but the solvency concerns spilled over to the cryptocurrencies where most were down double digits on the day. There has also been increasing chatter of Ukraine’s Zelenskyy and his potential willingness to negotiate with Russia. Stocks had an overall positive day with the S&P 500 rising 0.56% while Treasury yields moved lower across the curve.

Election Day was the other topic of conversation, as Republicans did not get the red wave they were hoping for. Control of the House and Senate were still undecided, but expectations are that Republicans will win control of the House while the Senate is a tossup. In company headlines, Disney’s parks and resorts segment showed very strong growth but that was offset by higher costs in its streaming services, while Meta made news after it announced it would lay off over 13% of its workforce to reduce costs. Crypto stayed in the headlines after Binance walked back its offer to acquire FTX, leading to more volatility. Stocks fell again with the S&P 500 down 2.08% and NASDAQ down a larger 2.48%.

All eyes were on the inflation report Thursday morning, which showed consumer prices rose less than expected in October, leading to a massive rally in stocks, particularly growth and tech stocks. Fed fund futures expectations for the peak Fed Funds rate moved from 5.02% to 4.83% with Treasury yields falling substantially. It was the best day for the S&P 500 since April 2020 with a 5.5% gain, while the NASDAQ increased 7.4%.

Fed speak returned and most of the comments from policymakers suggested a slower pace of rate increases, but officials emphasized that does not mean the terminal rate is lower, indicating the rate the Fed aims to get to has not changed despite a slowdown in the size of rate hikes. Friday was a more uneventful day, with crypto still in the headlines after the FTX exchange filed for bankruptcy.

Stocks had an overall positive week, but a bulk of the performance came from Thursday after the softer than expected inflation data. Major indices finished as follows: NASDAQ +8.10%, S&P 500 +5.90%, Russell 2000 +4.60%, Dow +4.15%. Oil had another volatile week with oil prices trading in correlation to China Covid lockdown news, but by the end of the week traded lower by 3.9%. The fixed income markets saw a volatile week as well, with yields falling dramatically on Thursday and ending the week lower overall. The 2-year Treasury yield fell from 4.70% to 4.33% while the 10-year yield fell from 4.16% to 3.81% as the peak Fed Funds rate projections moved lower.

Recent Economic Data

• The consumer price index rose 0.4% in October, lower than the 0.7% increase expected, and follows a 0.4% and 0.1% increase in the prior two months. The increase in October was driven by another large increase in food, rising 0.6% which is the first time food hasn’t risen at least 0.8% since December last year, while energy prices moved 1.8% higher after three months of declining. Excluding the volatile food and energy categories, consumer prices were up 0.3%, lower than the 0.5% expected, and follows a 0.6% increase in the prior two months. The lower than expected increase was due to a 2.4% decline in used car prices, 0.7% decline in apparel, and a 0.6% decline in medical services (the first decline since a 0.1% decline September 2021), offset by another large increase in shelter which was up 0.8% in the month and the largest increase since 1990 as the component continues to catch up with the significant increase in home prices. Over the last 12 months, prices are up 7.7%, below the 8.0% expected and down from 8.2% in September, while core prices are up 6.3%, lower than 6.6% expected and down from 6.6% in September.

• The number of claims for unemployment benefits filed for the week ended November 5 was 225,000, an increase of 7,000 from the prior week. The four-week average has been steady, at 217,000 for the latest week. The number of continuing claims was 1.493 million, up slightly from the prior week with the four-week average rising 32k to 1,450 million.

• The University of Michigan’s consumer sentiment survey index level for the November preliminary reading fell to 54.7 from 59.9 in October, and lower than expected. The all-important inflation expectation for the next 12 months increased to 5.1% from 5.0% last month, while the five-year ahead inflation expectation increased to 3.0% from 2.9%, disappointing after the consumer price index showed inflation rose less than expected in October.

Company News

• Early last week, reports came in that Facebook parent company Meta is preparing for massive layoffs, with a number in the “many thousands.” Meta has about 87,000 employees. Recall, Facebook fell over 20% after its most recent earnings report after it said its spending would be much higher than expected.

• Meta, Facebook’s parent company, CEO Zuckerberg said in a meeting to executives he is to blame for the missteps at the company and its strategy for its aggressive push to the metaverse. In a memo to employees Tuesday night, the company said it would cut 11,000 jobs, or about 13% of its workforce, while saying the company is taking additional steps to become a leaner company by cutting discretionary spending and extending the hiring freeze through Q1. In the filing to the SEC, the company also reiterated its revenue outlook.

• The WSJ reported Netflix has been increasingly showing interest in bringing live sports to the platform, with sources saying the company recently bid on streaming rights for the ATP tennis tour for European countries. It ultimately dropped its bid, mostly likely due to the high costs of the rights. The company is supposedly looking at low-profile sports.

