Historically, mid-term election years are notoriously periods of underperformance in the stock market. The post-election year is a different story altogether. Will 2023 be one of those years?

 

The average return for the stock market in the 12 months after elections has been 16.3 percent.

 

2022 will qualify in history as one of those underperforming mid-term election years. To date, the benchmark S&P 500 Index, has lost roughly 20 percent thus far and may end the year even lower.

 

Historically, looking back to 1932, S&P 500 returns have averaged 14 percent in a split Congress and 13 percent in a Republican-held Congress under a Democratic president. The facts are that stock markets do well when there is gridlock in Congress. Neither new spending initiatives nor tax increases are likely to pass a divided Congress. In the aftermath of this election, if the House and or Senate flip to the GOP, the best that can be said is that additional business regulation will be limited and may even be rolled back somewhat in areas such as energy, pharmaceuticals, biotech, and the financial sectors.  

But a rebound in the markets next year is far from a sure thing given the global economic background. We are wrestling with the highest inflation rate in a generation, sky rocketing interest rates, the Ukrainian war, and a worldwide economic slowdown. The International Monetary Fund has cut its forecast for global growth from 3.2 percent in 2022 to 2.7 percent next year. That is the weakest growth rate since 2001.

 

As the global economic pie shrinks, I expect to see a rise in worldwide trading blocs as the world fights for a bigger piece of the shrinking pie. A North-South economic and political axis has been forming for more than a decade with China in the lead in expanding trade and investment in Asia, Latin America, and Africa.

 

Russia has joined this bloc in response to Western economic sanctions, while nations such as India, Brazil, some of Eastern Europe as well as certain energy producers in the Middle East are strengthening economic ties with both Russia and China. Together, these countries represent more than one-third of the world's economic output and two-thirds of its population. As global growth slows, expect trade wars to accelerate between this bloc and a U.S.-led trading bloc. That trade group includes most of Western Europe, Japan, South Korea, and a host of other pro-democratic nations.   

 

A recession seems to be all but guaranteed in 2023 here in the U.S. In a recent CNBC CFO Council survey, more than 68 percent of chief financial officers (CFO) are convinced that a recession will unfold during the first half of 2023. No CFO surveyed believed the country will escape a recession. It is just a question of how severer the recession will be. I believe that will depend on how high the Fed must raise interest rates to bring inflation down.

 

Inflation was identified as the biggest risk facing the economy and businesses by the Federal Reserve Bank. Most Americans would agree with that position. Unfortunately, inflation, now over 8 percent, has been much stickier than most experts expected. As a result, the ongoing central bank tightening of monetary policy that began this year will continue into 2023.

 

The longer inflation remains elevated, the longer and higher interest rates must climb. The main debt instrument the Fed uses in raising interest rates is the Fed funds rate. All other debt instruments key off that rate. Bond investors expect the Fed will ultimately target a Fed Funds rate above 5 percent. The Fed's announced target rate is now between 3.75 percent-4 percent. Bond investors expect the Fed will ultimately target a rate above 5 percent before all is said and done. That means we still have a sizable amount of tightening yet to come.

 

The Fed is counting on higher interest rates to slow demand by reducing economic growth while increasing the unemployment rate. That would hopefully reduce the rate of inflation. Some economists could see inflation fall to 5-6 percent under this scenario.

 

I expect that rising interest rates will result in a slowing economy in the first half of 2023, resulting in a mild recession, and a decline in the headline inflation rate. The financial markets, I expect, will remain volatile as these economic developments unfold. Traders, witnessing a gradual decline in inflation, will jump the gun, bid markets higher, and expect the Fed to ease, only to be disappointed.

 

The Fed will remain steadfast for months, in my opinion, until they are sure their policies are working. This divergent behavior will whipsaw investors. It will likely create a series of vicious bear market rallies only to see chasers caught in nasty bull traps. I expect to see lower highs and lower lows as January and February progress.

 

At some point in the first quarter, fears that the Fed will "over tighten" and force the economy into an even deeper recession will make the rounds on Wall Street as well as in Washington. That will add fuel to the fires of uncertainty and likely make a life for Fed officials difficult, especially if the labor market weakens. We could also see increased stress in financial markets here and abroad, as credit markets grow tighter.

 

U.S. corporate earnings for the benchmark S&P 500 Index currently at $225 will probably take it on the chin. I expect at best, earnings will be flat versus 2022 and may decline to roughly $200 in a worst-case kind of scenario. If you slap a 15 times earnings ratio onto that number, you come up with a 3,000-price level on the Index, compared to the 3,900 level today.  

 

As such, I see a rather nasty first-quarter decline in the stock markets to fresh lows that could take the S&P 500 Index down another 10 percent-20 percent or so from here. I am forecasting a final capitulation in the stock market around the end of March 2023 with a tentative bottom of 3,200.

