For all the different feel of this market in 2023, the price action is revealing that it is actually still broadly behaving much as it did in 2022. It’s still being driven by Fed expectations and those expectations are being determined by earnings and economic data.
In January, the data was mostly better-than-feared and the market developed the view that the Fed was close to ending rate hikes and that end-of-2023 interest rates would actually be lower than they were at the end of 2022. Stocks rallied hard and tech/growth names outperformed, including many of those that were slaughtered in 2022.
Then came that stunning Jobs Report on February 3rd, showing over half a million new jobs created in a month and everything began reversing.
Since then, additional data (notably retail and wholesale inflation and retail sales) has swung the narrative pendulum back the other way. Now the more accepted tale is that the Fed is in fact not close to done hiking and that rates will remain high for a good while even when they do finish raising them. Plus no rate cuts for you in 2023!
This new normal is reflected most obviously in the changing market expectations of interest rates (see FEDWATCH TOOL below to see exactly what I mean). For example, the market now prices interest rates ending the year above 5% as almost a total certainty, when just a month ago this likelihood was priced as a 50/50 toss-up.
Minutes from the Federal Reserve's February meeting released on Wednesday showed that the central bank is still taking things very cautiously with its rate policy, with several committee members pushing to raise interest rates by 0.50% at the meeting rather than the eventually decided-upon 0.25% raise. The Fed clearly continues to believe that inflationary risk outweighs the possibility of raising rates too far/too fast.
The minutes gave no direct indication of what the Fed might do at its next meeting in March but, according to the CME Group’s FedWatch Tool, while a quarter of a percentage point rise in interest rates is still favored as the most likely outcome next month, the futures market now prices the probability of a half a percentage point hike at 27% as compared to only 3% just a month ago.
At around the same time, Walmart (WMT) and Home Depot (HD) both highlighted the same phenomenon in their earnings guidance. Although supply chain problems are mostly abating, American consumers are now spending less on electronics, apparel and home improvements as inflation and evolving spending habits is now hitting demand for many of the more discretionary goods sold in large stores.
Unsurprisingly, the Consumer Cyclical sector, which is made up of the stocks of most of the companies who produce and sell more discretionary-type goods in stores and online, was the worst performing sector last week.
In its second estimate of Q4 2022 Gross Domestic Product (GDP), the Bureau of Economic Analysis reported that the US economy grew at an annual rate of 2.7% - down from the first estimate of 2.9%, compared to projections of 2.5% growth. In Q3 2022, the final estimate had been 3.2%.
The stock market initially seemed dazed and confused in response to all this, wandering around without much purpose, crossing from red to green and back again several times.
What finally seemed to nudge the market in one direction was the release of the Personal Consumption Expenditures (PCE) Price index. This is the Fed’s preferred gauge of inflation which it uses to guide its interest rate decisions more than any other indicator. That kind of makes it the most important single piece of economic data these days.
We learned that it rose 0.6% in January, more than the expected 0.4% rise and well up from December’s 0.3% increase. The index was up 5.4% from a year ago, accelerating a bit from December’s 5.3% but, more importantly, much higher than the 4.3% rate that had been expected. The Core PCE rate, which excludes more volatile food and energy prices, also climbed by more than estimates. This was a blow for those hoping for a swift pivot in the Fed’s higher interest rate policy.
It finally prompted the markets to make a directional decision and stocks started to accelerate sharply lower to end the holiday-shortened week down 2.7% in the case of the S&P 500 and 3.3% in the case of the NASDAQ.
There was a general sense, however, the market was actually showing a degree of resilience most of the time, with stock prices heading lower but in a somewhat orderly fashion (see UNDER THE HOOD, below, for more on this).
The feeling is that this resilience should stay in place as long as:
1) Economic growth doesn’t roll over hard, and
2) The Fed does not signal that peak interest rates will be substantially above its current 5.1% expectation. Any indication of an expectation of above, say, 5.4% will likely be met by a steeper fall in stock prices and an alarming jump in bond yields.
Interestingly, a number of analysts are starting to express a degree of skepticism around the validity of some of the recent economic data, which has included some remarkably quirky numbers indicating a very strong economy and a stubborn level of both inflation and job creation, owing to unusual seasonal adjustments that may be impacting the results.
