Last week was a busy one with plenty of economic data to chew on and lots of soundbites from International Monetary Fund (IMF) officials and Federal Reserve presidents. It also marked the opening of the Q1 2023 earnings season.
Monday started out mostly jittery and trendless as the stock market tried to digest the Jobs Report from the holiday Friday before. Interestingly, the laggards were stocks in the defensive sectors like Utilities and Consumer Defensive that had outperformed the previous week, as worries eased about the prospect of an economic “hard landing” (i.e. inflation is only finally killed by a nasty recession).
The IMF said that the rampant inflation around the world of the past year or so, along with accompanying higher interest rates, will turn out to be just a blip on some charts. The recent banking turmoil (I think it’s generally agreed now that the term “banking crisis” is an overblown description of what happened and needs to be downgraded to “banking turmoil”) illustrates the concerns IMF economists have been voicing for a while as central bankers continually tighten monetary policy and raise interest rates.
“Downside risks dominate and the fog around the world economic outlook has thickened,” wrote IMF Director of Research Pierre-Oliver Gourinchas, bringing to mind the writing style of Charles Dickens who was, of course, the author of both “Hard Times” and “Great Expectations” - which, when combined, seem to conveniently express the two ends of the spectrum of the economic outlook right now.
The Consumer Price Index (CPI) measure of retail inflation came out on Wednesday and showed a rise of just 0.1% from February to March, lower than the expectation of 0.2% after the previous month’s 0.4% gain. Annualized inflation in the US is now running at 5.0%; below expectations, the lowest level since May 2021 and down from 5.5% the month before.
Inflation might be cooling according to some metrics, but it isn't completely going away. Excluding volatile food and energy components, Core CPI actually accelerated a bit, ticking up 0.4% month-to-month and is up 5.6% year-on-year vs. 5.5% the previous month. Rises in the cost of housing and shelter was the largest contributor to the monthly increase.
The good news piled up the next day when we saw the Producer Price Index (PPI) measure of wholesale inflation affecting manufacturers (which is kind of a leading indicator for retail inflation). PPI fell 0.5% from February to March after being unchanged the previous month. The biggest factor was a sharp decline in gasoline costs. The annualized reading was up just 2.7%, falling precipitously from 4.9% the month before.
The fact is that many categories of goods have now returned to pre-pandemic levels of inflation and many commentators believe that is a good enough reason for the Fed to stop raising interest rates immediately. Futures markets are currently showing that probability as being 22% with a 78% chance of a 0.25% increase at the next meeting in early May (see FEDWATCH TOOL, below).
This heightened expectation of a maximum of just one more interest rate increase was also fueled by a slate of speeches midweek from Federal Reserve officials. Minneapolis Federal Reserve President Neel Kashkari said that he foresees headline inflation falling to the “the mid 3’s” by the end of 2023 and move closer to the Fed’s target range of 2.0% by next year. New York Fed President John Williams spoke about how he believed that the recent failures of Silicon Valley and Signature Banks were “unique” and “unlikely to reflect the broader trends in the financial system.” That helped ease some of the lingering market angst about the health of the banking sector.
The newly-released minutes from the Fed’s most recent policy-making meeting revealed that members anticipate a mild recession this year in the US partly because of the fallout from last month’s banking turmoil. They also projected that the unemployment rate will rise another full percentage point by the end of the year — an event that historically has only ever occurred during a recession.
Friday’s much better-than-expected Q1 2023 earnings from some of the big box banks was swiftly overshadowed by the release of data that showed consumer spending falling twice as much as expected in March. Retail Sales declined by a full 1.0% last month, much more than the expected 0.5% decline, as consumers seem to be increasingly keeping their hands in their pockets. It’s yet another sign that it's probably only a matter of time before a recession of some kind fully engulfs the US economy and the stock market ended Friday on a downbeat note, although the headline indexes were a little higher for the week overall.
The biggest question for markets is now not so much “will there be a recession?” , I think everyone now assumes that there will be - and pretty soon. It’s more about whether the recession is going to be an extended, deep and painful one (“Hard Times”) that results in sharp equity market losses and broader turmoil across financial markets or a shallow and relatively short-lived one (“Great Expectations”) that markets will be able to weather fairly well. The answer to that question still remains to be seen, but we are definitely getting closer to learning which it is.
