Date: Nov 2, 2022

Dow: 32,892Dow Jones Fair Value: 30,500
S&P 500: 3,873S&P 500 Fair Value: 3,800
Nasdaq: 10,915

The market remains overvalued but is within the range of rationality. The Federal Reserve is having an impact and will continue to be a headwind for stocks. I forecast continued market oscillation. My short-term outlook is positive, and my intermediate outlook is negative. Long-term outlook is always positive – it’s a good way to live your life.  

The economy looks good which is a cause for concern. 

Q3 real GDP growth came in at 2.6%, higher than economists expected, and higher than I expected. Non-farm payroll continues to surprise, with a 263,000 increase in jobs in September, and a 239,000 increase in October. Unemployment followed, decreasing to 3.5% nationwide.  The Case Shiller Home Price Index decreased month-on-month for the second time in a row. A potential bright spot for Americans being priced out of the home market. 

Consumer sentiment, as measured by the University of Michigan, is 58.5 and is trending up. I expect this to continue through the holiday season.

Early signs suggest that the supply chain is loosening up.  The global container freight rate is down to $4,014 from a year-ago high of $10,361.  This trend is corroborated by a decrease in the Federal Reserve Global Supply Chain Pressure Index from a height of 4.35 to 1.05. A barrel of WTI crude is down from $103 in May to $90.

A growing economy, increasing consumer confidence, and a relaxing supply chain, what’s not to like?  Well, an unfettered Federal Reserve and a decreasing money supply could certainly throw a wrench in things. 

Inflation management is working but there is a long way to go. 

September 2022 Consumer Price Index: All Urban Consumers came in at 296.761, an 8.2% increase year over year, and a .39% increase month over month (or 4.73% geometric annualization).  September 2022 Producer Price Index: All Commodities was 269.294, an increase of 14.26% year over year, but -.11% month over month.  PPI has increased at an incredible rate over the last 2 years, much of it due to the increase in oil and transport costs. Both metrics suggest that inflation is controllable and that the Federal Reserve is having an impact. However, core CPI, the Fed’s favorite inflation metric, is still well above the stated policy of 2%. Core CPI for September was 298.66, a 6.6% increase year over year, and a .58% increase month over month (7.1% geometric annualization).  

One early, but concerning, trend is a change in inflation by component.  Energy and housing price increases appear to be abating, but food costs are not.  It’s too early to consider the trend actionable, but it’s worth watching.  

My suspicion is that the current inflation has two layers. The first tranche is caused by residual, surplus demand from stimulus and constrained supply from the pandemic. This layer is depleting quickly as the pandemic and stimulus fade into history.  The second tranche is caused by excess money supply, good underlying demand, and sticky wages/employment.  This second tranche will be more difficult to quell. Will the Fed’s FOMC interest rate strategy and quantitative tightening be enough to control the second tranche? Probably, but it might take 18-24 months to get there. 

We can’t ignore the elephant in the room. 

The Fed’s interest rate forecast, as interpreted via dot plot, suggests that short-term interest rates will increase to 4.25% by the end of the year 2022 and 4.625% through 2023.  Additionally, the central bank shows no signs of slowing its quantitative tightening policy. The good underlying GDP and supply chain data will heighten the Federal Reserve’s resolve in fighting inflation, and I think interest rate expectations for the market and FRB will trend higher through the end of the year.   

Moreover, I think we are still only ⅓ of the way through the economic decline. There is reshuffling to come. A good economy and high inflation give the Fed license to raise rates, creating a headwind for most equities and long-term bonds.  

The cross-return analysis between equities and bonds will lean bonds – especially when you consider how far the pendulum pointed to equities during the pandemic. As a money manager, it’s going to be difficult for me to have a large allocation to equities when low risk short-term and intermediate treasuries yield more than 4.5%.  This discussion is going on across the industry, and I suspect intermediate future demand for stocks will be muted. 

What wins out? 

Value stocks. Particularly companies with low price to free cash flow multiples, reasonable growth prospects, meaningful dividends, and good balance sheets with long-term fixed debt instruments. Industry is important too; I’m specifically hunting consumer staples and specialty insurers. Oh…and a large dollop of Treasury bills is better than a sharp stick in the eye.  

Has the market returned to normality?

Valuations are more reasonable. Asset bubbles are deflating. Inflation is high but seems manageable.  And Treasury yields are high (relative to the last few years).  On the whole, I think markets are reverting to the mean, but there are still various asset classes and industries to avoid.  As the specter of continued high short-term interest rates settles in, time to mean revision and normality will decrease.


Much to my annoyance, Crypto is still trundling along. That suggests to me that the markets have not capitulated.