Weekly Market Commentary

It’s a three-ring circus!

For centuries people have embraced the circus. Enjoying the sticky fluff of cotton candy while elephants, clowns and trapeze artists perform in the spotlights. Merriam Webster Dictionary defines the experience as wild, confusing, engrossing and entertaining.

Some aspects of that description apply to recent financial market activity. Last week, we saw:

Investors aren’t happy, but stocks are up.

If you ever participated in a fantasy football league, you may have experienced a run on a position during your draft. One person picks a kicker or defense mid-round and, suddenly, almost everyone rushes to follow suit. A similar occurrence may be happening in the United States stock market.

While major U.S. stock indices are in positive territory year-to-date, market gains have been concentrated in just a few companies’ stocks. Al Root of Barron’s explained:

Brace yourself! The debt ceiling standoff continues.

Consumers aren’t optimistic. The Consumer Sentiment Index fell to a six-month low in May, dropping 9.1 percent month-to-month. Participants in the University of Michigan survey were:

• Less concerned about current economic conditions (down 5.4 percent, month-to-month), and
• More concerned about future economic conditions (down 11.7 percent, month-to-month).

They were wary about the outcome of debt ceiling discussions, concerned that policymakers will cause the United States to default on its debt, and apprehensive about how that could impact the economy, according to Director of Surveys Joanne Hsu.

The labor market just keeps growing…and growing…

Last week, the April employment report for the United States arrived. It showed that unemployment dropped to the lowest level in more than 50 years – 3.4 percent. Other highlights included:

• The creation of 253,000 jobs in April. That was well above consensus estimates, according to Catarina Saraiva and Steve Matthews of Bloomberg.
• The highest workforce participation rate since 2008. This is the percentage of Americans who are either working or looking for a job, reported Megan Cassella of Barron’s.
• The lowest unemployment rate for black workers ever. By race, the April unemployment rate was 2.8 percent for Asian Americans, 3.1 percent for white Americans, 4.4 percent for Hispanic Americans, and 4.7 percent for Black Americans.
• Average hourly earnings rose 4.4 percent year-over-year. Wage growth may be one reason inflation remains higher than the Federal Reserve would prefer, according to a source cited by Bloomberg.

Get real!

Despite more than a year of aggressive Federal Reserve rate increases, the United States economy is still growing, albeit more slowly. U.S. gross domestic product (GDP) – the value of all goods and services produced in the U.S. economy – grew by 5.1 percent over the first quarter.

You may have read or heard that real GDP increased by 1.1 percent over the first quarter. That is also true. In economics, “real” means the value of something after inflation (inflation is the rate at which prices are increasing). For example:

Better than expected.

 It’s earnings season – the time when publicly traded companies report on how profitable they were during the first quarter of 2023. So far, reports suggest that companies listed on United States stock exchanges did better than many had anticipated. Almost 20 percent of companies in the Standard & Poor’s 500 Index have reported and three-out-of-four have exceeded earnings expectations, reported John Butters of FactSet.

“At any given moment, earnings expectations reflect everything that’s happening in the world, from the economy and the Federal Reserve to interest rates and geopolitics. Right now, most of the fear stems from expectations about the economy. The Fed has lifted interest rates to tamp down inflation by reducing economic demand, and so far, that seems to be working. The rate of inflation has been cut almost in half from its post-COVID peak, but growth is slowing with it...And since higher rates operate with a lag, the full effects of the rate hikes probably haven’t been felt yet, raising the possibility of a recession,” reported Jacob Sonenshine of Barron’s.

Keep your eye on the big picture.

Last week, there was nothing too surprising in economic and financial news.

Inflation eased, as expected, although it remained above the Federal Reserve (Fed)’s target rate. The Treasury yield curve remained inverted with three-month Treasury bills yielding more than 10-year Treasury notes, as they have been since November 2022. Also, we may be nearing an end to rate hikes around the world. Bloomberg News reported:

“With the first signs of dents in economic growth now visible, and fallout from financial-market tensions lingering, any pause by the Federal Reserve after at least one more increase in May could cement a turn in what has been the most aggressive global tightening cycle in decades.”

Ambiguous images.

Some illustrations are optical illusions. When two people view the picture, they may see completely different images. A good example is Rubin’s Vase. One viewer may see a vase, while another sees two faces.

