Those of us hoping for a clearer picture to emerge from the release of the January’s Consumer Price Index (CPI) measure of retail inflation and other subsequent data were left sorely disappointed last week. If anything, things just became more confused.
Stocks drifted nicely higher on Monday as traders laid their bets ahead of the high-stakes inflation reports that would start arriving the following morning.
When CPI came out pre-market on Tuesday, it showed that consumer prices rose at a more rapid monthly pace in January, interrupting a months-long streak of cooler month-to-month readings. Prices rose 0.5% last month, as what we paid for shelter, food, energy and apparel in particular accelerated at a more rapid pace. In the twelve months through January 2023, inflation was 6.4%, compared to 6.5% in December and above the expectation of 6.2%. Core CPI, which excludes the food and fuel prices, rose by 0.4% in January, unchanged from December’s pace for a slightly lower annualized rate of 5.6%.
Then on Thursday, we learned that the Producer Price Index (PPI) measure of wholesale inflation felt by manufacturers for January rose 0.7%, more than the expected 0.4% and is up 6% year-over-year, down from the 6.5% rate in December. Excluding food, energy, and trade services, the year-on-year Core PPI was up 4.5%, easing slightly from the month before.
On the surface, the reports looked to be saying that inflation was running mildly hotter. But looking deeper, you can see that a highly disproportionate portion of the retail price gains were attributable to housing. This was initially interpreted as a positive thing, since pricing there tends to react slower than other parts of the economy, meaning already-existing recent rate hikes may have yet to be felt and might not need to be added to. On the wholesale side, the Core PPI number still looks somewhat promising, although it wasn’t quite as warm and fuzzy as it was perhaps expected to be.
Simply put, these numbers tell us that inflation is still declining, but that the pace of that decline is slowing.
In a sign that US consumers are still willing to spend like crazy even as prices and interest rates rise, the Commerce Department's report showed that Retail Sales surprisingly surged 3.0% in January, way above the estimates of a 1.8% increase and almost 3x the rate of increase seen in the normally buoyant month of December.
Paired with the (also quite stunning) recent January jobs report from the Friday before, the retail sales number gave yet another indication that the US economy is proving to be massively more resilient to inflation and interest rate increases than anyone ever expected, which on one hand is great for stocks but on the other hand gives the Fed the green light to just keep on lifting and holding rates until it inflicts some real damage.
Federal Reserve Bank of Cleveland president Loretta Mester and St. Louis president Jim Bullard both raised eyebrows on Thursday, each separately expressing the opinion that there had been a strong case for a 0.50% hike at the last Fed meeting, rather than the 0.25% that the committee actually went for (neither Mester nor Bullard are voting members of the rate-setting committee any more) and introducing the possibility of a full 0.50% bump in the upcoming March meeting (see my new feature; FEDWATCH TOOL, below). They also both strongly pushed back on the idea of any interest rate cuts this year.
Creaking under the weight of all this mixed economic data and hawkish Fed-speak, the stock market took a day or so to digest it all and then finally decided that it didn’t really like what it saw and headed lower, led by the energy sector which had a bad week.
The interest rate market, however, was much quicker to sour on the data and futures market wagers on where interest rates will be at the end of the year are finally starting to mirror the Fed’s most recent forecasts of above 5%. Just a month ago, this probability was priced at just 2% by the futures market. By the end of last week, it was up to 69% and fast becoming consensus (see my new feature; FEDWATCH TOOL, below). The rebellious teenager from my report of a couple of weeks back is grudgingly starting to listen to the parent.
There was a clear narrative coming into 2023: The Federal Reserve had spent months pushing interest rates rapidly higher at a historic pace in a bid to tame inflation and those moves would slow growth and the labor market so much that the economy would be at risk of plunging into a nasty recession.
The worries about inflation aren't going away. But the growl of a recession is becoming increasingly distant, despite what is being loudly shouted by eight months now of an inverted yield curve, where short term interest rates are higher than long term ones, which is traditionally a strong sign of imminent recession.
Employers added more than half a million jobs in January, the housing market is starting to show some signs of stabilizing or even picking back up, Americans are still spending money like water and many Wall Street economists and analysts have marked down the odds of a harmful recession this year.
