The much-anticipated Santa Claus Rally window came and went last week with only more volatility and a lot of lower prices to show for it. With hardly any discernable meaningful catalysts and a lot of end of year tax-loss selling going on, there simply wasn’t much to stop stocks from rolling over early in the week. Wednesday (good) and Thursday (bad) basically cancelled each other out. Friday was a moderately decent low-volume snooze-fest.
As we begin the transition that I highlighted last week (investors shifting to taking note of what data actually shows about inflation and the economy, as opposed to exclusively caring only about how the Fed might react) we are frequently experiencing conflicts when it comes to an assessment of what we are actually looking at.
For example, the Fed’s most beloved set of indicators, the Core Personal Consumption Expenditures (PCE) last week showed its particular version of inflation (ex- food and energy prices) as moving 0.2% higher from October to November and up by 4.7% from a year ago. This showed inflation decelerating more than expected. Good news, right?
Well, yes, but it also showed that over the same period, Americans’ spending slowed substantially, up just 0.1% - a stat that just weeks ago would have fit the “bad news is good news” narrative and taken as evidence that the Fed could react to that by easing up on interest rate hikes. Nowadays it is being seen for what it really is; evidence that the pace of consumer spending is falling and could soon be in a tailspin. Newsflash: that isn’t good for stocks.
The report also showed that earnings for the average American were up 0.4% month over month, exceeding the rate of inflation, muddling the message even further.
I’m not trying to imply that Fed rhetoric or policy doesn’t matter, it absolutely still does. But as we enter 2023, it’s no longer going to be the single most important factor for this simple reason: The Fed will have to react to the data just like it did in 2022. And if inflation and growth both fall fast enough, then the Federal Open Market Committee (FOMC) will definitely stop tightening, whatever they may say in speeches and press conferences.
But inflation data has to fall faster than economic data, otherwise we’re looking at stagflation and a potential huge Fed policy mistake. Thursday and Friday’s data implied that the opposite is happening right now; growth estimates are falling faster than inflation. And the bond market is screaming the imminent arrival of a recession by means of the persistently inverted yield curve (see EXPLAINER: FINANCIAL TERM OF THE WEEK below).
The good news (for the Fed, at least) is that interest rate hikes are totally wrecking the real estate market - as emphasized by the continued, worse-than-expected decline in housing metrics released last week, including sales of existing homes slumping 7.7% from October to November, the tenth consecutive month of declines and now down more than 35% from this time last year.
The median sales price of a house in the US fell more than 10% from June to November to $370,700. Building permit applications for privately-owned housing units crashed 11.2% over the course of the last month and are now over 22% below the level of a year ago.
All this shows just how much the vastly increased cost of borrowing has utterly destroyed demand and sentiment among both homebuyers and homebuilders. But the Fed wants to see this interest rate-related demand destruction move beyond just housing. At some point it likely will, and that's why the worries about an upcoming recession are so widespread and continue to cast a shadow over stock prices.
This has been a year in which all the world's major central banks engineered a serious pivot toward higher interest rates and tighter money. Almost all, that is. Until last Tuesday, the Bank of Japan (BOJ) stood out as the exception to the rule.
In a surprise move and a sign that the war on inflation is now truly a worldwide affair, it “loosened its yield curve control" which is a central bank-y way of saying it will allow market interest rates to drift higher before it intervenes to cap out any rise. That tolerance cap for the ten year bond went up from 0.25% to 0.50%.
It may not look like like much, but it’s a pretty epic policy shift from the BOJ, which has been supporting easy money for many, many years. And despite recent calls from Japanese government officials to raise rates, it has refused to budge until now.
This move raises the value of the yen at the expense of the US dollar. Corporate America has been crying out for a fall in the value of the US currency, which has soared since early 2021, to help with exports - so the effect of the BOJ’s actions could even be a net positive for US stocks.
Last week I identified the two key questions that will dominate the assessment of stock market direction in early 2023 as being:
1) How fast will inflation decline?
2) How bad will the economy get?
This week I want to show more precisely what we need to see (and when) to answer those questions properly.
The Core Consumer Price Index (CPI) measure of retail inflation (most recently up 0.2% month-on-month, 6.0% year-on-year) is the important one as it will tell us more clearly when services inflation is declining (as opposed to just goods and commodities) and it’s that decline that ultimately leads to a Fed policy pivot to re-start the process of actually lowering interest rates.