Current economic conditions can be interpreted in different ways, too. Recent economic data and a possible credit crunch, resulting from upheaval in the banking sector, suggest growth is slowing. After viewing the data, some say we’re heading for a soft landing, and others say a recession is coming. Here is the recent data:

Perhaps we should call this a pushmi-pullyu market.

The first quarter of 2023 brought Dr. Dolittle’s pushmi-pullyu – the rarest animal of all – to mind. It is the offspring of goat-antelopes and unicorns, and has a head at each end of its body. The pushmi-pullyu’s unusual anatomy allows it to easily and rapidly change direction, making it difficult to catch.

So far this year, the direction of the economy and financial markets has been elusive, too.

What’s your jam?

When you think of fun, are you running an Arctic marathon? Biking to your favorite burger place? Gaming with friends online? Each has inherent risk: Polar bears and hypothermia, traffic and flat tires, and viruses and identity theft. Those who enjoy these activities, understand the possible risks and manage them.  

Investing is similar. Investors are willing to take on risk to achieve their long-term financial goals, but not everyone manages it in the same way. Some people are willing to embrace risk, and others prefer a less adventurous option. While it’s not possible to completely eliminate the risks associated with investing, it is possible to manage investment risk with asset allocation, diversification, and other strategies.

Unknowns and uncertainty.

Financial markets were volatile last week as investors parsed the risks around bank closures, central banks offered additional protections for depositors, and regulators took a harder look at bank balance sheets.

“For much of last year, volatility was elevated, but the risks were somewhat ‘known’ (chiefly inflation and recession)…Now, the introduction of the banking crisis has created a new unknown, which could ultimately mean a sharper increase in volatility (if worse than expected) or a quick reprieve (if fears prove unfounded),” opined a source cited by Nicholas Jasinski of Barron’s.

Thrown for a loop.

Early last week, Federal Reserve Chair Jerome Powell told Congress the Fed is committed to bringing inflation down to 2 percent. If economic data continues to come in hot, he said, then it’s likely the Fed will raise rates higher than expected and keep them higher for longer.

Economist Lawrence Summers estimates there is 50 percent chance that the Federal funds rate will be 6 percent or higher before the Fed will reach its inflation target, reported Chris Anstey of Bloomberg. Currently, the effective Fed funds rate is 4.57 percent.

A similar statement made by another Fed official the previous week caused United States Treasury yields to rise in anticipation of rate increases and had little effect on the stock market. After Powell’s comments last week, the stock market headed lower.

Sibling discord.

Stocks and bonds are two of the better-known asset classes in the family of potential investments. Last week, they were in opposition.

Bond yields have been moving higher in anticipation of the Federal Reserve raising rates again. For a while last week, every maturity of Treasury – from the 1-month Treasury bill to the 30-year Treasury bond – boasted a yield above 4 percent. Some shorter-maturity Treasuries yielded more than 5 percent.

When bond rates move higher, borrowing becomes more expensive for companies. As the cost of doing business rises, the outlook for company earnings tends to moderate, pushing stock prices lower. (Companies in the financial industry are often an exception because financial companies often benefit from higher rates.)

Is it good news or bad news?

The answer depends on your perspective. Last week, we learned that:

Consumer sentiment is at its highest level in more than a year. Consumers are feeling better about current economic conditions and the future. That said, the University of Michigan Index of Consumer Sentiment remains 20 points below its long-term average. Consumer expectations for inflation over the next year increased from 3.9 percent to 4.1 percent and, over the longer term, consumers anticipate inflation will average about 2.9 percent.

Brace for a bumpy ride.

There were some unwelcome surprises in last week’s economic data that caused markets to reassess expectations for 2023. For example:

Inflation didn’t fall as fast as expected. Last week, the Consumer Price Index showed inflation rose 6.4 percent, year-over-year, in January. That was an improvement over December’s pace and the seventh consecutive month of falling prices, but economists expected price increases to slow more quickly, reported Megan Cassella of Barron’s.

“Look into the details, and it is easy to see that the inflation problem is not fixed. America’s ‘core’ prices, which exclude volatile food and energy, grew at an annualized pace of 4.6% over the past three months, and have started gently accelerating. The main source of inflation is now the services sector, which is more exposed to labor costs…It is hard to see how underlying inflation can dissipate while labor markets stay so tight,” reported The Economist.

This time may be different...or it may not be.

