Tag: Inflation

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Market In a Snap! September 22nd, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,320-2.93%12.52%
Nasdaq Composite13,211-3.62%26.23%
Russell 2,0001,776-3.76%1.34%
Crude Oil90.34-1.47%12.56%
US Treasury 10yr Yield4.43%  
Source: YCharts, Yahoo! Finance, WSJ

After a “Hawkish Pause,” What’s Next for the Fed?

The Federal Open Market Committee (the Fed), as widely expected, decided this week to maintain short-term borrowing costs between 5.25%-5.5%.   Despite its acquiescent pause, the Fed released its forecast for future rates which sent a message to markets that expectations for significant rate cuts in 2024 may be too optimistic.  Currently, the market expects the Fed to maintain the current level of rates before beginning rate cuts in mid-2024 (with three total 0.25% cuts priced in for full-year 2024). 

Throughout the year, we have expected core inflation to persist above the Federal Reserve’s 2% target for longer than what the current market expectations suggest…leading to pain for markets, especially in highly interest-rate sensitive asset classes such as technology stocks and long-term bonds.  Asset prices may be beginning to reflect in this “higher for longer” scenario.

As students of economic cycles, we acknowledge that the remedy for elevated inflation might materialize through a combination of decelerating economic growth and a less robust labor market. Despite the prevailing narrative in financial media advocating for a “soft landing,” we retain a sense of caution regarding the possibility of a recession on the horizon.

In our assessment, investors who are well-prepared stand not only to endure the challenging conditions but also to uncover more appealing risk-to-reward prospects amid this evolving landscape. 

 

What We’re Reading:

Axios: This economy runs on Girl Power

WSJ: August Home Sales Declined to Slowest Pace Since January

Bloomberg: McCarthy Cancels House Votes, Raising Risk of US Government Shutdown

Reuters: Yellen: No signs US economy in downturn, warns against gvt shutdown

Chart of the Week:

Forward-looking economic data continues to point towards slowing GDP growth in the coming quarters.

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Market In a Snap! August 18th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,369-2.11%13.81%
Nasdaq Composite13,290-2.59%26.98%
Russell 2,0001,859-3.84%5.92%
Crude Oil81.28-0.88%1.27%
US Treasury 10yr Yield4.25%  

Source: YCharts, Yahoo! Finance, WSJ

Stocks And Bonds Have Both Been Falling.  Is This a Repeat of 2022?

Investors will not soon forget 2022 – a Federal Reserve frantically tightening monetary policy to curb inflation led to pain for both the stock and bond markets, with a diversified portfolio of 60% stocks & 40% bonds suffering its worst calendar year loss since the great depression.  After a torrid start to 2023, stocks have cooled of late as stronger-than-expected economic data has sent bond yields higher and challenged the rosy hopes of a Federal Reserve that has reached the conclusion of its rate-hiking cycle.  Bonds, in turn, have also turned lower as the yield on the US 10-year treasury bond has risen to its highest level in 15 years.  While challenging in the short-term, we do not believe that bond investors should abandon bonds in favor of (now higher yielding) money market funds for a few key reasons:

  1. The Fed now has some “ammo”:  High quality bonds typically do well when economic growth slows.  This wasn’t the case in 2022 despite consecutive quarters of negative GDP growth because interest rates were too low and inflation was still accelerating.  Inflation has now moderated and the Fed has increased fed funds rates to 5.25-5.5%.  Slowing growth can now be helped by the Fed cutting rates, a net positive for bonds.
  2. Real interest rates are now positive: “real”, or inflation-adjusted interest rates have turned positive and have reached a level that has historically slowed economic growth and inflation.  Higher real rates may counteract the still-stimulative fiscal policy stance and reduce the risk of additional Fed hikes into 2024 and beyond.
  3. Bond math may now benefit investors: while “cash-like investments” i.e. money market funds offer investors a yield advantage over longer-term treasuries, the duration (or interest-rate sensitivity) of longer-term bonds offers investors the opportunity to see the price of their bonds go up and interest rates go down.

So, at a point where the market cycle is considered by many to be “late cycle”, high quality bonds appear to offer an opportunity for investors to diversify some of the stock risk that they hold in their portfolios.