The Positive Answer: < 5.0% year-on-year before April. The Negative Answer: > 5.0% after April.
Markets need to see a serious deterioration in the labor market. If the unemployment rate can rise and stay above 4% early in 2023 (currently it’s 3.7% and has remained stubbornly there or thereabouts for a good while), then that will be a clear sign that Fed rate hikes are restoring economic balance.
The Positive Answer: > 4.0% before March. The Negative Answer: < 4.0% after March.
The good news is that if both these questions are answered positively, then the bottom in stocks could well be in by the end of next quarter. On the other hand, if they’re answered negatively, then more new lows aren’t just likely, they’re almost certain.
This is my final report of 2022 .. I have often expressed the futility of looking forward using forecasts, but I am a big fan of the learning opportunities derived from looking back, so I will shortly be sending my Q4 review.
This has not been an easy year in the markets, to put it mildly. The fact that stocks now seem to be defying the traditional Santa Claus Rally is a sign that those difficulties could well continue into next year.
I do want to emphasize, however, that every single time we have had to endure a period like this in the markets, it has ultimately yielded generational buying opportunities to help longer term investors secure their financial futures and I’m very confident that this is the case this time as well.
Hopefully in 2023 and beyond, this weekly report will be a part of helping guide clients and subscribers towards that security.
OTHER NEWS
Payback is a bitch .. America’s most despicable and worst behaved bank, Wells Fargo, agreed to pay a colossal fine to settle allegations that it defrauded its customers in its fake account scandal that dates back as far as when Justin Bieber was advising you to love yourself in 2016. The settlement includes a $1.7 billion penalty, the Consumer Financial Protection Bureau (CFPB)’s largest-ever fine, and more than $2 billion in consumer restitution.
The bank is still facing further scrutiny and possible further penalties and sanctions from multiple other regulators more than six years after its astonishing illicit behavior came into public view. It deliberately assessed illegitimate fees and interest charges on loans for cars and homes so that many bank customers had their vehicles illegally repossessed while others had overdraft and other penalty fees unlawfully applied.
In any other sector, such behavior would result in the institution being completely shut down and its officers jailed. It’s still beyond me why anyone still has anything to do with Wells Fargo.
Bow-cession? .. Manufacturers and sellers of those oversized red or green bows that you see sitting on the hoods and roofs of holiday-gifted cars have reported a steep decline in business this holiday season, according to the Wall Street Journal. Car dealer inventories have been low due to supply-chain holdups, which means fewer cars on the lot to crown with a bow. On top of that, the high price of new cars has more drivers opting to instead purchase the car they have been leasing.
Big Retirement Plan Changes Coming .. Congress passed an omnibus bill on Friday, known as SECURE 2.0 after the original, dreadfully-named Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 on Friday that includes a number of measures to help people save more for retirement and able to leave their retirement savings untouched and untaxed for longer.
Once I have had a chance to pore through the details, I plan on shortly sending out my take and an easy-to-read summary of what the changes will mean to you. Stand by.
UNDER THE HOOD:
If we examine stock price charts, there is very little holiday cheer to be found. And the deeper we look under the hood, the less there is. In fact, there have been developments in technical readings over recent weeks that indicate that sellers have really woken up.
I have frequently referred to the classic market bottom scenario when investors throw in the towel, sell almost anything and everything and rapidly force prices down to significantly depressed levels where buyers finally see real value and come roaring in with indiscriminate, irresistible and sustained buying.
We are just not seeing that. When sellers do get active, the response of the buyers has been mostly pretty pathetic. A few days (or, very occasionally, weeks) of rather lukewarm rebound buying and then they crawl back under their rocks, allowing the sellers back into the ascendancy.
While oversold conditions are becoming apparent in several short-term indicators, the slight bounce that we may be experiencing is likely to be only fleeting and unlikely to be sustained, according to the deteriorating technical indicators. On the contrary, technical probabilities suggest that any rebound could well soon give way to another down-leg.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
Stock and bond markets are closed on Monday for the Christmas holiday.
Unsurprisingly for the week between Christmas and New Year, the corporate calendar is empty. There are no major companies reporting earnings or speaking with investors. Q4 2022 earnings season kicks off on January 13th starting with results from several big banks.
