Note: this report was completed before confirmation of the debt ceiling deal reached by negotiators. See my subsequent post: “Debt Ceiling Update”.
Stocks skidded lower most of the week, giving back a lot of the previous week’s gains, as there was minimal reported progress towards a debt ceiling deal between the White House and Congressional Republicans. Talks seemed to collapse and restart over and over again with negotiators constantly talking out of both sides of their mouths so as to make absolutely nothing any of them said ever remotely believable.
We are now just days away from Treasury Secretary Janet Yellen’s newly-firmed up “X” date of June 5th, when the federal government is expected to “have insufficient resources to satisfy its obligations” which could result in the cancellation of social security payments, federal employees’ salaries and the repayment of national debt.
Also, any agreement will still need to go swiftly through the House and the Senate where it could be at the mercy of arsonists like Boebert, Taylor-Greene, Roy, Lee and (as ever) Rand Paul. Keep an eye on these particular lawmakers in the next week or so. Meanwhile, on the other end of the economic brainpower spectrum, the International Monetary Fund (IMF) said on Friday that the political brinkmanship in Washington is in danger of creating an “entirely avoidable” systemic risk to the global economy and called for the ceiling to be raised "immediately”.
And the fact is that, even if there is some kind of resolution, the spending cuts required to get Republicans to an agreement may cost as many as 570k jobs (as reported by Bloomberg) and will likely of themselves push the country over the edge by crashing growth and sending the economy reeling into austerity at precisely the wrong time when it is on the brink of a potentially significant recession.
But the damaging fallout from all this nonsense has already started anyhow. DBRS Morningstar last week placed the AAA sovereign credit rating (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) on the United States “under review with negative implications.” Fitch Ratings said that it may downgrade its US sovereign credit rating by placing it on what it calls a Rating Watch Negative reflecting the worsening partisan shit-show (my word, not theirs) that’s preventing a deal.
It’s about managing fear and jitters as much as anything else - the stock market even briefly reacted negatively to a report last week that Federal Reserve Chair Jerome Powell might have been spotted near the Capitol building. The yield on the one-month US Treasury bill, which straddles the X-date and is currently acting as a “fear gauge” for default risk, is now at a record high of above 6% (see US TREASURY INTEREST RATE YIELD CURVE below).
The market-generated probability that the Fed has now ended its campaign of rate hikes next month crashed from a near-certainty (83%) of a pause just a week ago to not even very likely by Friday (29%). And conviction that interest rates will be lower at the end of the year than they are now has collapsed from a literal 100% certainty just two weeks ago to only 40% by Friday (see FEDWATCH INTEREST RATE PREDICTION TOOL below).
Sentiment rapidly reversed after the St. Louis Federal Reserve President James Bullard said on Monday that he’s thinking there’ll be two more interest rate increases this year. As he loves to do from time to time, Minneapolis Fed President Neel Kashkari threw even more fuel onto the fire when he said that even if the US central bank were to pause next month, it should simultaneously signal that the hiking process is not over. In other words, no hike in June absolutely does not mean no hike in July.
Also playing into the higher rather than lower interest rate narrative is the latest Personal Consumption Expenditures (PCE) inflation report released on Friday. The Fed’s preferred inflation measure rose 0.4% over the last month and is up 4.4% vs. a year ago, still more than double the Fed’s target rate.
Earnings from Lowe’s (LOW) echoed and reinforced concerns expressed recently by other major retailers, including Home Depot (HD), about the health of the American consumer. This did not help sentiment early in the week in a market already pre-disposed to heading lower in response to the shenanigans in DC.
On the other hand, blockbuster AI chip-driven earnings from Nvidia (NVDA) and Marvell Technology (MRVL) single-handedly salvaged some of the more ‘risk-on’ corners of the market on Thursday and Friday, at the end of what was otherwise a pretty dismal week for stocks all round. Unlike NFTs (remember them?) and some other types of crypto-adjacent rubbish, AI does appear to be a gold rush that may possibly be real and functional, rather than just some hollow hypes being bigged up by a few money-grubbing bros.
I am frequently asked why stocks are mostly holding up in the face of headwinds like an apparently imminent recession, big earnings declines and debt default? Well, the fact is that these bad things haven’t happened yet and that has caused stocks to lift and for the rally to be fueled by under-invested investment professionals who have been worried about all these things having to chase returns higher. Remember that everything in financial markets is relative to expectations and in 2023 the expectation has generally been, thanks to the historic rate hikes of 2022 and persistent inversion of the yield curve for the best part of a year now, that there will be a significant and potentially damaging recession any minute now.