 

When do I see the Fed pivot or at least pause in tightening? That depends on inflation, but I do believe it will take several months before the Fed will be willing to relax its policies once inflation begins to fall. That hasn't happened yet. Let's say it does happen over the next six to nine months, sometime in the second quarter of 2023.

 

If so, I expect the markets will anticipate this change. The U.S. dollar will begin to retreat, interest rates start to decline, and we should see stocks and bonds bounce in the Spring and throughout the summer. For the year, my guesstimate, which will change for sure as the year progresses, is a target of 4,500 on the S&P 500 index.

 

I would expect to see assets that are negatively correlated to a declining dollar such as materials, commodities, energy, and maybe cryptocurrencies do well. Emerging markets would also benefit as would U.S. and foreign stocks in general. As interest rates decline, there would also be an upside in bond prices across the board as well as bond funds. High-yielding dividend stocks and value stocks would also do well.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

 

Fed Chairman Jerome Powell delivered a bagful of gains this week for investors. Stocks roared to life as "Santa" came to town. And then the job numbers on Friday spoiled the mood.

 

"The time for moderating the pace of rate increases may come as soon as the December meeting," said Powell in his opening remarks at the Brooking Institute on Wednesday, Nov. 30. The word "moderating" was all the algos needed to hear.

 

It was equivalent to striking a match to a kid's backyard toy rocket. The U.S. dollar fell, stocks across the board exploded and the main indexes racked up gains of 3-4 percent-plus by the end of the day. Commodities also roared higher led by precious metals.

 

Thursday the Personal Consumption Expenditures Price Index, a key inflation data point that the Fed uses to monitor inflation also came in cooler for October. The PCE rose 6 percent in October versus last year and down from September's 6.3 percent annual increase. Overall prices rose 0.3 percent, which was the same monthly increase as in each of the previous two months. It could be that Powell had an inkling that the inflation numbers were improving, which could have contributed to the slight shifting of goalposts this week.

 

However, Friday's monthly jobs report for November came in "hot." Non-farm payrolls came in with a 263,000 gain versus the 200,000 expected. Average hourly earnings on a month-to-month basis rose 0.6 percent versus the 0.3 percent expected. That data may be good for the continued growth of the economy, but also means that the Fed has no reason to relent in its hawkish stance. As a result, markets gave back about a third of their gains for the week.

 

Does that mean we should expect hotter or cooler Consumer Price Index (CPI) on Dec. 9, and Price Producer Index (PPI) data on Dec. 13? Given the inaccuracy of macroeconomic data, I would say that is at best a crap shoot.

 

The most important events that investors face are the OPEC-plus meeting on Dec. 4, and the European Union (EU) Russian oil embargo and price cap on oil the following day. This could prove to be a disruptive event on world energy prices. What happens to the oil price has a direct bearing on future inflation, so financial markets will react to these events.

 

If an EU ban on purchasing Russian oil leads to the removal of up to 2 million barrels per day of oil from the market, we could see a spike in energy prices.  To prevent that from happening, the U.S. and G-7 nations have devised a price cap scheme where that oil can be sold to non-European nations but only at a lower price. The question is the price.

 

The latest number was $62 a barrel cap, but Poland, Estonia, and Lithuania are arguing that the price is still too high. The facts are that if India or China ignore the whole price cap ban, which is a distinct possibility, then what could happen is that most of this spare Russian oil will simply be rerouted to these two large consumers of oil.

 

Bottom line: next week could see some wild swings in oil based on geopolitical headlines from various players so be prepared. 

 

Last week, I wrote that my target for the S&P 500 Index of a high between 4,000-4,100 had been met and it was time to take profits. This week we hit the top end of my range before falling back. Could it climb higher? It could, but it seems to me that market action tells me that we are closer to a top, not a bottom. I will be taking profits as we climb higher.

 

If I am right, what is the potential downside for the markets? I expect a 125-to-250-point (up to 6 percent decline) to as low as 3,700 on the S&P 500 Index. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

American workers are making more dollars per hour than they did before the pandemic. That's the good news. The bad news is that inflation is wiping away most of those gains and the rate of wage growth is slowing.

 

Most Americans look at their paychecks today and feel pretty good. However, they realize that after spending on essentials such as food, fuel, education, and health, they realize that their wages are not keeping up with the cost of living. 

 

"Real wages on average are falling, not rising," says San Francisco Fed President Mary Daly, summing up the present state of wage growth.

 

To be sure, there was a one-time surge in salaries back in 2021, which spilled over into the early months of this year, but since then, wage growth has been slowing.

 

Real average hourly wages in the U.S. in the private sector rose at a 3.9 percent rate in the three months ended in October, which is down from a high of 6.3 percent at the end of 2021 and fell further to 5.9  percent as recently as the three months ended in July.