There has been a lot of speculation about how the Federal Reserve’s policies will affect the United States economy. Economists have differing opinions about whether the country is headed for:

• A recession, which occurs when the economy stops growing and begins to contract; or
• A soft landing, which occurs when economic growth slows but does not decline.

It’s an important question because recessions often are accompanied by layoffs, rising unemployment rates, dwindling investor confidence, lower consumer spending, and stock market downturns.

Recently, a new theory bubbled up.

What do Samuel Clemens (a.k.a. Mark Twain) and the current economic expansion have in common?

Author and humorist Twain was prematurely reported to be dead. It first happened in 1897. Twain was on a speaking tour in London when rumors that he had fallen ill and died began to circulate. Then, about a decade later, The New York Times reported that a yacht Twain was on had sunk.  

Ben Welter of the StarTribune wrote that Twain responded to the latter story by saying, “I sincerely hope that the report is not true and I suggest that all my friends suspend judgment until such time as I can ascertain the true state of affairs.”

The vicious cycle of inflation.

Last week, we learned that pay increases at central banks in many parts of the world won’t keep pace with inflation. As a result, their employees may not be able to maintain the standards of living they had before inflation began rising. For example, at the United States Federal Reserve (Fed) the maximum pay increase was 5.1 percent for 2022. That’s significantly below inflation which averaged 8 percent last year, reported Jana Randow and Enda Curran of Bloomberg.

It’s a similar story elsewhere in the world. Inflation in the Eurozone averaged 10.6 percent in 2022, yet the average salary increase at the European Central Bank (ECB) and Bank of France was 4.0 percent. Germany’s Bundesbank offered a 1.8 percent raise. In the United Kingdom, where inflation was 9.1 percent on average last year the Bank of England offered a 4.5 percent annual pay increase.

“It’s hard to be a contrarian for very long these days because the consensus seems to change so quickly,” opined Ed Yardeni via LinkedIn last week.

We’ve certainly seen a shift in investors’ preferences during the first few weeks of this year. Despite widespread expectations that markets would move lower early in 2023, major U.S. stock indices have trended higher. Year-to-date through January 20, 2023:

•  The Standard & Poor’s 500 Index, which is comprised of 500 of the largest publicly traded companies in the United States, was up 3.5 percent.
• The Nasdaq Composite, which is comprised of stocks listed on the Nasdaq Stock Exchange and includes a significant number of technology stocks, was up 6.4 percent.
• The Dow Jones Industrial Average, which is comprised of 30 large U.S. stocks, was up 0.69 percent.

The year-to-date gains reflected stock investors’ optimism about where the economy may be headed, reported Nicholas Jasinski of Barron’s.

Bullish or bearish?

After last year’s geopolitical turmoil, economic malaise, and tumultuous stock market decline, many financial professionals – from investors to asset managers – have strong opinions about what will happen in 2023.

Some are bullish. While individual opinions are quite nuanced, in broad terms, bulls tend to think the Federal Reserve (Fed)’s rate hikes will slow soon since headline inflation has been trending lower. Some bulls anticipate an economic recession in the United States and expect the Fed to reverse course and begin lowering rates to pull the country out of recession. Lower rates, in turn, may reinvigorate the economy and corporate earnings, and the stock market will move higher. Some expect the market to move lower before it moves higher.

It’s being called the “Goldilocks” report.

Last Friday, we learned that demand for workers in the United States remained strong in 2022. The unemployment rate dropped to 3.5 percent in December. (It was 3.7 percent in November.) That brought U.S. unemployment back to where it was before the pandemic – at the lowest level in more than 50 years, reported Megan Cassella of Barron’s.

“Hopes the Federal Reserve can tame inflation without widespread job losses mounted Friday after a government report showed robust hiring and a historically low unemployment rate paired with a cooling in wage growth. In some respects, the December jobs report offered a best-case scenario for the Fed — Americans keep their jobs but inflationary pressures of earnings are easing — giving policymakers room to slow the pace of interest-rate hikes,” reported Reade Pickert of Bloomberg.

It’s finally over.

2022 was a dismal year for financial markets. Major United States stock indices moved lower, trimming or eliminating the previous year’s gains.

• The Standard & Poor’s 500 Index, which had gained about 27 percent in 2021, dropped almost 20 percent in 2022.
• The Nasdaq Composite Index, which had gained more than 21 percent in 2021, lost about 33 percent in 2022 
• The Dow Jones Industrial Average, which had gained about 19 percent in 2021, fell almost 9 percent in 2022. It’s performance reflected the improved performance of value stocks.

