December 2022

Where will the market go from here?
In our economic forecast published in Aug 2022, we indicated that we expect the inflation to be more sticky requiring more drastic measures from the Fed in order to reached the desired 2% target. Even though at the time we were more

Indicator	Result	Period	Impact/Significance/Discussion
Federal Funds Rate (FOMC)	50 bps increase 4.25% to 4.5%	Dec 14, 2022	As expected, the Fed increased the rates by 50 bps to a range between 4.25% and 4.50%. As indicated in our November update, this was expected. As of the date of the meeting, the expectation is that the Fed will go ahead with two more 25 bps increases in Q1-2023 and then pause. The sentiments, spending patterns, and financial position of individuals and corporations during the next two months will set the course for the Fed during 2023 and maybe 2024. Events such as upside surprises in inflation data or speculative market rallies would be indicative of more fundamental issues for which the remedy would be even higher interest rates. More rational reactions and slow-down of economic activities, close to the Fed's forecasts (see below), will result in a more benign reaction from the Fed. that being said, we expect the rates remain between 4.5% to 5% through the end of 2023 and into 2024. Moreover, we don't expect the rates to get close to 0% during the next decade. See below the link to the Fed's economic forecast and the "dot plot" which indicates what the Fed members think the Fed's Fund Rate will be during the next 3 years and long-term. Fed's Summary of Economic Projection
ISM Manufacturing PMI (Institute for Supply Management)	49%	Nov 2022	Manufacturing PMI was reduced by 1.2% to 49% from the prior month (50.2% in October, which in turn, was down from September). An amount lower than 50 indicates a slowdown in manufacturing activities. This is in line with a more restrictive environment that the Fed is trying to create.
ISM Services PMI (Institute for Supply Management)	56.5%	Nov 2022	Services PMI increased in Nov 2022 to 56.5% (Oct 2022 was at 54.4%). The feedback from businesses was generally positive. This indicates the strength of the service sector which is strong in contrast with manufacturing PMI that is weakening. Note that this finding is consistent with the CPI report which shows inflation is cooling off in durable goods but still strong in services.
Employment Situation Report (BLS - Bureau of Labor Statistics)	3.7%	Nov 2022	The unemployment rate remained unchanged at 3.7% in November 2022. In October, the unemployment rate increased by 0.2% to 3.7% compared with September 2022. The unemployment rate has been in a narrow range of 3.5% to 3.7% since March. The Participation Rate was at 62.1% in November (62.2% in October, and 62.3%, 62.4% and 61.7% in Sep 2022, Aug 2022, and Oct 2021, respectively.) So, even though the participation rate improved compared with last year, it has been on a decline since August, which is not a desirable outcome. Note that the most desirable outcome for the Fed is an increase in the unemployment rate by an increase in the participation rate. But an increase in participation rate will not happen unless immigration laws make it possible. The reason for low participation rate is retirement (population aging). The participation rate among prime age population is still high.
CPI (BLS - Bureau of Labor Statistics)	7.1% y/y 0.1% m/m	Nov 2022	Prior month (October): up 0.4% m/m and up 7.7% y/y Core inflation m/m was up 0.2% (October: 0.3) and 6% y/y. This is still a high amount, but interestingly enough, the market expected a marginally higher result. Food was up 0.5% m/m (Oct: 0.6%) and 10.6% y/y. Energy was down 1.6% m/m (Oct: up 1.8%) and 13.1% y/y. Used cars/trucks were down 2.9% m/m (Oct: down 2.4%) and down 3.3% y/y. Looking at different components of CPI, it seems that each month some categories show an increase while others show a decrease, with an overall direction being upward. Therefore, we will not try to find patterns or draw any conclusions. We believe that the inflation will be around an annual rate of 4% to 5% during 2023 with different categories taking turns in leading the upward move.
PCE (BEA - Bureau of Economic Analysis)	0.1% m/m	Nov 2022	Why PCE Matters? Similar to CPI, PCE is a measure of inflation. The Fed pays special attention to PCE (especially: "Core PCE"; i.e., PCE, excluding food and energy). M/M "PCE" (Headline PCE) change: Nov: +0.1% | Oct: +0.4% | Sep: +0.3% M/M "Core PCE" (Core PCE) change: Nov: +0.2% | Oct: +0.3% | Sep: +0.5% Y/Y Headline PCE: Nov: +5.5% | Oct: +6.1% | Sep: +6.3% Y/Y Core PCE: Nov: +4.7% | Oct: +5.0% | Sep: +5.2% Another measure that is published with PCE is DPI (Disposable Personal Income) M/M Real DPI change: Nov: +0.3% | Oct: +0.4% | Sep: 0% | Aug: 0.1% Moreover, this report publishes "Personal income" measure, which remained constant in the past few months except for a spike in October. Our Take from this report? Inflationary forces appear to be subsiding, but not significantly. Core inflation is more stubborn compared with the headline PCE, as expected. Disposable income (real personal income) is on a decline, which means consumer spending power will weaken in the coming months. An important observation is that everything is happening at a slow pace. So, don't expect a sudden change in the coming two months (at least).
PPI (BLS - Bureau of Labor Statistics)	0.3% m/m	Nov 2022	The PPI (Purchase Price Index) for final demand increased 0.3% in November. BEA adjusted prior months' figures as follows: Oct: +0.3% | Sep: +0.3% Breakdown: PPI-Goods: +0.1% | PPI-Services: +0.4% Demand for Energy and 'Transportation and Warehousing' were down 3.3% and 0.9% respectively. Demand for Food was up by 3.3%
ISM PMI (ISM - Institute for Supply Management )	49%	Nov 2022	Since September 2022, the Manufacturing PMI has been on a decline: Nov: 49% | Oct: 50.2% | Sep: 50.9% Obviously, this data should be read in conjunction with other economic data (as well as remaining the indicator under 50 for longer). Note that the termination of the zero-covid policy in China, as well as policies made in the US (e.g. infrastructure expenditures), might impact this indicator. PMI that is above 50 indicates expansion and below 50 indicates contraction.
S&P Global US Manufacturing PMI (S&P Global )	46.2	Dec 2022	"The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI™) posted 46.2 in December, down from 47.7 in November, but matched the earlier released 'flash' estimate. The latest data signalled the fastest decline in operating conditions since May 2020, and was among the sharpest since 2009." (Source: pmi.SPGlobal.com)