The rally in March and April in stocks and bonds has been driven by anticipation of a“Fed hike, pause, cut” narrative, not actual hard improvement. That doesn’t mean it’s wrong (these expectations could end up being entirely accurate), but it does leave markets vulnerable to disappointment and if that disappointment comes about (a delayed pause? No prospect of a cut this year?), a 5%-10% pullback in stock prices shouldn’t surprise anyone.
Watch this space.
OTHER NEWS ..
Stamp-flation .. The price of postage stamps is poised to increase again in July for the second time in 2023 and the 17th rate change since 2000, under a new proposal by the US Postal Service (USPS). If approved by the Postal Regulatory Commission, this would be the shortest time between increases in history. Rates last went up just three months ago and before that, in July 2022. In contrast, between 1970 and 2000, rates only increased once on average every two to three years.
The Postal Service said the proposed increases raise first class mail by approximately 5.4% to “offset the rise in inflation” and are needed “to address continued elevated inflation and prior years defective pricing model”.
With the proposed rates, postage for a first class 1-ounce letter will go to 66 cents, up from 63 cents and 2x the 1999 rate of 33 cents. The Postal Service said it is also "seeking price adjustments for Special Services products including Certified Mail, Post Office Box rental fees, money order fees and the cost to purchase insurance when mailing an item".
Much less swiping going on .. Office vacancy rates hit a record high in New York and rose nationwide as tenants cut back on space they don't need because so many employees are working from home.
In New York City, the office vacancy rate rose to a record 16.1% in Q1 2023, representing more than 76 million square feet of empty office space, according to a report by commercial real estate firm, JLL. As office leases, which typically run 10 years or more, expire, companies are reassessing their space needs and not in a good way for the commercial real estate market in New York.
That vacancy rate means about 84% of available space is theoretically being leased but that absolutely does not mean that it's all being used. New York's actual office occupancy rate is more like around 49%, according to Kastle Systems, which tracks card swipes through its security systems.
Careful what you wish for .. If history is any guide the market may be overestimating the positive effects of interest rate cuts, if they happen. The previous occasions when the Fed has embarked on a meaningful rate-cutting cycle have tended to work best (i.e., resulted in very positive stock market returns in the following year or two) when rates are being cut from very high starting point (e.g. 1981: from 20.0%, 1974: from 13.0%) and it’s mostly a far less exciting outcome historically when rates were being cut starting from lower levels (e.g. 2007: from 5.25%, 1995: from 6.0%).
If the Fed does begin cutting rates later this year, as the market expects (but the Fed denies), the starting point is likely to be barely above 5.0% or maybe even lower. So, it may be prudent to hold off on popping the champagne corks too early, even when those long-anticipated interest rate cuts from the Fed do eventually materialize.
UNDER THE HOOD ..
The net percent spread Between Buying Power and Selling Pressure has been essentially stuck in a range since at least last October. The spread continues to hover near zero, crossing one way then the other frequently and is currently sitting right on its 40-week moving average. That is a lot of heat and light over the last six months or so expended on basically going nowhere.
93% of stocks are above their 10-day moving average, giving short term hope to those anticipating an imminent return to finally paying taxes on some capital gains (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) but looking further out, only 61% are above their 30-week moving average and that’s way down from the 83% reading of as recently as February 2nd. Unfortunately the longer term averages usually trump the shorter term ones when it comes to determining what is really going on beneath the surface and this one is trending strongly lower.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
This week will be chock full of Q1 2023 earnings reports along with several more indicators on the US economy and housing.
The big dogs reporting earnings this week include Tesla, Netflix, Charles Schwab, Bank of America, Goldman Sachs, Johnson and Johnson, IBM, Morgan Stanley, Procter and Gamble, AT&T, Freeport-McMoRan, Taiwan Semi-Conductor, Lockheed Martin, Schlumberger, Abbot Laboratories, Las Vegas Sands and United Airlines.
Economic-data highlights next week include the Leading Economic Indicators index and both the manufacturing and the services purchasing managers’ indexes.