After months of asking whether or not the Fed could pull off a “soft landing” (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) in which the economy slows but does not plummet, the trendy new narrative is that there may not be any landing at all, soft or hard, for a few months — that growth will simply hold up until it finally decides to either accelerate or fall off a cliff.
Growth is the critical factor here that is currently propping up the stock market. It needs to stay strong because if stocks have to confront slowing growth alongside interest rates where they are, then risk asset prices will drop, likely very sharply.
OTHER NEWS ..
The strange math of stocks .. If you had bought shares of the troubled online used car retailer Carvana at the start of this year, you’d be up 170% by now. If you had bought them a year ago, even after that 2023 spike, you’d still be down by over 91%.
Trillions .. Americans assumed a record amount of debt at the end of 2022. The Federal Reserve Bank of New York’s quarterly report on household debt and credit found that in Q4 2022, overall household debt in the US rose by almost $400 billion or 2.4% to $17 trillion (that’s $17,000,000,000,000).
Credit card debt jumped over $60 billion to an all-time high of almost $1 trillion. Mortgage balances grew by a quarter of a trillion dollars to $12 trillion, up almost $1 trillion from 2021. Debt on auto and student loans also increased, lifting total non-housing balances by $126 billion.
The bank noted that the share of current debt becoming delinquent rose again for almost all types of borrowing. That came after two years of historically low delinquencies.
The reason for these increased delinquencies is said to be inflation combined with the Fed’s effort to get it under control. While low unemployment has kept consumer finances generally strong, stubbornly high prices and climbing interest rates are now testing some borrowers’ ability to repay their debts. The Fed added that the data show particular signs of stress among younger borrowers who are starting to miss some credit card and auto loan payments at a much higher rate.
Another bro icon charged with fraud .. Tearful crypto bros will have to take down yet another poster of one of their heroes from their bedroom walls. After having to terminate their man-crush on FTX’s disgraced Sam Bankman Fried, they now have to resign themselves to the realization of what everyone else kinda figured out last year, that Do Kwon was also a lying fraud. The founder of collapsed cryptocurrencies TerraUSD and Luna and his company bilked investors who purchased billions of dollars’ worth of the digital assets, the Securities and Exchange Commission (SEC) said.
The SEC filed a civil fraud lawsuit against Do Kwon and Singapore-based Terraform Labs in Manhattan federal court, accusing them of deliberately misrepresenting the risk of TerraUSD and knowingly misleading clients, particularly about how Luna was used in South Korea.
UNDER THE HOOD ..
The market has been trading very methodically with the major indexes, notably the S&P 500, tending to gravitate towards and bounce off very round number price levels that comprise many of the options and other derivatives contracts. Case in point, the S&P began the year with a test of almost exactly 3,800 before rallying to 4,000 in early January only to fall back to 3,900 in the middle of the month. From there, the index powered on to push right up to 4,200 before retreating back to bounce around either side of 4,100.
The reason this is noteworthy is that this type of price action is more evident of fast money in-and-out trading, algorithms and execution by options and derivatives traders as opposed to systematic, large-scale organic buying by long-term institutional investors, which is what the market really needs to execute a legit turnaround.
Instead, the primary beneficiaries of the most recent rally have been the beaten-down technology, consumer cyclical, and communication cervices sectors, along with other speculative securities. This suggests that the engine of the most recent leg of the advance, which has got so many investors so excited, could just be a mean-reversion focused on the battered growth stocks (see the Carvana example in OTHER NEWS, above).
Interestingly, Mid Cap stocks continues to show technical outperformance relative to both Large Cap and Small Cap.
From a technical standpoint, none of this really screams lift-off.
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 for Presidents’ Day on Monday. After that, investors can look forward to quite a busy slate of earnings and some fresh economic data.
Home Depot, Walmart, Alibaba, Moderna, eBay, Block, Warner Bros, Newmont, Intuit, TJX, Keurig Dr. Pepper, Booking Holdings, Autodesk, Lucid and Palo Alto Networks are set to headline earnings reports this week.
On Wednesday, the Federal Open Market Committee will release the minutes from its early February meeting which could make interesting reading after some comments by Fed insiders last week.
The second estimate of Q4 2022 Gross Domestic Product (GDP) comes out on Thursday. Forecasts are that GDP increased at an annual rate of 2.5%.