Overall, the economic indicators published for December and November 2022 are signaling an upcoming economic slowdown. But the process will be slower than many anticipate. Due to the strong balance sheets of both individuals and corporations, the decline will not be in a form of panic in which people will line up in front of the banks to withdraw cash. Instead, it will be a gradual and grinding process. There will multiple false optimisms along the way, resulting in bear market rallies. We anticipated that in our economic forecast earlier in 2022. However, as time passes by, the duration and intensity of the bear market rallies will become shorter (some might be even called as such).

The prevalent fallacy will be the gamblers’ fallacy, or expectation of mean reversion. That is, uninformed investors will expect higher share prices only because they fell so much in the past few months, forgetting the baseline as well as the dramatic change in the market. At GGC, we believe we’re at the beginning of a regime change, were bonds are becoming an alternative again. Many institutional investors are buying Investment Grade bonds. Many still consider High Yield bonds too risky, but experienced investors have been able to find exceptions. This shift puts pressure on alternative investments and stocks. We still haven’t seen a chaos in private markets but there have been some indications of trouble.

Moving forward, we will cautiously monitor the markets in 2023 for the signs of weakness and opportunities. Cryptocurrency, China, private equity, zombie companies, “re-shoring”, energy crisis, and the Fed’s fight on inflation will all shape the markets in the year ahead.