One of my favorite live concert movies is “Stop Making Sense” (1984), featuring the avante garde rock group Talking Heads. I thought of that film title, while writing this installment of my column.

The U.S. economy has stopped making sense. Consider the following contradictions:

The housing market is in sharp decline, but the labor market is robust. Inflation is elevated and interest rates are rising, but key inflation indicators are cooling, consumer spending is resilient, and the Federal Reserve is making faintly dovish noises. Consumers express gloom and doom, but holiday retail spending is staying on track.

Initial gross domestic product numbers have been paltry, but the quarterly numbers have been getting revised substantially higher. Corporate earnings are growing, but year-over-year growth is decelerating and some sector bellwethers have missed expectations (and provided disturbing forward guidance). We’re still in a bear market amid Fed tightening, but investors are in risk-on mode again.

And yet, from this seemingly nonsensical data noise, I think we can still divine clues about the direction of equities for the rest of this month and into 2023.

Santa in the wings…

Can the rally of October-November maintain its momentum through year-end? To be sure, 2022 has been a tough year for the equity and bond markets, but even with Monday’s retreat, markets have strongly rebounded over the past two months. A Santa Claus rally this month is a distinct possibility.

A bright spot came Monday, with the latest survey from the Institute for Supply Management (ISM) on the U.S. services industry. Economic activity in the services sector grew in November for the 30th month in a row, with the Services PMI registering 56.5%, 2.1 percentage points higher than October’s reading of 54.4%. Any reading at 50 or above is expansionary (see chart).

Here’s a more detailed breakdown of the latest ISM report:

• Business Activity Index: 64.7%
• New Orders Index: 56%
• Employment Index: 51.5%
• Supplier Deliveries Index: 53.8%

Services activity surprisingly picked up steam in November, with employment recovering, providing yet more evidence of underlying strength in the economy despite fears of a recession in 2023.

Last week, we also got data that showed the economy continued to create jobs at a fast clip in November, with wage growth accelerating. Consumer spending rose in October as well.

We’re being reminded that geographical diversification is crucial. From their October lows, U.S. stocks are up 12%, international large-caps are up 20%, and emerging-market stocks are up 16%. Asian stocks have been leading the charge, as investors respond favorably to Beijing’s compromises over COVID lockdowns. The Hang Seng Index (Hong Kong) has gained 33% over the last few weeks.

Don’t withdraw from the world stage and become a parochial investor. To be sure, emerging markets have been grappling with multiple pandemic-induced crises, but the global diversification imperative still applies to all geographic regions and countries.

Emerging market stocks have passed in and out of vogue over the past two decades. Investors have fluctuated from unbridled enthusiasm about their growth prospects to intense hand-wringing about their riskiness. But we’re now seeing inklings that emerging markets, after taking a beating this year, are poised for a comeback in 2023.

The great disconnect…

Despite multiple headwinds, investors and consumers are behaving with optimism. The midterm elections are a prime example of this disconnect.

The GOP assumed it could make political hay out of recession fears and high inflation, but voters instead were driven more by issues such as abortion and election denialism. History says the incumbent party should have gotten clobbered, but pocketbook issues did not reign supreme.

Consumers are telling pollsters that they’re worried about the economy, but those same consumers are spending freely. Small wonder, many economists are scratching their heads. The pandemic did indeed create a unique set of circumstances not found in textbooks.

On Tuesday, the main U.S. stock market indices closed lower, as follows:

• DJIA: -1.03%
• S&P 500: -1.44%
• NASDAQ: -2.00%
• Russell 2000: -1.50%

Regardless, there seems to be enough gas in the tank for a market sprint this month, although it would only take a dire headline (say, from the Russia-Ukraine war) to send investors scurrying for cover.

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John Persinos is the editorial director of Investing Daily. You can reach John at: mailbag@investingdaily.com

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