 
What We’re Reading:

FT: Bond fund giant Pimco prepares for ‘harder landing’ for global economy

Marcus: What if Generative AI turned out to be a Dud?

WSJ: Mortgage Rates Hit 7.09%, Highest in More Than 20 Years

Chart of the Week:

Source Charles Schwab This chart published by Charles Schwab, shows the total return of short-term bonds vs intermediate-term bonds in the 12 months following the Fed’s last rate hike.  In each of the last seven instances, investors would have been rewarded by both coupon and price gains in their intermediate-term bond positions.   

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Market In a Snap! July 14th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,5052.42%17.37%
Nasdaq Composite14,1133.32%34.85%
Russell 2,0001,931.093.68%9.84%
Crude Oil75.272.62%-6.22%
US Treasury 10yr Yield3.82%  

Source: YCharts, Yahoo! Finance, WSJ

Stocks Celebrate Cooling Inflation!

As we discussed in our Podcast this week (click here to view recent PCM podcasts – most recent episode available soon), markets celebrated CPI and PPI inflation numbers this week showing signs of moderation.  Headline inflation moderated to 3% year-over-year, while core inflation came in at 4.83% (mostly reflecting lower energy prices since summer ’22).  Small-cap stocks performed better on the week than their large-cap counterparts, extending recent outperformance (small-caps +11.7% v. large-caps +8.5% since June 1st).   Markets will turn their eyes next to Q2 earnings reports.  While still early in the reporting season, blended earnings for the S&P 500 show a year-over-year decline of -7.1%.  If this holds, it will be the weakest quarter since Q2 2020 and the third consecutive negative quarter.  Analysts are, however, expecting a rebound in earnings into year-end and for 2023 earnings to be finish the year roughly equivalent to the number posted in 2022, and 2024 to post a 10% increase in earnings.  Somewhat incongruous with this estimate, however, is the continued expectation that the Federal Reserve will begin cutting interest rates in early 2024.  Absent a “hard landing” recession, policy makers may be content to leave rates at currently restrictive levels.  While the Fed is broadly expected to raise rates at its late-July meeting, it may yet surprise markets with a hawkish message that investors should prepare for “higher for longer.”    

 
What We’re Reading:JPMorgan Asset’s Michele Says Global Bond Rally Is Just StartingAxios: NASDAQ 100 Index to rebalance after Magnificant Seven grow to disproportionate share

Chart of the Week: 

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Market In a Snap! June 30th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,450.382.35%15.91%
Nasdaq Composite13,787.922.19%31.73%
Russell 2,0001,888.733.67%7.36%
Crude Oil70.450.86%-12.27%
US Treasury 10yr Yield3.81%  

Source: YCharts, Yahoo! Finance, WSJ

The First Half of the Year Is in the Books!

Halfway through 2023, little on Wall Street has gone according to plan.  Entering the year, many Wall Street banks were preparing for a rocky first half based on the expectation that the Fed monetary policy tightening would spill over to the economy and lead to recession.   While the Fed did indeed continue its path to higher rates, the stress in the banking system was enough to lead the Fed to pause (although, Fed Char Powell insists that the pause will be momentary and rate hikes will continue to be necessary).  Despite economic risks piling up, investors cheered the AI boom and resumed torrid buying of tech stocks.  As we turn the page to the 2nd half of the year, we pause to reflect on the following economic and market indicators which will drive asset class returns going forward:

  • Interest Rates & Inflation: The 2022 broad market sell-off was prompted by the reversal of ultra-low interest rates as policy markers combatted rampant inflation.  We have seen inflation moderate, yet Core PCE (the Fed’s preferred measure of inflation) remains above 4% and is showing few signs of a quick return to the 2% mandate.  Meanwhile, short-term interest rates are at their highest levels since 2007, the yield curve is more inverted than it has been since the 1980s, and the Fed is insistent that it will continue to tighten until inflation reaches 2%.
  • Earnings & Valuations:  S&P 500 corporate earnings fell in the first quarter and 2nd quarter expectations are expected to continue to show lower earnings as higher wages and interest rates reduce profit margins (from still very high levels); yet the rally in share prices has pushed the Price to Earnings ratio to 19.2x, almost a 10% increase since the beginning of the year.
  • Economic Growth: Forward-looking economic indicators, such as the ISM Manufacturing Purchasing Managers Index, credit conditions, the yield curve and initial employment claims point to slower economic growth.

