US stocks endured a difficult holiday-shortened week amid concerns that higher interest rates could cause a slowdown in economic growth both here and abroad and a sense that stock market professionals may be starting to take profits on mega-cap tech and put the proceeds into bonds.
There was also a feeling coming into the week that the recent rally had stretched short term valuations a bit and some cooling off of an over-bought condition was to be expected. And that’s exactly what we saw. The S&P 500 snapped its five-week winning streak, falling more than 1.4% (its worst week since March).
Investors have been yawning at “Fedspeak” from various Federal Reserve officials and regional Presidents which has gone in one ear and out the other for about a year now. They have been indulging in a FOMO/AI-led rally since March and scornfully dismissing the notion of any interest rate-related economic pain and an earnings-wrecking recession.
The stock market is essentially saying that it simply doesn’t share the Fed’s ongoing caution and is choosing to disregard it. One side or the other is going to be very wrong here and will have to back down from their current position.
Markets would love a definitive all-clear signal from the Fed that the end of the rate-hiking cycle has arrived. But they are not even getting a sniff.
Last week saw the launch of an onslaught of Fedspeak specifically aimed at pushing back on this stock market skepticism, particularly when Fed Chair Jerome Powell told a House panel that he fully expects more interest rate increases ahead because getting inflation under control “has a long way to go”, while also saying that the frequency of increases would be“more moderate” than the fast and furious back-to-back-to-back rate hikes of the previous fifteen months.
He described the idea of two more rate hikes this year as“a pretty good guess”. The comments were clearly intended to press home the message that the Fed’s June inaction was very much a pause and very not a halt.
Other central banks around the world were also scrambling last week to regain their credibility with a constant drumbeat of attempts to shock markets into believing in stickier inflation (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) and a long, hot summer of ongoing interest rate rises in response. Turkey, which long ago lost the battle to restore any kind of investor trust and is now basically a financial basket case, raised interest rates to 15%.
In the post-Brexit UK, core inflation is at its highest level since Sir Mix-a-Lot pointed out that baby got back in 1992 and food inflation there is currently running at over 18% per year. British bond markets are now even frothier than they were during the chaotic times of Liz Truss’ unhinged 49-day reign as Prime Minister last year. Of the top 25 economies in the world, only Argentina and Turkey currently have a higher level of inflation than the UK.
The Bank of England (BOE) reacted with a half a percent hike in interest rates, as did the central bank of Norway. The BOE made it clear that at least three more rises were in the hopper, which is terrifying variable rate mortgage holders who do not have access to long-term fixed rate products like in the US. Meanwhile, the Swiss central bank followed the previous week’s example of the European Central Bank and raised by a quarter of a percent and they also warned of more hikes soon.
The problem with this current consensus view by central banks around the world is that many of the effects of their already-implemented rate hikes have not yet been felt in their economies. Rises in interest rates usually take months or quarters to meaningfully impact growth. Additionally, the economic data that policymakers are relying on for their inflation readings is, by definition, lagging data.
Put these two issues together and you can easily see why many feel that the central banks (including the Fed) are risking an overshoot of interest rate rises which could, of itself, directly cause a painful global recession. This conclusion is strengthened by that often reliable recession indicator, the deepening inversion of the US yield curve (as measured by 2 year interest rates vs. the 10 year), which hit a 40-year high with the shorter rate 0.97% higher than the longer rate on Tuesday morning and stayed there all week (see US TREASURY INTEREST RATE YIELD CURVE below).
On the more optimistic side of things, however, when you look at the important pieces of economic data and track them over recent months, a soft landing (inflation eventually conquered without a meaningful recession) still appears more likely than a hard one. There are few signs that US consumer spending is materially slowing and business spending remains robust. Expectations for the upcoming Q2 2023 earnings season (which kicks off in just three weeks) are quietly ticking higher.
To be clear, this analysis does not mean a hard landing won’t happen. But so far, it’s evident that it isn’t happening. Yes, the economy is most definitely slowing and potential weakness in the service sector and labor market will be significant negatives for growth if they get materially worse. But for now, economic growth is moderating at a pace that is considered consistent with a soft landing and that’s one of the reasons that stocks have proven so resilient in recent weeks.
OTHER NEWS ..
Not so charitable any more .. Charities love to say that "every penny counts". In reality though, individual charitable donations have never mattered less. As reported by Axios last week, it's increasingly just a small number of ultra-high net worth individuals, alongside even fewer old money foundations, who determine whether charities thrive or fall apart.