 

In general, the rate of change in wages has been falling for well over a year, while inflation at 7.8 percent remains close to its highest rate in decades. In dollars and cents terms, let's say you are an average worker making $30.06, which was the average wage back in March of 2021. Fast forward to August of this year and now you are making $32.36. Not bad, huh?

 

Now let's throw in the inflation rate during that period, which had risen by 11.81 percent. Let's say it costs you $5,000 per month to pay all your bills, after inflation that monthly nut had now climbed to $5,591.  

 

Over the past year, the Federal Reserve Bank has been doing its best to battle inflation back down to the 2 percent range, but they caution that this is a process that will take time. This week in a speech at the Economic Club of New York, John Williams, the New York Fed president, sees inflation falling to 5.0-5.5 percent by late 2023 as more interest rate hikes restore balance to the economy. How does raising interest rates to reduce inflation and restore economic balance?

 

For one thing, it reduces demand in the economy by reducing discretionary spending, which is an economic buzzword for making it harder to make ends meet if you are a typical worker. Higher interest rates spill over into borrowing rates, which make buying a home, or an automobile, or paying down your credit card more expensive to consumers. So, the tools that the Fed is using to reduce inflation are hurting the labor force, while wages are not keeping up with inflated expenses.

 

One way out of this dilemma for many workers is to job jump. After all, jobs are plentiful right now, so if you don't like the one you have, just get another one. As an added incentive, in this tight labor market, switching jobs frequently comes with another bump up in pay or at least a signing bonus. Some workers I know personally have moved positions two or three times in the last two to three years while upping their total compensation on every move.

 

However, those days may be coming to an end. Fed President Williams, while admitting that the job market remains remarkedly tight, expects the U.S. unemployment rate to rise from 3.7 percent today to 4.5 percent-5 percent by the end of next year. If so, job hopping to keep ahead of inflation might not be as easy to pull off.

 

If it makes any difference, you are not alone. European workers are experiencing a similar gap between wages and inflation even though they are represented by far more unions than here in the U.S.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

December could be a risky month for the stock market. A spate of inflation data, a European Union Russian energy embargo, and another Fed meeting toward the middle of the month, could determine the state of the stock market.

 

Traders are split between bulls and bears. The bearish view says that we hit the 4,100 level on the S&P 500 Index, and then we begin a decline that continues into next year. The bulls argue that the seasonal factors dictate a continued rally into at least January.

 

Many readers know where I stand. I have been predicting a market rise that could see the S&P 500 hit somewhere in the range of 4,000-4,100. That is the area where we find the 200-Day Moving Average (DMA) for that index. At this point, I am taking my money and running. Why?

 

There are numerous significant data points in December that can send markets up or down. The Personal Consumer Expenditures Price index on December 1, The Group of Seven/EU decision on an embargo of Russian oil on Dec. 5, the Consumer Price Index on Dec. 9, the Producer Price Index on Dec. 13, and the FOMC meeting on Dec. 14.

 

There is no consensus on any of these areas. If the inflation data comes in hotter than expected, stocks go down. If Fed Chairman Jerome Powell remains hawkish at the FOMC meeting, and or, becomes more so, the markets fall.

 

In this week's column, "Is it time to rebuild the Strategic Petroleum Reserve?" I examined the upcoming events of Dec. 5, in which the G-7 plans to further hamstring Russia by placing an embargo on Russian oil in the European Community. It also seeks to place a price cap on Russia's oil, although there is some disagreement on what that price should be. Russia has already warned that it will not sell oil to any nation entertaining such a price cap scheme. If the response to the embargo and price cap on Russian oil results in higher oil prices, the markets would likely decline.

 

Given that the stock market has already run up more than 15 percent since October, it seems sensible to me that a cautious approach is called for. For sure, some of the data may be negative, others positive, but there is no way of knowing that ahead of time. If all the data points end up positive for the market, then it will be a very Merry Christmas and Happy New Year. The point is that the odds at best are only 50 percent that the bulls get the lucky number 7 on each roll of the data dice.

 

From a macroeconomic point of view, it seems to me that we are a long way from achieving the Fed's target rate of 2 percent inflation. The economy, while slowing, is still growing and employment remains healthy. A recession seems certain, but so far elusive. This is not good news for a central bank that needs economic demand to slacken in its fight against inflation.

 

About the best investors can hope for may be a slowdown in the pace of rate hikes. The Fed minutes from the last FOMC meeting buttressed that hope when a number of participants preferred to slow interest rate hikes in December. However, that doesn't mean Jerome Powell will heed their advice.