The National Association of Realtors will report existing home sales for January. Expectations are for 4.1 million homes sold.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
↑Bullish: 34% (37% the previous week)
→Neutral: 37% (38% the previous week)
↓Bearish: 29% (25% the previous week)
Net Bull-Bear spread .. ↑Bullish by 5 (Bullish by 12 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% at year-end?
At/above: 69% — Below: 31%
(one week earlier: 45% — 55%, one month earlier: 2% — 98%)
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 earlier: 0%, one month earlier: 19%)
85% probability of a 0.25% increase
(one week earlier: 91%, one month earlier: 77%)
15% probability of a 0.50% increase
(one week earlier: 9%, one month earlier: 4%)
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Consumer Cyclical (two biggest holdings: Amazon, Tesla) - up 1.6% for the week
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon-Mobil, Chevron) - down 6.3% for the week
- The NASDAQ-100 did slightly better than the S&P 500
- Foreign Developed markets surpassed US Markets and Emerging Markets
- Small Caps and Mid Caps handily beat Large Cap
- Value stocks just about outperformed Growth stocks
- The proprietary Lowry's measure for US Market Buying Power is currently at 166 and fell by 4 points last week and that of US Market Selling Pressure is now at 128 and rose by 2 points over the course of the week.
- SPY, the S&P 500 ETF, remains above both its 50-day and 90-day moving averages and its long term trend line. SPY ended the week 11.8% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above both its 50-day and 90-day moving averages and its long term trend line. QQQ ended the week 18.9% below its all-time high (11/19/2021).
The Lowry’s Percent of Stocks Above Their 30-Day Moving Average reading last week fell very slightly from 58% to 57%.This important 0-100% reading measures overall positive stock participation. Higher readings indicate increasing positive market momentum, lower readings indicate increasing downside momentum. Extreme readings below 20% and above 80% could potentially point to imminent short term trend reversals.
- 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 20.0. It remains below its 50-day and 90-day moving averages and still below its long term trend line.
ARTICLE OF THE WEEK ..
What do the wealthy do with their money? Probably not what you think. Nick Maggiulli dives in.
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 soft landing, in economics, is a cyclical slowdown in economic growth that avoids recession. A soft landing is the goal of a central bank when it seeks to raise interest rates just enough to stop an economy from overheating and experiencing high inflation, without causing a severe downturn. Soft landing may also refer to a gradual, relatively painless slowdown in a particular industry or economic sector.
While airline passengers can take soft landings for granted these days, the Federal Reserve's past interest-rate hiking cycles don't have the same track record of regular success.
The term "soft landing" gained currency during the tenure of former Federal Reserve chair Alan Greenspan, widely credited with engineering one in 1994-1995. Federal Reserve Chair Jerome Powell has also suggested the Fed achieved soft landings in 1965 and 1984 and was on course for another one in 2020 before the COVID-19 pandemic intervened.
In contrast, a recession followed the last five instances when inflation peaked above 5%, in 1970, 1974, 1980, 1990, and 2008. Inflation has gone above 5% in 2022, and given the definition of a recession (two consecutive quarters of negative GDP growth), which occurred after Q1 and Q2 of 2022, the economy was in a recession; however, Q3 saw GDP growth.
To combat this inflation, the Fed implemented interest rate increases over the year, which resulted in a decrease in inflation combined with economic growth in Q3 2022.
The Fed's soft landings record is, at best, mixed because the central bank doesn't exercise nearly the same control over the course of the economy as a pilot has over aircraft. The Fed's main policy tools—interest rates and asset holdings—are blunt instruments not designed to solve supply chain disruptions or pandemics.
In dismissing another vehicular analogy, former Fed chair Ben Bernanke once said that "if making monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield, and a tendency to respond unpredictably and with a delay to the accelerator or the brake." Nothing that's happened since has made the Fed's job look any easier.
Soft landing vs. a hard landing .. A country's central bank adjusts interest rates to manage the economy. If inflation is too high, a central bank will increase interest rates with the goal of slowing down spending. If the central bank raises interest rates too high or too soon, that would be a hard landing. If the central bank raises interests slowly or by a small amount, that is a soft landing. There is a fine line between the two and how the raising of interest rates will impact the economy. A central bank would not want a hard landing as it could have serious negative repercussions.
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