There will also be several indicators of US housing market activity released this week. including the Housing Market Index, New Residential Construction statistics and Existing Home Sales numbers.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.27%
(one week ago: 6.28%, one month ago: 6.60%, one year ago: 5.00%)
Weekly data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
↑Bullish: 26% (33% a week ago)
↔ Neutral: 39% (32% a week ago)
↓Bearish: 35% (35% a week ago)
Net Bull-Bear spread: ↓Bearish by 11 (Bearish by 2 a week ago)
Weekly data courtesy of: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
FEDWATCH TOOL ..
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 4.875%) on May 3rd after its next meeting?
↔ No change .. 22%
(one week ago: 29%, one month ago: 46%)
↑ 0.25% increase .. 78%
(one week ago: 71%, one month ago: 41%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of market close on Friday.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Financials (two biggest holdings: Berkshire Hathaway, JP Morgan Chase) - up 3.0% for the week
- Last week’s worst performing US sector: Utilities (two biggest holdings: NextEra Energy, Southern Co) - down 1.4% for the week
- The proprietary Lowry's measure for US Market Buying Power is currently at 170 and rose by 9 points last week and that of US Market Selling Pressure is now at 144 and fell by 16 points over the course of the week.
- SPY, the S&P 500 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line. SPY ended the week 13.7% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line. QQQ ended the week 21.1% below its all-time high (11/19/2021).
- 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 1.3 points lower at 17.1. It remains below its 50-day and 90-day moving averages and below its long term trend line.
ARTICLE OF THE WEEK ..
In 2021 and 2022, if someone asked, “Should I buy an I Bond?”, the answer was definitely ‘yes’. Today the answer is, at best, ‘maybe’. Are I Bonds losing their luster?
(for my explanation of I Bonds and how they work, see here)
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).
The term capital gain refers to the increase in the value of a capital asset when it is sold. Put simply, a capital gain occurs when you sell an asset for more than what you originally paid for it.
Almost any type of asset you own is a capital asset. This can include a type of investment (like a stock, bond, or real estate) or something purchased for personal use (like furniture or a boat).
Capital gains are realized when you sell an asset by subtracting the original purchase price from the sale price. The Internal Revenue Service (IRS) taxes individuals on capital gains in certain circumstances.
Capital gains are typically realized at the time that the asset is sold. Capital gains are generally associated with investments, such as stocks and funds, due to their inherent price volatility. But they can also be realized on any security or possession that is sold for a price higher than the original purchase price, such as a home, furniture, or vehicle.
Capital gains fall into two categories:
Short-term capital gains: Gains realized on assets that you've sold after holding them for one year or less
Long-term capital gains: Gains realized on assets that you've sold after holding them for more than one year
Both short- and long-term gains must be claimed on your annual tax return. Understanding this distinction and factoring it into investment strategy is particularly important for day traders and others who take advantage of the greater ease of trading in the market online.
Realized capital gains occur when an asset is sold, which triggers a taxable event. Unrealized gains, sometimes referred to as paper gains and losses, reflect an increase or decrease in an investment's value but are not considered a capital gain that should be treated as a taxable event. For example, if you own stock that goes up in price, but you haven't yet sold it, that is an unrealized capital gain.
Short- and long-term capital gains are taxed differently. Remember, short-term gains occur on assets held for one year or less. As such, these gains are taxed as ordinary income based on the individual's tax filing status and adjusted gross income (AGI).
Long-term capital gains, on the other hand, are taxed at a lower rate than regular income. The exact rate depends on the filer's income and marital status, and can range from 0% to 20% (higher net worth investors may have to also pay the additional net investment income tax, on top of the 20% they already pay for capital gains).
A capital loss is the opposite of a capital gain. It is incurred when there is a decrease in the capital asset value compared to an asset's purchase price.
Note that there are some caveats. Gains on certain types of stock or “collectibles” (such a precious metals, either held physically or as a security such as an ETF) may be taxed at a higher 28% capital gains rate regardless of holding period and real estate capital gains can go as high as 25%.
In addition, certain types of capital losses are not deductible. If you sell your house or car at a loss, you will be unable to deduct the difference on your taxes. unless what you sell is your primary residence (as determined by certain criteria laid down by the IRS) when the first $250,000 is exempt from capital gains tax. That figure doubles to $500,000 for married couples.
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