Bond markets didn’t fare much better. As rates moved higher, the value of previously issued bonds moved lower. The Bloomberg U.S. Aggregate Bond Index dropped about 13 percent during 2022. The silver lining is that bonds now offer more attractive yields, opening new opportunities for income investors.

What a year! 

In some ways, it feels as though we lived through several years in 2022. The onslaught of events included, “The first major European war since the 1990s, unprecedented sanctions, energy-price mayhem, bail-outs, global interest rates rising at their fastest pace in four decades, a faltering Chinese economy, an overheating American one, housing markets looking peaky across the rich world, [and] a crypto blow-up for the ages…,” reported Hamish Birrell in The Economist’s Money Talks newsletter.

The impact of these events was felt around the world. Global inflation averaged 10 percent, and global stock markets were down about 20 percent through November, reported The Economist. Yet, some countries showed remarkable economic resilience, performing far better than average. The Economist surveyed economic and financial data from 34 wealthy countries. The data included gross domestic product or GDP (which is the value of all goods and services produced in a nation), inflation, breadth of inflation, stock market performance and government debt.

Bad news is bad news, once again.

For months, investors have cheered bad economic news. When the United States economy showed signs of weakness, stock markets often reflected investor enthusiasm. The thinking was that bad economic news would persuade the Federal Reserve to slow the pace of rate hikes. Inflation would slide lower, and recession would be avoided 

Last week, there was a shift in attitude.

What comes next?

The U.S. stock market tends to be a forward-looking vehicle. Investors make decisions today based on what they think may be ahead for the economy, and how economic change may affect the companies they’re considering for investment. Currently, key questions include:

• Will inflation be lower in 2023?
• Will Federal Reserve (Fed) policies change? When will they change?
• Will economic growth remain strong next year? Or will it slow or contract?

What will it take to slow this economy down?

In 2001, railway workers slowed a runaway train in Ohio by latching a second engine to the back of the locomotive and applying the brakes. In all, the train traveled sixty-six miles over two hours, decelerating from a maximum speed of 47 miles per hour to 10 miles per hour before workers regained control of it, according to CNN.

Throughout 2022, the United States Federal Reserve has been trying to slow inflation by putting the brakes on the U.S. economy. So far, the Fed has raised rates six times, but the economy continues to grow apace. Last week, the Bureau of Economic Analysis reported the economy grew faster than originally thought from July through September 2022. Gross domestic product (GDP), which is the value of all goods and services produced by the U.S., was up 2.9 percent, annualized, rather than 2.6 percent as the advance estimate indicated.

There was a shift in the winds of monetary policy.

Last week, it became clear the Federal Reserve (Fed) had softened its hawkish stance. The minutes of the central bank’s November policy meeting indicated the Fed was likely to slow the pace of rate hikes soon. There was a caveat, though. The minutes noted:

“…with inflation showing little sign thus far of abating, and with supply and demand imbalances in the economy persisting…the ultimate level of the federal funds rate that would be necessary to achieve the Committee’s goals was somewhat higher than [Fed officials] had previously expected.”

In other words, rate hikes are likely to be smaller in the future, but the federal funds rate will probably move higher than previously expected. Last week, the CME FedWatch Tool suggested that the federal funds target range will:

Thanksgiving and football go together like turkey and stuffing.

For some families, though, this year may be more like a turducken, stuffed with American football and the sport the rest of the world knows as football (soccer). The men’s World Cup, which is played every four years for national glory, the Jules Rimet trophy, and millions of dollars in prize money, began on Sunday and will end on December 18 

During the tournament, researchers may track the influence of sentiment on markets. According to Mark Hulbert of MarketWatch, previous research has found that a team’s performance – especially a loss – can have a short but powerful effect on the national mood.

Last week was remarkable for many reasons.

One reason is that sky watchers around the world had an opportunity to see a total lunar eclipse. The moon, Earth and sun aligned, causing the moon to appear crimson. We won’t see another total lunar eclipse for three years, reported Denise Chow of NBC News.

Another reason, and one that’s far more important to consumers and investors, is that data suggested inflation may be waning. The Consumer Price Index, which is a measure of inflation, was released last week. It showed that prices rose more slowly than expected in October. On an annual basis:

It’s the lag time.