• Salesforce is reported by CNBC to have laid off employees as of Monday and the report says it could cut as many as 2,500 jobs, citing a weakening of demand in some countries and business areas.

• At an investor conference Tuesday, FedEx said it has reduced the frequency of flights and parked some more of its planes as a result of weaker than anticipated demand for deliveries, particularly in Asia, as well as the shift in consumer spending to services, away from goods.

• According to the WSJ, Amazon has told employees in unprofitable segments to seek roles elsewhere in the company as it prepares to end/suspend more projects. It was last month the company said it would pause hiring and shutter certain projects. The company is looking at roles that are no longer necessary and instead of laying off those employees, relocating them to other segments. Its Alexa business, with generates significant losses, is one segment going through such scrutiny.

Other News

• OPEC’s oil production increased 220k barrels/day in October, despite its agreement to cut by 100k bbl/day. However, its output is still 3.31 million bbl/day below its quota.

• Russia ordered troops to leave Ukraine’s city of Kherson, which was the first major city it seized in its initial invasion.

• The crypto markets returned to the headlines due to solvency concerns at the crypto exchange FTX, which led to another sharp decline in cryptocurrencies as investors questioned their confidence in the crypto markets. As a result, FTX exchange was almost acquired by Binance to help shore up its balance sheet, who later walked back on the offer due to additional concerns. The FTX crypto token fell over 80%, leading to a larger selloff in the cryptocurrency sector. There were increasing concerns this would spill over into other crypto exchanges like the largest, Coinbase.

• Biden will meet with Xi on Monday, expected to bring up Chinese economic practices, Taiwan, and Russia’s war in Ukraine.

• Late last week, after tons of speculation, China took steps to ease Covid restrictions, cutting the time travelers/people in contact with a positive case are required to quarantine and looking to end city-wide mass testing.

• A Texas District court judge blocked Biden’s student loan forgiveness plan, saying the plan to cancel billions of dollars in debt was unlawful and must be vacated. The Biden administration has already filed an appeal.

• Recent Fed speak – Recent public appearances from policymakers toward the end of the week suggested the pace of rate increases going forward may slow. However, policymakers made it a point to emphasize just because the pace of increases would be slower, it should not be confused with adjusting the terminal rate, which appears to remain unchanged, and it should not be meant to represent easier monetary policy.
• Philly Fed president Harker said he expects the pace of rate hikes to slow in the coming months due to the cumulative tightening that has already been done, but made it clear that “a rate hike of 50 basis points would still be significant.” He said at some point next year rate hikes will stop and the Fed expects to hold rates at those high levels to let “higher cost of capital to work its way through the economy.”
• Dallas Fed president Logan said a slower pace of rate hikes “should not be taken to represent easier policy,” and said it does make sense to slow the pace so the Fed can better asses how economic conditions are evolving.
• Richmond Fed president Barkin said we are likely at the back end of the surge in inflation.
• San Francisco Fed president Daly said one month of data (when referring to Thursday’s softer inflation data) does not make it a victory, rather it is one positive piece of information, and the Fed is looking at a range of information. She reminded her audience that 7.7% was a relief as it dropped from the previous month, but it is nowhere close to the Fed’s 2% goal. She also reminded her audience that adjusting the pace of increases does not mean and should not be confused with adjusting the terminal rate.
• Kansas City Fed president George said she sees additional advantages of a “steady and deliberate approach” to continue raising rates, suggesting it is better to do too much versus too little. She added it is tempting to speculate what the terminal rate is, but this is unknown and will be determined by observing the dynamics of the economy and inflation.

Did You Know…?

• 401(k): Individuals can now contribute up to $22,500 to their 401k, 403b, and other select qualified retirement savings plans, up from $20,500 this year. The catch up contribution, which allows those over the age of 50 to contribute an additional “catch up” amount, increases to $7,500 from $6,500.
• IRAs: Individuals can now contribute up to $6,500 in earned income to Individual Retirement Accounts (traditional or Roth), up from $6,000 this year. The catch up contribution for those over 50 remains at $1,000.
• The income ranges that determine whether an individual’s contribution is tax deductible (for traditional IRAs) or not if covered by a workplace retirement plan as well as phase out limits for Roth contributions moved higher as well. The income phase out range for Roth IRAs single taxpayers is $138,000 to $153,000 up from $129,000 to $144,000.
• The IRS also released tax inflation adjustments for tax rate schedules. The standard deduction increases $1,800 to $27,700 for married couple and $900 to $13,850 for single filers. To see the updates to the tax tables, you can view this IRS link here.

• Will your primary doctor still accept you Medicare Advantage Plan?
• Have your medical needs changed? Different plans offer different benefits and different costs
• Are there comparable, lower cost plans available? Don’t forget to consider out-of-pocket costs when comparing options
• Are you medications still on your plan’s list of covered medications?

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