However, it’s important to remember that “not yet as bad as feared” is still not “good”. Slowing economic growth and falling earnings are still not a positive, even if they are diminishing at a slower pace than many worried they would, and - as I have said before - this leaves the stock market very vulnerable to any downside surprises or disappointments that may emerge going forward.
What we need are actual positive resolutions from the issues that overhang the markets, i.e., a clear soft landing, earnings stability (which keeps valuations reasonable), a sensible debt ceiling deal very soon and confirmation from the Federal Reserve that rate cuts are coming sooner rather than later (the long sought-after pivot). Give us all those and then maybe we can start thinking about a real and sustainable market turnaround.
Absent that, short and medium term caution is still warranted.
OTHER NEWS ..
Feeling poorer .. 35% of Americans said their financial situation was now worse than it was a year ago, according to the annual Fed survey of American households that assesses their economic well-being. This is the largest share on record since the Fed began asking the question almost a decade ago.
The least-educated consumers were the most likely group to say they were worse off: 40% reported as much in 2022, up from 33% in 2021 and just 18% in 2019. But there was also a historic jump in higher-educated respondents who said the same; 31% reported being financially worse off, a huge surge from just 13% in 2021.
Last year saw an important shift in the pandemic-era economy, with the expiry of stimulus checks, expanded unemployment benefits and more. Also Investment portfolios shrank as stock and bond markets simultaneously declined in 2022, something that hardly ever happens.
It seems, however, that soaring costs are the biggest factor at play here. Inflation was the top financial challenge cited among people of all income levels in 2022, which suggests "a widespread effect of higher prices across the population," as the Fed writes in the report.
Reality hits home at FRB .. First Republic Bank (FRB) made its name catering to wealthy clients across California and New York, reeling in many of them with unusually sweet mortgages. The system made its employees rich. The San Francisco-based bank, which regulators seized and sold to JPMorgan Chase (JPM) early this month, is said to have been paying dozens of employees annual salaries of more than $10 million apiece before its collapse. One of them was even making more than JPM CEO Jamie Dimon. But those days are over it seems: the bank’s new boss last week informed a thousand FRB employees that they are now out of a job.
UNDER THE HOOD ..
The two headline indexes, the S&P 500 and the NASDAQ, are handily higher so far in 2023. Yet the average stock is down for the year so far. The Dow Jones Industrial Average is down for the year so far. Eight of the eleven sectors are down for the year so far. Why is that? Because this market is very narrow and getting even narrower. And that is generally not healthy.
We saw a great example of this on Thursday when just two stocks, Nvidia (NVDA) and Microsoft (MSFT), were responsible for over 80% of the robust gain of the entire S&P 500 index that day.
As a senior Wall Street analyst said last week; “This is what bear markets do. They’re designed to fool you, confuse you, make you do things you don’t want to do, chase things at the wrong time”.
The S&P 500 is in a pattern of higher highs and lower lows so far in the month of May. That dynamic is historically consistent with investor indecision and low conviction increasing the technical likelihood of an imminent sharp pullback.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
US stock and bond markets will be closed on Monday for Memorial Day. Tuesday kicks off a week of some remaining Q1 2023 earnings reports and important job-market data.
Earnings highlights will include results from Hewlett Packard, Dell, Salesforce, Broadcom, Dollar General, Advance Auto Parts, Lululemon and Chewy.
On Wednesday, we will see the results of the latest Job Openings and Labor Turnover Survey (JOLTS). Expectations are for a slight decline to 9.44 million job openings.
The big one, however, is the Jobs Report on Friday before the market opens. It is expected to report a gain of 200k payrolls in May, after a 253k increase in April. The unemployment rate is expected to tick back up to 3.5%.
Other economic data to watch next week includes the Consumer Confidence index and the Manufacturing Purchasing Managers’ index.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.57%
(one week ago: 6.39%, one month ago: 6.43%, one year ago: 5.10%)
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: 27% (23% a week ago)
↔ Neutral: 33% (37% a week ago)
↓Bearish: 40% (40% a week ago)
Net Bull-Bear spread: ↓Bearish by 13 (Bearish by 17 a week ago)
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.
