WISDOMTREE- Weekly commentary from Professor Jeremy J. Siegel (12/12/2022) :

The markets ended last week with a negative tone, but this week we will have more market moving events with the CPI inflation release and the key Federal Reserve interest rate decision.

First on last week’s data. We had the PPI inflation data, which was a little higher than expected and that ruffled the markets. One of the inflationary data points dealt with interest rate margins charged by banks, but I don’t view that as a central worry for inflation forecasts today.

On the positive side, unit labor costs fell quite a bit and more than expected—and that is because of rising productivity. Rising productivity is also a major theme for 2023. While productivity was dreadful this year, I am more optimistic next year and think that both official economic GDP data but also corporate profit related productivity and margins should improve.

There is a good chance we see declining total employment (particularly in first half of the year) but positive real GDP growth—with more productive workers staving off cost pressures, inflation, and leading to a better than feared margin situation for corporates.

There is a chance we can avoid the worst of a recession—but that requires the Fed to recognize the disinflationary forces I see everywhere—including the dramatic drop in 10-year bond yields we’ve seen recently. In addition, the University of Michigan Consumer Sentiment Index showed 1-year inflation expectations unexpectedly dropped considerably from 4.9% to 4.6%.

This week there should no surprises from the Fed—a 50 basis point hike is well telegraphed from Jerome Powell. If the CPI report the day before the FOMC meeting comes in very hot, perhaps we get a dissent or two in favor of a 75 basis points hike, but I do not see the Fed veering from a 50 basis points hike.

But all eyes and subsequent reports will be on the Dot Plot for future hike expectations.

I want to caution our readers to be very discerning here. Headlines are likely to read out hawkish language with the Fed participants penciling in further hikes well into next year and a stated ‘plan’ to keep rates elevated. Recall that Dot Plot projections last year predicted quite limited (almost no) hikes for 2022 and we’ve already had 15 hikes of 25 basis points and 2 more pending this week.

The Fed narrative can pivot very quickly—just like it did in 2022—and not just for lowering the pace of hikes from 50 to 25 in February but to pausing and then cutting rates. This is what I think will happen sooner than most anticipate, but the Dot Plot will not reveal that yet.

It is quite possible (and preferred in my view) the Fed skips another downshifted hike to 25 basis point hike on February 1st and just pause the hikes after this upcoming 50 basis point increase.

Employment has yet to soften notably, but I think the jobs data is likely to deteriorate meaningfully and quickly. The Fed should recognize their aggressive rate hikes have worked and official inflation data will come down quickly in 2023.

Analysts currently expect solid earnings growth next year, but the bear case and recession calls can see S&P 500 profits going from $230 currently estimated to perhaps $200. I think firms will start getting rid of excess labor and employees will becoming increasingly motivated for fear of layoffs—supporting profitability, so profits will come in over $200.