There's a move away from the previous model of raising smaller sums from many households and toward a much more targeted strategy of just cultivating wealthy donors (or at least the kind of people who still itemize their taxes and can claim the charitable tax deduction) or corporations.
By the numbers: Overall charitable donation in the US dropped in 2022 by $17.3 billion. The amount given by corporations went up, as did bequests and contributions from foundations. But, in a year when Americans’ disposable cash levels have never been higher, charitable giving by individuals fell by a massive $21.9 billion, causing the overall decline.
WFH is winning .. With the pandemic well behind us, evidence continues to mount that working from home will be a lasting feature of the American economy. It's hard to overstate the importance of the fact that more than one-third of American workers aren't schlepping into the workplace each day.
Vast amounts of empty downtown office space, high demand for suburban housing and major shifts in consumer behavior and buying patterns are just a few of the transformative economic changes that can be traced to the WFH revolution.
The Bureau of Labor Statistics' annual survey on Americans’ time use provides some of the most authoritative readings on the trend.
Nearly 35% of American workers worked from home on an average day last year, up from just 22% a decade earlier.
Yes, but: Peak work from home (nearly 40% in 2021) may be behind us.
The work-from-home trend is far more pronounced among those with college degrees, of whom about 54% work from home on an average day.
UNDER THE HOOD ..
The S&P 500 came into last week as technically overbought as it has been since 2020 and the risks of a profit-taking pullback loomed large and so it proved as the index moved lower on three of the four trading days, with Friday being the worst of the bunch.
The disjointed recent advance in the Large Cap-weighted price indexes since last October has been anything but typical of a new bull market, as I have repeatedly emphasized in this report. The burden is now on the buyers to extensively broaden the rally into the Mid and Small Cap corners of the market so that it can be sustained. Like a freight train, the more stocks that are moving in the same direction, the more difficult it is to reverse course.
However, unfortunately for the bulls, beneath the surface of index price returns, Small Cap breadth remains exceptionally weak relative to what’s going on in Large Cap-world. A fairly pitiful number of Small Cap stocks are trading above their long term moving averages and a pretty alarming number are trading 20% or more below their one year highs. While Large Cap stocks are now only about 9% below their all-time highs, Small Cap stocks are still over 25% away from theirs.
So this is where the focus needs to be now - rather than getting all excited because Microsoft makes a new all-time high or Tesla shifts 3% in a day or whatever. In terms of assessing the true validity of this rally, it’s all about what’s happening with the Small Caps.
In keeping with this sentiment, I am now including data on IWM, the Small Cap ETF in my LAST WEEK BY THE NUMBERS section below.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
A small number of companies are scheduled to report earnings this week, including Nike, General Mills, Walgreens, Carnival, Micron, Paychex and Constellation Brands.
The Federal Reserve will reveal the results of its annual stress test of America’s largest banks, including determining how much banks can return to shareholders via stock buybacks and dividends.
Economic data out this week will include Durable Goods, New Home Sales and Personal Income and Expenditures data for which expectations are a 0.4% rise in income and a 0.3% increase in spending. The big one, though, is the Federal Reserve’s preferred inflation measure, which is what influences its interest rate decisions, the Core Personal Consumption Expenditures (PCE) index. It is forecast to be up 4.7% from a year earlier, unchanged from the previous month.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com
Last week’s best performing US sector: Consumer Defensive (two biggest holdings: Walmart, Pepsico) - up 0.3% for the week.
Last week’s worst performing US sector: Real Estate (two biggest holdings: Prologis Inc., American Tower Corp) - down 2.9% for the week.
The proprietary Lowry's measure for US Market Buying Power is currently at 156 and fell by 9 points last week and that of US Market Selling Pressure is now at 140 and rose by 13 points over the course of the week.
SPY, the S&P 500 Large Cap ETF, is made up of the stocks of the 500 largest US companies. It remains above its 50-day and 90-day moving averages and above its long term trend line with a no-longer-overbought RSI of 58**. SPY ended the week 9.3% below its all-time high (01/03/2022).
IWM, the Russell 2000 Small Cap ETF, is made up of the bottom two-thirds in terms of company size of the group of 3,000 largest US stocks. It remains just above its 50-day and 90-day moving averages and above its long term trend line with a RSI of 48**. IWM ended the week 25.6% below its all-time high (11/05/2021).