If this is indeed the case and there’s something of a walk-back in the revised data which we’ll hear about in the coming weeks, we could see a sharp reversal in the broadly bearish (see EXPLAINER: FINANCIAL TERM OF THE WEEK, below) sentiment that first emerged from that “crazy” Jobs Report of February 3rd.
OTHER NEWS ..
Feeling better .. A survey of US consumer sentiment, which helps gauge how Americans feel about their own finances as well as the broader economy, rose in early February to a 13-month high of 67.0, suggesting a somewhat improved level of optimism about the economy. The final reading in February was up from 64.9 in January. This third straight gain pushed the index well above the record low of 50.0 set last summer.
Levels are still far below “normal”, however. The survey’s most recent peak was 88.3 in April 2021. Before the pandemic it topped out around 101.
Nevertheless, Americans think inflation, which is currently running at a twelve month rate of 6.4%, will persist for some time. They expect the inflation rate in the next year to average about 4.1% and 2.9% per year over the long run, still well above the Federal Reserve’s 2.0% target.
Taking off .. With borders now mostly open, some of the airline carriers that were burning through cash a year ago are posting big profits now. British Airways’ parent said last week it was in the black last year for the first time since the pandemic began. Singapore Airlines posted a record net profit for its latest nine month reporting period and Qantas of Australia showed a record pre-tax profit for its latest half-year.
It seems the results are being driven by a combination of pent-up demand and cost-cutting, with a big boost from government funds in some countries. With supplies of seats limited since carriers are still scrambling to hire staff and get planes back in the air, fares are high but passengers have been willing to pay.
Piling up .. Department of Justice attorneys last week added four additional counts to the eight previously made against Sam Bankman-Fried, the disgraced founder and former CEO of collapsed crypto exchange FTX. The new charges allege that SBF conspired to commit bank fraud and operate an unlicensed money-transmitting business. He also faces more securities and commodities fraud counts.
The newly-unsealed indictment provided a comprehensive account of his conduct, which prosecutors have stated led to a multibillion-dollar fraud. He is said to have stolen client funds to enrich himself and his fellow Bahamian frat house crypto bro pals and to help prop up FTX and its associated crypto investment firm, Alameda Research, run by his ex-girlfriend who has now agreed to testify against him.
The scheme was exposed when a rush of withdrawals from FTX created a liquidity crisis, leading to the firm's bankruptcy and SBF’s removal as CEO. His court-appointed replacement called what occurred at FTX "old-fashioned embezzlement."
SBF has pleaded not guilty to the original set of charges and is currently free on $250 million bond. His trial is set to begin on October 2nd.
UNDER THE HOOD ..
The clearly overbought condition of the market that had developed by the end of January made knocking it back down again easier from a technical perspective and short term indicators deteriorated. This was not really that surprising.
What is more interesting, however, is the way that the more medium and longer term technical readings are proving robust in the face of what has been, on the surface at least, a difficult two/three week period for the headline indexes.
The dominance of Buying Power over Selling Pressure still remains in an broadly upward trend and above its moving average. The key longer term reading of the Percent of Stocks Above Their 30-Week Moving Average remains at a healthy 68%.
Indeed, the general picture painted by the technical data is of a market moving lower mostly because it was overbought (as shown by the fact that it was the names that had spiked the highest in January which came down the hardest in February), not because of a passionate desire to sell everything.
Should the current dip continue and round-trip the market all the way from overbought to oversold, the eventual positive upwards snap-back could be quite meaningful.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
The rump end of Q4 2022 earnings season and a number of economic indicators will be this week's highlights.
With 35-ish companies left to report, average S&P 500 earnings are down more than 3% from the same period a year ago. Target, Costco, Salesforce, Best Buy, Lowe’s, Zoom, Occidental Petroleum, AutoZone, Monster Beverage, Norwegian Cruise Line Holdings, Dollar Tree, Lowe’s, Snowflake, Broadcom, and Kroger all report this week.
Chevron and Goldman Sachs Group will both hold investor days this week and Tesla may unveil a new, cheaper EV model on Wednesday.