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 (6.02%) being paid currently for the 1-month duration and the lowest rate (3.80%) 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 sharply from 0.58% to 0.74%, indicating an overall steepening of the inversion of the curve during the last five days.
The curve has been inverted since July 2022 based on the 2 year vs. 10 year spread. 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.
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?
↑ Higher than now .. 21% probability
(one week ago: 1%, one month ago: 0%)
↔ Unchanged from now .. 39% probability
(one week ago: 8%, one month ago: 0%)
↓ Lower than now .. 40% probability
(one week ago: 91%, one month ago: 100%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on June 14th after its next meeting?
↑ 0.25% increase .. 71% probability
(one week ago: 17%, one month ago: 14%)
↔ No change .. 29% probability
(one week ago: 83%, one month ago: 64%)
↓ 0.25% cut .. 0% probability
(one week ago: 0%, one month ago: 22%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Technology (two biggest holdings: Apple, Microsoft) for the second week in a row - up 4.7% for the week.
- Last week’s worst performing US sector: Consumer Defensive (two biggest holdings: Proctor and Gamble, Pepsico) - down 3.2% for the week.
- The proprietary Lowry's measure for US Market Buying Power is currently at 138 and rose by 2 points last week and that of US Market Selling Pressure is now at 159 and fell by 2 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 with a RSI of 60**. SPY ended the week 12.1% 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 with a technically over-bought RSI of 74**. QQQ ended the week 13.8% below its all-time high (11/19/2021).
** RSI (Relative Strength Index) above 70: technically over-bought, RSI below 30: technically over-sold
- 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 1.1 points higher at 17.9. It remains below its 50-day and 90-day moving averages and below its long term trend line.
ARTICLE OF THE WEEK ..
There are times in nature when 2 + 2 = 10. When two little things combine to form one huge thing. This same thing can often happen with personality traits which affect how you approach investing - and not always with good results. Are you any of these?
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).
A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity. Sovereign credit ratings can give investors insights into the level of risk associated with investing in the debt of a particular country, including any political risk.
At the request of the country, a credit rating agency will evaluate its economic and political environment to assign it a rating. Obtaining a good sovereign credit rating is usually essential for developing countries that want access to funding in international bond markets.
In addition to issuing bonds in external debt markets, another common motivation for countries to obtain a sovereign credit rating is to attract foreign direct investment (FDI). Many countries seek ratings from the largest and most prominent credit rating agencies to encourage investor confidence. Standard & Poor's, Moody's, and Fitch Ratings are the three most influential agencies.
Other well-known credit rating agencies include China Chengxin International Credit Rating Company, Dagong Global Credit Rating, DBRS, and Japan Credit Rating Agency (JCR). Subdivisions of countries sometimes issue their own sovereign bonds, which also require ratings. However, many agencies exclude smaller areas, such as a country's regions, provinces, or municipalities.
Investors use sovereign credit ratings as a way to assess the riskiness of a particular country's bonds.
Sovereign credit risk, which is reflected in sovereign credit ratings, represents the likelihood that a government might be unable—or unwilling—to meet its debt obligations in the future. Several key factors come into play in deciding how risky it might be to invest in a particular country or region. They include its debt service ratio, growth in its domestic money supply, its import ratio, and the variance of its export revenue.
Many countries faced growing sovereign credit risk after the 2008 financial crisis, stirring global discussions about having to bail out entire nations. At the same time, some countries accused the credit rating agencies of being too quick to downgrade their debt. The agencies were also criticized for following an "issuer pays" model, in which nations pay the agencies to rate them. These potential conflicts of interest would not occur if investors paid for the ratings.
Examples of Sovereign Credit Ratings:
Standard & Poor's gives a BBB- or higher rating to countries it considers investment grade, and grades of BB+ or lower are deemed to be speculative or "junk" grade. S&P gave Argentina a CCC- grade in 2019, while Chile maintained an A+ rating. Fitch has a similar system.
Moody’s considers a Baa3 or higher rating to be of investment grade, and a rating of Ba1 and below is speculative. Greece received a B1 rating from Moody's in 2019, while Italy had a rating of Baa3. In addition to their letter-grade ratings, all three of these agencies also provide a one-word assessment of each country's current economic outlook: positive, negative, or stable.
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