To no one’s surprise, the Federal Reserve continued to battle inflation last week, raising the federal funds rate for the fourth time this year, reported Claire Ballentine of Bloomberg. The Fed is making borrowing more expensive to dampen demand for goods, which should lower inflation – but it’s not a quick fix.

Rate hikes are kind of like winter planting. In cold weather areas, people sometimes spread grass seed in November with the expectation that it will germinate the next spring. It’s similar for rate hikes. The Fed lifts rates with the expectation that the increases will work their way through the economy over the next 12 to 18 months and bring inflation down, reported Matt Levin of MarketPlace.

Some companies are doing better than others – a lot better.

It’s earnings season; the time when companies share how well they performed during the previous quarter. Earnings reports are important because they provide information about a company’s financial health. Shareholders pay particular attention to earnings, which are company profits after expenses have been subtracted.

At the end of last week, slightly more than half of the companies in the Standard & Poor’s (S&P) 500 Index had reported results for the third quarter of 2022. The blended earnings growth rate^* for the S&P 500 was 4.1 percent, year-over-year, according to I/B/E/S data from Refinitiv.

Markets turned – again.

Markets continue to be volatile. Last week, stocks headed north. Nicholas Jasinski of Barron’s reported the change of direction reflected investors’ desire for the market to finally hit bottom. He may be right, but corporate earnings suggest we are not there yet, according to Bob Pisani of CNBC.

Corporate earnings season is underway. It’s the time when management tells shareholders how their companies performed during the previous quarter. With 20 percent of S&P 500 companies reporting actual results for the three-month period that ended September 30, the blended* earnings growth rate was 1.5 percent. That’s a slower pace of growth than we saw during the previous quarter, but earnings are still growing. The blended net profit margin was 12 percent, which is above the five-year average, reported John Butters of FactSet. 

We’re not there yet.

Investors are understandably eager for the stock market to hit bottom. Some hoped it happened last week, but it did not. 

Despite the Fed’s rate hikes, last week the Consumer Price Index showed the annual rate for headline inflation was 8.2 percent in September. That’s down from June when the annual inflation rate was 9.1%, but a long way from the Federal Reserve’s two percent target. The core inflation numbers, which exclude food and energy, hit at a 40-year high last month.

The news rocked the markets. “A lot of investors are looking at inflation to get guidance on what the Fed is going to do, to find the bottom in the market once the Fed pivots…But looking at CPI, unemployment, there’s obviously a lot of heat in the economy. Inflation is going to take some time to come down,” said a source cited by Stephen Kirkland and Lu Wang of Bloomberg.

Bah humbug!

Last week, OPEC+, which includes the Organization of the Petroleum Exporting Countries and allied oil producers like Russia, chose to cut production by two million barrels a day. The stated goal is to keep crude oil prices above $90 a barrel. The production cut, which will push gasoline and other prices higher, complicates efforts to fight inflation, reported Salma El Wardany and colleagues at Bloomberg.

According to economic data, the Federal Reserve’s inflation fight has produced mixed results, so far. Like the ghosts that visit Scrooge in A Christmas Carol, economic data offers information about what has happened in the past, what is occurring in the present, and what could happen in the future. Recently, the data has been sending mixed signals. Nicholas Jasinski of Barron’s explained:

The third quarter marked a change in attitude.

So far, 2022 has been a tough year for investing. We’ve experienced an unusual phenomenon – the simultaneous decline of stock and bond markets. Throughout the third quarter, investors’ concerns focused on global instability, rising prices and the possibility that central bank efforts to tame inflation would cause economic growth to falter. The result has been tremendous volatility in stock and bond markets.

Early in the third quarter, U.S. stock markets gained ground as investors latched onto the idea that inflation had peaked, and the Federal Reserve would soon moderate the pace of rate hikes. Following the release of July’s Consumer Price Index (CPI), Carleton English of Barron’s reported:In the United Kingdom, fiscal and monetary policies collided last week. Britain’s new government plans to encourage economic growth with a stimulus package to offset energy costs and big unfunded tax cuts. The government’s fiscal stimulus plan could spark at the same time Britain’s central bank is trying to tamp inflation down. Investors showed their disapproval by selling U.K. government bonds, which are known as gilts. As yields surged, gilts rapidly lost value, imperiling the nation’s pension funds. The Bank of England staged an emergency intervention, calming bond markets by promising to continue its bond purchases, reported Brian Swint of Barron’s.