Economic data out next week starts includes Durable Goods for January, a decent proxy for business investment. The latest Consumer Confidence Index out next week is expected to continue an upward trend.
The Institute for Supply Management will publish the Purchasing Managers’ Indexes for February this week, both the Manufacturing and Services versions.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
The data flipped back to a bearish tilt after two weeks of bullishness.
↑Bullish: 21% (34% the previous week)
→Neutral: 40% (37% the previous week)
↓Bearish: 39% (29% the previous week)
Net Bull-Bear spread .. ↓Bearish by 18 (Bullish by 5 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.
FEDWATCH TOOL ..
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of market close on Friday:
How does the market view the probability that interest rates (Fed Funds rate, currently 4.625%) will be at/above or below 5.0% at year-end?
At/above 99%-1% Below
(one week ago: 69%-31%, one month ago: 49%-51%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate) on March 22nd after their next meeting?
0% probability of no change
(one week ago: 0%, one month ago: 17%)
73% probability of a 0.25% increase
(one week ago: 85%, one month ago: 80%)
27% probability of a 0.50% increase
(one week ago: 15%, one month ago: 3%)
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: Proctor & Gamble, PepsiCo) - unchanged for the week
- Last week’s worst performing US sector: Consumer Cyclical (two biggest holdings: Amazon, Tesla) - down 4.4% for the week
- The NASDAQ-100 performed worse than the S&P 500
- Emerging Markets underperformed both Foreign Developed Markets and US Markets
- Large Cap did a little worse than Small Caps and Mid Caps
- Not much difference in the performance of Value or Growth stocks
- The proprietary Lowry's measure for US Market Buying Power is currently at 157 and fell by 9 points last week and that of US Market Selling Pressure is now at 139 and rose by 11 points over the course of the week.
- SPY, the S&P 500 ETF, fell below both its 50-day and 90-day moving averages but remains above its long term trend line. SPY ended the week 14.1% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains just above both its 50-day and 90-day moving averages and its long term trend line. QQQ ended the week 21.4% 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 1.6 higher at 21.7. It moved above its 50-day moving average but is still below its 90-day and its long term trend line.
ARTICLE OF THE WEEK ..
Heavily concentrated positions in one single stock, either as the result of employer stock ownership or a strategic choice through stock-picking, decreases long-run wealth-compounding probability and leads to a much higher chance of being wiped out in a catastrophic loss. Bad news bears.
Larry Swedroe explains.
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 terms "bear" and "bull" are often used to describe general actions and attitudes, or sentiment, either of an individual asset or the market as a whole. Investors use the terms "bearish" or "bullish" as a quick way to describe their market sentiment regarding specific securities or financial markets.
A bear market refers to a decline in prices, usually for a few months, in a single security or asset, group of securities, or the securities market as a whole. In contrast, a bull market is when prices are rising. Typically, a move of 20% or more from a recent peak or trough triggers an "official" bear or bull market.
While the terms are relatively simple to understand, the impact either a bull or bear market can have on your portfolio and wealth is undeniable. Both animals are known for their incredible and unpredictable strength, so the image that each evokes in regards to stock market volatility certainly rings true.
Interestingly enough, the actual origins of these expressions are unclear. Here are two of the most frequent explanations given:
The terms "bear" and "bull" are thought to derive from the way in which each animal attacks its opponents. That is, a bull will thrust its horns up into the air, while a bear will swipe down. These actions were then related metaphorically to the movement of a market. If the trend was up, it was considered a bull market. If the trend was down, it was a bear market.
Historically, the middlemen in the sale of bearskins would sell skins they had yet to receive. As such, they would speculate on the future purchase price of these skins from the trappers, hoping they would drop. The trappers would profit from a spread—the difference between the cost price and the selling price. These middlemen became known as "bears," short for bearskin jobbers, and the term stuck for describing a downturn in the market. Conversely, because bears and bulls were widely considered to be opposites due to the once-popular blood sport of bull-and-bear fights, the term bull stands as the opposite of bears.
Even Shakespeare's plays make reference to battles involving bulls and bears. In Macbeth, the ill-fated title character says his enemies have tethered him to a stake but "bear-like, I must fight the course”. In Much Ado About Nothing, the bull is said to be “a savage but noble beast”.
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