Not much in the way of economic data releases to watch for this week either, although we will get a further little peek into the shit-show that is the US housing market right now as we get data concerning Pending Home Sales and the latest House Price Index.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):
↑Bullish: 20% (24% the previous week)
→Neutral: 28% (31% the previous week)
↓Bearish: 52% (45% the previous week)
Net Bull-Bear spread .. ↓Bearish by 32 (Bearish by 21 the previous week)
Source: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
The highest recorded percentage of AAII bearish sentiment was 70% and occurred on March 5th 2009, right near the end of the Great Financial Crisis. The lowest percentage of AAII bears was recorded at 6% on August 21st 1987, not long before the stock market crash of October 1987.
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
LAST WEEK BY THE NUMBERS:
Last week’s market color from finviz.com:
- Last week’s best performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) for the second week in a row - up 3.3% for the week
- Last week’s worst performing US sector: Consumer Cyclical (two biggest holdings: Amazon, Tesla) for the second week in a row, yet again driven in large part by the ongoing price collapse in Tesla - down 3.4% for the week
- The S&P 500 was about flat for the week vs NASDAQ-100 down over 2%
- International Developed Markets were the week’s winners ahead of US and Emerging Markets
- Mid and Small Caps outpaced Large Caps
- Value stocks up for the week, Growth stocks down
- The proprietary Lowry's measure for US Market Buying Power is currently at 155 and rose by 1 point last week and that of US Market Selling Pressure is now at 156 and fell by 7 points over the course of the week.
- SPY, the S&P 500 ETF, remains below its 50-day and 90-day moving averages and is also still below its long term trend line. SPY ended the week 19.8% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains below its 50-day and 90-day moving averages and is still a long way below its long term trend line. QQQ ended the week 32.7% below its all-time high (11/19/2021).
The Lowry’s Percent of Stocks Above Their 30-Day Moving Average reading fell from 28% to 27%.This important reading measures the direction and extent of market momentum. Readings remaining consistently below 25% have historically tended to indicate an over-sold condition, possibly primed for a technical rebound and those above 75% are often considered to be over-bought, possibly primed for a technical decline.
- VIX, the commonly-accepted measure of anticipated stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week lower at 20.9. It remains below its 50-day and 90-day moving averages and well below its long term trend line.
ARTICLE OF THE WEEK: A very thought-provoking article from The Atlantic suggesting a complete rethink of how we look at home ownership and how real estate should maybe be treated as consumption (not dissimilar to groceries, vacations and cab rides), rather than as an investment.
EXPLAINER: FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity) .
An inverted yield curve shows that long-term interest rates are less than short-term interest rates. With an inverted yield curve, the yield decreases the farther away the maturity date is. Sometimes referred to as a negative yield curve, the inverted curve has proven in the past to be a reliable indicator of a recession (although false positives have occurred).
The yield curve graphically represents yields on similar bonds across a variety of maturities. It is also known as the term structure of interest rates. For example, the U.S. Treasury publishes daily Treasury bill and bond yields that can be charted as a curve.
Analysts often distill yield curve signals to a spread between two maturities. This simplifies the task of interpreting a yield curve in which an inversion exists between some maturities but not others. The downside is that there is no general agreement as to which spread serves as the most reliable recession indicator.
The normal yield curve slopes upward from bottom left to top right, reflecting the fact that holders of longer-term debt have taken on more risk. When inverted, it slopes in the opposite fashion (see below).
A yield curve inverts when long-term interest rates drop below short-term rates, indicating that investors are moving money away from short-term bonds and into long-term ones. This suggests that the market as a whole is becoming more pessimistic about the economic prospects for the near future.
Because yield curve inversions are relatively rare yet have often preceded recessions, they typically draw heavy scrutiny from financial market participants.
Academic studies of the relationship between an inverted yield curve and recessions have tended to look at the spread between the yields on the 10-year U.S. Treasury bond and the three-month Treasury bill, while market participants have more often focused on the yield spread between the 10-year and two-year bonds.
Federal Reserve Chair Jerome Powell said in March 2022 that he prefers to gauge recession risk by focusing on the difference between the current three-month Treasury bill rate and the market pricing of derivatives predicting the same rate 18 months later.
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