** RSI (Relative Strength Index) above 70: technically overbought, RSI below 30: technically oversold
The VIX, the commonly-accepted measure of expected upcoming stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week 0.1 points lower at 13.4. It remains below its 50-day and 90-day moving averages and below its long term trend line.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.67%
(one week ago: 6.69%, one month ago: 6.57%, one year ago: 5.81%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 43% (45% a week ago)
↔ Neutral: 29% (32% a week ago)
↓Bearish: 28% (23% a week ago)
Net Bull-Bear spread: ↑Bullish by 15 (Bullish by 22 a week ago)
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.
Data courtesy of: American Association of Individual Investors (AAII).
FEAR & GREED INDEX ..
“Be fearful when others are greedy and be greedy when others are fearful.” Warren Buffet.
The Fear & Greed Index from CNN Business can be used as an attempt to gauge whether or not stocks are fairly priced and to determine the mood of the market.
It is a compilation of seven different indicators that measure some aspect of stock market behavior. They are market momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe haven demand.
Extreme Fear readings can lead to potential opportunities as investors may have driven prices “too low” from a possibly excessive risk-off negative sentiment.
Extreme Greed readings can be associated with a sense of “FOMO” and investors chasing rallies in an excessively risk-on environment, possibly leaving the market vulnerable to a sharp downward correction at some point.
Data courtesy of CNN Business.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. most shorter term interest rates are higher than longer term ones) with the highest rate (5.44%) being paid currently for the 4-month duration and the lowest rate (3.74%) for the 10-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week rose from 0.93% to 0.97%, indicating an overall deepening of the inversion of the curve during the last week and its deepest level in four decades.
Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term. The deeper the inversion, the greater the deemed risk of recession.
The curve has been inverted since July 2022 based on the 2 year vs. 10 year spread.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
FEDWATCH INTEREST RATE PREDICTION TOOL ..
Where will interest rates (Fed Funds rate, currently 5.125%) be at the end of 2023?
↓ Lower than now .. 5% probability
(one week ago: 0%, one month ago: 82%)
↔ Unchanged from now .. 32% probability
(one week ago: 24%, one month ago: 15%)
↑ Higher than now .. 63% probability
(one week ago: 76%, one month ago: 18%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on July 26th after its next meeting?
↔ No change .. 26% probability
(one week ago: 26%, one month ago: 58%)
↑ 0.25% increase .. 74% probability
(one week ago: 74%, one month ago: 42%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
ARTICLE OF THE WEEK ..
“Volatility is timeless and wild swings in sentiment are the rule, not the exception” More enduring market wisdom from Josh Brown.
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).
Inflation is a rise in prices, which can be translated as the decline of purchasing power over time. The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over some period of time. The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. Inflation can be contrasted with deflation, which occurs when prices decline and purchasing power increases.
While it is easy to measure the price changes of individual products over time, human needs extend beyond just one or two products. Individuals need a big and diversified set of products as well as a host of services for living a comfortable life. They include commodities like food grains, metal, fuel, utilities like electricity and transportation, and services like healthcare, entertainment, and labor.
Inflation aims to measure the overall impact of price changes for a diversified set of products and services. It allows for a single value representation of the increase in the price level of goods and services in an economy over a period of time.
Prices rise, which means that one unit of money buys fewer goods and services. This loss of purchasing power impacts the cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.
Inflation is measured in a variety of ways depending on the types of goods and services. It is the opposite of deflation, which indicates a general decline in prices when the inflation rate falls below 0%. Keep in mind that deflation shouldn't be confused with disinflation, which is a related term referring to a slowing down in the (positive) rate of inflation.
Depending upon the selected set of goods and services used, multiple types of baskets of goods are calculated and tracked as price indexes.
The Consumer Price Index (CPI)
The CPI is a measure that examines the weighted average of prices of a basket of goods and services that are of primary consumer needs. They include transportation, food, and medical care.
CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them based on their relative weight in the whole basket. The prices in consideration are the retail prices of each item, as available for purchase by the individual citizens.
Changes in the CPI are used to assess price changes associated with the cost of living, making it one of the most frequently used statistics for identifying periods of inflation or deflation. In the U.S., the Bureau of Labor Statistics (BLS) reports the CPI on a monthly basis and has calculated it as far back as 1913.
The Producer Price Index (PPI)
The PPI is a family of indexes that measures the average change in selling prices received by domestic producers of intermediate goods and services over time. The PPI measures price changes from the perspective of the seller and differs from the CPI which measures price changes from the perspective of the buyer.
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