With the year half-way through, the same Wall St banks which predicted a rocky first half and a buoyant second half of the year are raising their year-end expectations and painting a rosy picture of a ‘goldilocks’ scenario of a prolonged pause from the Fed, moderating inflation and tech stocks living up to their very optimistic expectations.  While market rallies can extend beyond “reasonable” levels, investors may be well-served by taking some profit and seeing how the growth/inflation picture plays out.

 

What We’re Reading:

Federal Reserve: Accumulated Savings During the Pandemic: An International Comparison with Historical Perspective

CNBC: Decision of when to retire has little to do with how much you’ve saved for retirement, report finds

McKinsey: The economic potential of generative AI: The next productivity frontier

The Economist: Americans love American stocks.  They should look overseas.

Chart of the Week:

    Source: CNN Fear/Greed Index

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Markets In a Snap! June 5th – June 9th, 2023

By: Dave Chenet, CFA, CAIA

  Close Weekly return YTD return
       
S&P 500 4,299.58 0.41% 11.95%
Nasdaq Composite 13,261.48 0.14% 26.62%
Russell 2,000 1,864.46 1.64% 6.10%
Crude Oil 70.22 -3.38% -12.4%
US Treasury 10yr Yield 3.73%    

Source: YCharts, Yahoo! Finance, WSJ

Market Recap: Can Small Cap Stocks Catch Up to Large Caps?

As widely reported in financial media, the year-to-date rally in stocks has been led almost exclusively by mega-cap stocks (those with a market capitalization of $200B+).  Through the end of May, mega-caps boasted 17% year-to-date outperformance vs their small-cap peers.  Small-caps, however, have shown some signs of life so far in June.  They have risen over 7% vs. the 2% gain in mega-caps.  Is this a blip or a sign of things to come?

We see the potential for small-cap stocks to outperform for two key reasons:

  1. Mega-caps have rallied on valuation, not earnings: Since the October 2022 recent market low, mega-caps are +26% vs small-caps of +14%.  The outperformance has been due to rising valuations –forward price/earnings ratios for mega-caps have improved from 20 at the lows to 30 today, while small-cap stocks are trading with forward price/earnings of 12.  Seemingly, small-caps are pricing in a more challenging economic environment while mega-caps have yet to recognize the rising risk of recession.
  2. Shifting bets on the path of monetary policy: For much of this year, investors have been betting on the Federal Reserve reversing course in the near future and beginning to decrease interest rates.  That narrative is beginning to shift as inflation has not fallen as quickly as markets had hoped and a higher interest rate/higher inflationary environment seems more likely.  Easy monetary policy has lifted tech-oriented mega-caps and depressed small-caps.  The recognition that the Fed may have to remain tighter for longer has helped small-caps begin to catch-up.

In summary, the recent outperformance of small-cap stocks compared to mega-cap stocks in early June may be indicative of a broader trend. Factors such as the reliance of mega-caps on valuation rather than earnings and the shifting expectations of monetary policy have created favorable conditions for small-caps to catch up. However, further monitoring and analysis are needed to determine whether this trend will persist or if it is merely a temporary fluctuation in the market.

What We’re Reading:

Federal Reserve Bank of San Francisco: The Rise and Fall of Pandemic Excess Savings

FPRI: China is Doubling Down on its Digital Currency

Chart of the Week:

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Market In a Snap! May 22nd-May 26th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,205.450.32%9.53%
Nasdaq Composite12,975.692.51%23.97%
Russell 2,0001,773.020%1.00%
Crude Oil72.773.13%-9.21%
US Treasury 10yr Yield3.81%  

Source: YCharts, Yahoo! Finance, WSJ

Market Recap: Have We Already Entered Recession and Should We Care?

The wall street aphorism that the market is not the economy has rung true so far this year.  US Large Cap stocks are up almost 10% through the first five months of the year, powered higher by the high-flying tech stocks, despite signs that the ongoing unwind of fiscal and monetary stimulus is slowing growth and leading to pockets of stress in the markets. 

