All eyes continue to be on the Federal Reserve at year-end and even recent positive news hasn’t been enough to sway them from their conviction in taming inflation.
The Fed’s hawkish stance at its latest meeting on Wednesday ruffled investors’ feathers.
U.S. and global stock markets are heading for a losing week following another interest rate increase accompanied by updated economic projections from the Federal Reserve, soft consumer shopping data, and fears the economy will dip into a recession in 2023.
On Wednesday, Fed Chairman Jerome Powell announced a 0.5% (50 basis point) interest rate hike, following 0.75% increases at the previous four meetings. This latest increase brings the target federal funds rate up to 4.25% – 4.5% — the highest in 15 years.
While investors were expecting that number, it was Powell’s comments reiterating the Fed’s ongoing commitment to a 2% target for inflation and warnings the terminal target funds rate range may be higher than previously anticipated – 5.1% by the end of 2023 – that sent stocks sliding.
“We still have some ways to go,” Powell said in his remarks. “Reducing inflation is likely to require a sustained period of below-trend growth and some softening of labor market conditions.”
Translation? Higher interest rates for longer than expected, which spooked investors and the market. Powell reiterated that “the historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done,” which stoked fears of overtightening to the point of economic recession.
As of market close on Thursday, the S&P 500 is down 1.7% for the week, the Nasdaq Composite is down 2.5%, and the Dow Jones Industrial Average is down 1.7%.
Earlier in the week, the market staged a brief rally on weaker-than-expected consumer price index (CPI) data. November’s CPI report showed a 0.1% increase in prices over October and a 7.1 increase year-over-year. The core index, which excludes volatile food and energy costs, was up 0.2% since the previous month and 6.0% annually – lower than the expected 0.3% and 6.1%, respectively.
But consumers are feeling the pinch all the same. Retail sales fell 0.6% in November according to the Commerce Department. It’s up 6.5% over this time last year, but below Dow Jones estimates of a 0.3% drop month-over-month, suggesting that inflation is starting to hit shoppers in the pocketbook.
The Fed’s next meeting is from January 31 to February 1. At that time, we could see another 50-point basis increase, or perhaps a pause to let the lagging effects of previous rate hikes take hold, depending on the data that emerges. For now, we’ll have to wait and see what happens.
Regardless of what the market does through the end of the year, experts recommend staying the course and dollar-cost averaging toward your long-term investment goals.
PRO TIP
Even – and especially – when there’s volatility in the stock market, the best course of action is to be aware, but stick to your investing plans. It’s impossible to time the market, and historically speaking, it’s always recovered. Stay the course through the dips and peaks, and remember why you’re investing.
What Experts Are Saying About the Federal Reserve Meeting
“We Have a Laser Focus on the Data Points”
“It’s clear [the Fed is] still committed to reducing inflation,” says Daly Andersson, CFA, CFP®, co-owner and managing partner at Tenet Wealth Partners. “The latest couple of CPI readings didn’t seem to sway the Federal Reserve much at all. And so that’s why we’ve seen the market respond negatively about Powell’s comments.”
Andersson encapsulates investor sentiment right now, explaining that “Powell expects the terminal interest rate to be over 5% next year, which is higher than what we had previously anticipated. Looking at 2024, the rate at which they start tapering of interest rates might also slow down.”
With regard to why the market is scrambling to even itself out, she says, “Any time interest rate expectations change, that’s going to impact the company profitability, and of where stock prices should be. We’re seeing a repricing in the market, based on those comments.”
Another big piece of the Fed’s puzzle is the tight labor market, Andersson says. “Demand is substantially exceeding supply of available workers” and unemployment is expected to “be up to about 4.6%. We’re currently at about 3.7%.”
For the foreseeable future and into 2023, “we have a laser focus on the data points. Anything that has to do with inflation, with unemployment, or with the Fed – that’s gonna move markets.”
“Rates Are Going to Stay Higher for Longer”
“There’s disagreement about what the expected terminal rate will go to,” says Ashley Sullivan, CFP®, private wealth advisor at LVW Advisors, referring to the latest rate hike. “People think it’s generally going to be between 5.0% and 5.25%. About 5.1% is the dot plot expectation, and then rates are going to stay higher for longer.”
How much longer? Sullivan says, “We won’t actually see rates cut or be reduced until 2024.” Because of that, 2023 might not be a good year for the stock market.
Economic growth targets are also very small, Sullivan explains. “The expected GDP rate is half a percent. That’s just barely above being in a recession,” she says, which is nerve-wracking for investors.