 

In any case, this week we hit a high of 4,033, less than 70 points from my highest target on the S&P 500 Index. Depending on the data, and especially the PCE data point on Thursday, stocks could hit or even exceed 4,100. It is a coin toss at this point. Invest accordingly.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The nation's Strategic Petroleum Reserve (SRP) has been reduced by more than 25 percent over the last year. That is the lowest level in 40 years. Oil had dropped below $80 a barrel mark this week, causing some critics to argue that it might be time to start building the SRP back up. I disagree.

 

My reasoning centers on a handful of geopolitical events that could send oil prices soaring in the first week of December. To understand how important the SRP might be in that case, one needs to know more about the Biden administration's use of the SRP since 2021.

 

A year ago this month, on Nov. 23, 2021, President Joe Biden announced the release of oil from the Strategic Petroleum Reserve in response to the Ukraine/Russian conflict, which caused o and gas prices to explode higher. The president's stated goal was to lower oil and gas prices while addressing the lack of energy supply worldwide.

 

Since then, Biden's activist intervention in global oil markets has succeeded in reducing U.S. gas prices at the pump, as well as contributing to the decline in oil prices to their lowest level in more than a year. So far, 160 million barrels of oil have been released with another 10 million barrels scheduled to be drained this month. Some say that is more than enough. Maybe, maybe not.

 

To gain some perspective, let's look at the history of the SRP. It was first created by Congress back in 1975 in response to the 1973 oil crisis. For those who are curious, the nation's emergency crude oil is stored in underground salt caverns at four major storage facilities on the Gulf Coast, two sites in Texas, and two sites in Louisiana.

 

The purpose of the SRP was to manage market disruptions such as a war in the Middle East, an oil embargo, or a natural catastrophe. Our energy stockpile has been used by several presidents, most notably during the Iraq/Kuwait War in 1990-1991, Hurricane Katrina in 2005, and the 2011 Arab Spring energy disruptions. The Ukraine War and the subsequent sanctions on Russian-produced oil certainly fit the bill for use of the SRP and thus the release of oil from the U.S. emergency energy storage.

 

Criticism of President Biden's move to employ the SRP as an energy weapon has been harsh and varied. Some Republicans have called his decision reckless because it endangers our energy security at a time when there is so much global conflict and uncertainty. Others accuse him of a blatantly political move.

 

They say his use of the SRP before the midterm elections was simply a ploy to win over voters. If so, it worked. Gasoline prices dropped from more than $5 a gallon to $3.80 a gallon today. Voters may have also been swayed by the decline in pump prices since the GOP failed to score the "red wave" they were expecting. 

 

But to be fair, several presidents besides Biden have released oil from our stockpile during political campaigns. Bill Clinton, for example, did so just before the 2000 presidential campaign between Al Gore and George W. Bush.

 

However, this is the first time a president went on the record in admitting that he was using our petroleum reserves to reduce prices, rather than to bolster supplies. Most economists would laugh at that distinction, since ordinarily if you increase the supply of something, its price will decline over time.

 

To me, the Biden administration's activist interference in the global oil markets may just be the beginning. Until recently, the global price of oil has been in the hands of a few volatile foreign governments and OPEC. But a lot has changed in the American oil patch since the 1970s. The U.S. is now one of the leading producers of oil and gas and a major energy exporter. Pricing power comes with that kind of production.

 

The willingness of the U.S. government to enter the fray and become a price setter instead of a taker via the SRP could become a geopolitical tool and an answer to the OPEC+ Cartel's domination and control of energy prices and supply. The bottom line: by focusing on price, President Biden may be putting the price-fixing cartel of OPEC+, and Russia on notice that there is a new boy on the block.

 

I also believe that the administration's announced intention to start rebuilding the SRP somewhere between $67-$72 a barrel of oil is an attempt at establishing a floor of price support for oil. That may be comforting news to U.S. energy companies. If the oil majors and shale producers believe that the U.S. government is willing to backstop their business at a certain oil price, would that give them added confidence and an incentive to increase U.S. energy supplies? I think so, but now is not the time to start building back our oil reserves.

 

On Dec. 5, 2022, the Group of Seven (G7) and the European Union (EU) are planning to embargo Russian oil. In addition, a G7 plan, intended as an add-on to the EU embargo, would allow shipping services providers to help export Russian oil, but only at enforced lower prices. An embargo like that could take as much as 2.4 million barrels per day of Russian oil off the market. That could increase oil prices dramatically. There is also an added risk that Russia retaliates and cuts off energy supplies to Europe in response.

 

Oil analysts worry that these plans could backfire, at a time when seasonal energy demand is at its highest. OPEC is worried as well. They are rumored (officially denied) to be debating a 500,000 barrel per day increase in production just in case.

 

If the worse happens and oil prices skyrocket higher into the first quarter of 2023, what will be the U.S. response? Will the president stand fast, or will he be forced to order another 90-100 million barrels, of oil, or more to be drained from the SRP? I am betting he would be forced to release more barrels because the alternative could be $120 barrel oil in the months ahead.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.