Hurry Up and Slow Down

HIGHLIGHTS:

• Markets may see a "two-steps forward, one-step back" type of rhythm in the coming months.
• The fourth-quarter earnings season is reflecting a decline in corporate earnings, which is forecasted to continue into the first and second quarter of 2023.
• Interest rates are likely close to their peak, with the Fed setting the tone at its meeting next week.
• Corporations are preparing for a cooler economy, and consumers may receive some relief if inflation continues to slow.

The first few weeks of the year have served investors with mixed messages and many questions about what lies ahead. Perhaps just happy to turn the page from 2022, markets have trended cautiously positive, punctuated by a couple of bad days. However, a two-steps forward, one-step back type of rhythm may resonate in the months to come. With earnings season underway and the first Federal Reserve rate meeting next week, all we have seen so far feels somewhat preliminary, and we are certainly on the edge of our seats.

One common characteristic that is likely to emerge is deceleration. Depending on the context, this will be both welcomed and feared. Indications of a slowdown in corporate earnings will certainly disappoint, but are not unexpected. Higher rates and shaky economic data seems to affecting corporate profitability with tighter conditions likely ahead. About a fifth of S&P 500 companies have reported so far, reflecting a decline of 2.9 percent in year-over-year earnings. Wall Street estimates are forecasting close to a 4.5 percent decline for the fourth quarter, though it's typical for positive surprises to lift the final number. That's on top of forecasts for 1 percent drops in both the first and second quarter of this year. These well-telegraphed declines should set the bar low, but may upset any upward price trends we've seen recently.

The Fed is also likely to slow the pace of interest rate hikes. This may embolden investors who fear the next recession may come sooner due to policy error. While the "higher for longer" theme song is still at the top of the Fed's playlist, indications that this process has reached its end, or at least a deceleration, should be well received. A continued tempering in inflationary forces could also help support markets. While inflation may have peaked last year, it may persist at higher-than-expected levels, particularly as wages and labor force factors retain momentum. Lastly, and most worryingly, the patience and endurance of consumers may also decelerate as pandemic savings dry up.

All of these forces are interrelated, and this tension between the positives and the negatives will likely set the tone for the months and quarters ahead. We suspect that the Fed may be doing a better job than some give them credit for. While some of the results will not be pretty, we feel that corporate balance sheets have been well managed in preparation for a cooler economy. Consumers should be given credit for the resilience they have shown through several difficult years. If inflation continues to cool, they may be close to getting some relief.

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