But, Sullivan doesn’t see a recession as a scary thing. “Historically, if you really look at the statistics, many times the stock market’s starting its recovery when we’re determined to be in a recession.” She also adds, “I know a lot of people are still concerned about earnings growth of companies given the higher interest rates.”
With regard to the interest rate hikes, the market is grappling with the point of when enough is enough, she says. “[The Fed is] trying to look at all the data points to come up with the absolute best thing for the economy.”
What’s her outlook for 2023? “The first half of the year, [the Fed’s] going to stick to their guns and they’re going to raise rates. Maybe it’s more in the half-of-a-point range like we saw in December. But I think they’re going to have to see signs that inflation is coming down and possibly that unemployment is going up,” she says.
Why the Federal Reserve Is Raising Interest Rates Right Now
For the last several years, easy-to-find jobs, record-high wages, and low interest rates heated up the economy to a point where everyday expenses like food, utilities, and housing are now more expensive.
Two of the Fed’s central mandates are to maintain low unemployment and keep inflation at a healthy level — around 2%. It does that through monetary policy, including adjusting the money supply in the country to make interest rates move toward the target rate they set.
The intention of the recent rate increases is to “reduce demand for consumer products, which is going to, in turn, slow down inflation,” explains Andersson.
That’s because higher interest rates mean higher costs of borrowing for businesses and individuals, which should cool down demand and reduce long-term price growth. However, raising interest rates too fast or high could potentially lead to an economic recession in the short term, which the Fed wants to avoid – but it’s a delicate balance to get right.
Moving into 2023, investors expect more volatility and investors increasingly worry about a recession.
Data points will “have the most impact, especially early in the year,” Andersson says. “Hopefully we’ll continue to see good inflation figures. It’s just a matter of continuing in that direction and the Federal Reserve being attuned to what’s going on in the overall economy – and being careful not to overtighten.”
Will the Stock Market Recover?
As the Fed navigates inflation and uses interest rate hikes as the main tool to curb it, investors are weighing the possibility of whether we’ll have a recession or a so-called “soft landing” more than ever.
Though it may seem counterintuitive, signs of a slowing economy are actually what investors are looking for. “Any numbers that are showing a more restrictive economy are going to be positive [for the stock market] in terms of showing that it’s going to lead to lower inflation numbers,” Andersson explains. “Inflation is still going to be that lagging indicator. It’s going to take a while to see a difference in those figures.”
Whatever happens, experts expect a volatile finish to 2022 – and likely a bumpy start to the new year.
“Right now the market is having a Black Friday,” says Linda García, founder of In Luz We Trust, a financial community geared toward Latinx investors. She adds that investors can think of stocks as being on sale during the current dip. “It’s important to look at the stock market in that way.” While it’s advantageous to invest money into the market right now, “it’s even more important to hold if you can’t continue buying. Holding is the key. Holding is what really helps us build our wealth.”
Keep in mind that investments easily outpace inflation over time – even with the normal ups and downs, which are a normal function of a healthy market.
How Investors Should Deal With Stock Market Volatility
For new investors, big swings in the market can be a lot to handle. There’s a lot of uncertainty right now because of interest rate hikes that raise the cost of borrowing, as well as everyday commodities getting more expensive due to inflation — and the market reflects that on a day-to-day basis.
But if you have a buy-and-hold strategy, remember that slow and steady wins the race. The best-performing portfolios are the ones that have the most time in the market.
“History has always told us that,” García says. “It’s about shifting our perspective, paying attention to when we start to feel emotional about the market, and understand that there truly is an opportunity. Buy in when we can, and just hold overall.”
“Going against the grain and [doing] what feels counterintuitive is actually the right thing when it comes to investing,” adds Sullivan. There are opportunities now, she says, “for us to lock in higher yields on the highest quality asset in the world” – the stock market.
Experts recommend diversifying your portfolio with low-cost, broad-market index funds, so your eggs aren’t all in one basket. Make sure your investments are appropriate for your goals, timeline, and risk tolerance.
Dollar-cost averaging spreads out your deposits over time, and has been demonstrated to perform better during a period of high market crashes, according to Rebecka Zavaleta, creator of the investing community First Milli.
Whatever you do, invest early and often, especially if you have a long investment timeline. Dips and crashes will happen, and so will other scary-sounding things like economic bubbles, bear markets, corrections, and recessions.
You can even take advantage of a dip to invest more, but not if it impacts your regular investing schedule. It’s hard to tell when there will be a dip or correction, and no one can time the market. As an investor, the best response is to stay the course and keep investing, regardless of what the market is doing.