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Mid Year Elections and Markets

It is interesting and worth noting that since World War II, stocks have not sold off in the year folowing a midterm election. There are no guarrantees that history will repeat itself but in the 20 midterm elections since World War II, stocks have risen the following year between 5% - 32% depending on the year. In 14 out of the 20 years following the mid-term election cycles the markets have risen by more that 10%.

Why is this? "Post-election outperformance is often driven by the market's expectation of increased government spending from a new Congress," says Liz Ann Sonders, Schwab's chief investment strategist. "But an additional infusion of funds seems unlikely this year, given the government's historic levels of spending and stimulus in response to the pandemic" 

Other perspectives say that equities tend to disappoint in the years before the election and that once anxiety about potential policy changes post-election subsde that there is a reversion to the mean. 

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Market Forces, Cycles and Financial Mechanics

Markets are cyclical. That is an undisputed fact backed up by hundreds of years of statistical proof. Capitalism is known for it's boom/bust cycles, periods of market expansion fuelled by cheaper credit followed by recessionary forces, tightening fiscal conditions and economic contraction. In recent years we have seen the lowest rates in US history coupled with the greatest injection of money into the economy in US history to avert the COVID induced economic global crisis.

The impact of supply chain disruptions, demand/supply imbalance, labor shortages, higher wages and QE squared has been the most feared outcome of all to economists, namely "Inflation". Inflation left unchecked destroys the economic fabric and "value" of currency in a country. As the word's reserve currency, the Federal Reserve will do whatever it takes to bring inflation to heel.

We have gone from record low interest rates of less than 1% to over 4% in a comparatively short period. 30 year mortgages have hit a new recent high of 7%. Just over 18 months ago you could get a 30 year mortgage for 2 -3% depending on your credit. The substantial rise in rents, food, energy, cars and most goods and services over the last three years are not a mirage. The poor and middle classes are significantly affected by this.

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Is the Economy Slowing? Realistic Interest Benchmark Forecasts May Signal the Beginning of a Reset

The end of "hope" may be a net positive when it comes to market expectations in a bear market. Up until recently the markets have been relying on a constant drip of an illusory - any moment now - "Fed Turnabout Cocktail". Each time the Federal Reserve dissappoints with renewed commitment to its hawkish policy, the markets pout. Volatility is the ineivtable result with almost daily commentary about the latest thoughts of the members of the Federal Reserve and upcoming economic indicators.

The markets have now - at last - factored in benchmark rates of between 4.9-5.4% which is closer to what the Federal Reserve has indicated as potentially possible. While markets and media talk about a pending recession in lock step with Federal Reserve policy, some argue that we are already in a recession. The markets are now factoring in or discounting the future on a more realistic basis which means a greater acceptance of what is likely and less hopeful about any imminent Federal Reserve policy turnabout. 

Federal reserve actions are slow to filter into the economy but as we mentioned in our previous article, there are signs of demand slowing appearing in the economy. Container prices which are seen as a more current indicator of economic demand have dropped from sky high prices of around $20,000 during the peak COVID era to the low $2-3,000 range today. Job openings are down substantially. Residentail real estate prices are falling. Commodity prices from lumber to copper are down from their recent highs. If it takes 260 hours for the world's largest supertankers to turn around, how much time does it take for the worlds largest economy?

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Recent Trends in GDP and Consumer Demand

The Fed Reserve and inflation have been primary market talking points. Today we will take a look at recent trends in GDP and consumer demand. While the Fed is doing all it can - with its tools - to put the breaks on consumer demand and inflation, the data - across multiple key indicators - shows clear signs that the economy is starting to slow.

After two consecutive negative GDP growth quarters, The GDPNow forecast for the the third quarter of 2022 has been falling steadily since August when it was projected at 2.5% to sub 0.3% as of last week, Tuesday. We will have a better estimate of GDP for the third quarter by the end of October. The trend and forecast shows consecutive declining growth.

The trend in slowing growth is also reflected by declining activity in inbound containers at major US ports. This is considered a coincident demand indicator and reflective of immediate shifting trends in consumer demand. Global commodity and food prices are showing some signs of price easing but remain high year over year. Jonathan Golub, Credit Suisse;s chief U.S. equity strategist maintains that: "Futures indicate that Food and Energy prices should fall -5.7% and -11.8% by year end 2023, while Goods inflation has declined from 12.3% to 7.0% since February,” he wrote. “Over the past year, Services and Rents are up less than Headline CPI (5.5% and 5.8% vs. 8.5%).”

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How Much Medicine is Enough to Shift Away from the Inflation Narrative?

"Inflation" numbers predictably continue to shape the market narrative. As you may have read in our previous blog posts we continue to see this being the case until the economic data starts to show a consistent declining trend. While markets will look for early signs that the tide is turning, only consistent data will mark a tangible shift in the markets and a change in Fed sentiment.

Until that time, the Federal Reserve will continue to hike rates aggressively. They have made it abundantly clear that this is their number one priority and while they would like to avoid a recession that is not going to sway their intent to bring inflation into their acceptable orbit of less than 2% per year. Given the significant monetary forces that were put in motion since the inception of COVID it may take more time and hikes than anyone would like or anticipates.

A good analogy is being at the dentist for an unpleasant procedure that takes more time to resolve. We want it to end but it won't until the dentist is satisfied they have done the job. The Fed dentist wont be done until they meet their objective.

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