The minutes released this week from the Federal Reserve’s May meeting showed the central bank’s delicate decision: continue to raise rates to fight inflation that remains persistently high and risk tipping the economy into recession or refrain from further hikes to stabilize the economy but risk inflation reaccelerating.  Economically, manufacturing data, corporate profits, constrained bank lending, rising consumer debt/delinquencies and higher borrowing costs all point to slowing growth.  Eventually the slowing growth picture will reduce demand-side pressure on inflation and will allow the Fed to lower interest rates to more accommodative levels, however, a recession would likely also lead to lower corporate earnings and lower stock prices in the short-term.

Disciplined investors may be well-served by paying close attention to the economic data and prepare their portfolio for rockier times ahead.  To quote another aphorism (or maybe a JFK quote): the time to repair the roof is when the sun is shining.

What We’re Reading:

FOMC Minutes from May Meeting

Strong US consumer spending, inflation readings put Fed in tough spot

Morningstar: What’s the Best-Performing Asset Type During a Recession

Chart of the Week:

The Bureau of Economic Analysis (BEA) compiles two measurements of economic output – Gross Domestic Product (GDP) and Gross Domestic Income (GDI).  In theory, these two measurements should be equivalent – they both track the aggregate output of the US economy.  In the short term, however, the two can deviate.  Economists argue that the GDI might more quickly predict recession as its inputs may be more timely than the output-focused GDP components.  Today, the GDI (blue line in the chart above) is signaling that we may have entered a recession – despite a modest pickup in the GDP estimate. 

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Market In a Snap! May 8th – May 12th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,124.04-0.29%7.41%
Nasdaq Composite12,284.740.40%17.37%
Russell 2,0001,740.85-0.99%-0.94%
Crude Oil70.02-1.43%-12.62%
US Treasury 10yr Yield3.46%  

Source: YCharts, Yahoo! Finance, WSJ

Market Recap

Despite inflation reports which showed the pace of inflation continues to moderate – both as measured by the Consumer Price Index and the Producer Price Index, markets finished the week lower, weighed down by little progress towards resolving the US debt ceiling.  Should congress fail to reach a debt ceiling agreement, the Brookings Institute estimates that the treasury could continue to make interest payments on government debt but would have to cut other outlays by 25%.  [1]Lower government spending would slow economic growth and borrowers may require a higher interest rate to lend to the government, thus leading to lower bond prices and lower stock market valuations.  Lower asset prices and higher borrowing costs would lower consumer and business confidence.  In an economy that many believe may already be on the precipice of recession, failure to reach an agreement would certainly increase recessionary risk.  Even if a deal is reached, the economy would not be out of the woods.  A deal would likely include spending cuts and act as a tightening of fiscal policy – at a point in time when the Fed has just raised borrowing costs and continues its $95b/month reduction in the size of its balance sheet.  Policymakers face a significant challenge – continue fiscal and monetary accommodation to support current growth but risk inflation and lack of progress towards containing ballooning deficits and levels of government debt.  Regardless of the outcome, current low levels of market volatility may prove to be overly complacent.

What We’re Reading:

CBO: Update to Budget Outlook 2023 to 2033

FT: US fiscal alarm bells are drowning out a deeper problem

WSJ: Druckenmiller Warns of Risk of US Hard Landing

CNBC: Jamie Dimon warns panic will overtake markets as U.S. approaches debt default

Chart of the Week:

The Consumer Price Index continued to moderate in April yet remains above the Federal Reserve’s 2% mandate.  As reflected in the chart above, goods inflation has moderated from the COVID-related supply chain issues, yet services inflation remains high.  Core Services inflation will likely continue to moderate (housing and wage growth tend to be leading indicators), yet we believe that it is likely inflation will remain above the level in which the Federal Reserve is likely to cut interest rates.

[1] https://www.brookings.edu/2023/04/24/how-worried-should-we-be-if-the-debt-ceiling-isnt-lifted/#:~:text=choices%20policymakers%20legislated.%E2%80%9D-,If%20the%20debt%20ceiling%20binds%2C%20and%20the%20U.S.%20Treasury%20does,event%20would%20surely%20be%20negative.

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Market In a Snap! May 1st – May 5th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,136.25-0.80%7.73%
Nasdaq Composite12,235.410.07%16.90%
Russell 2,0001,759.88-0.43%0.05%
Crude Oil71.21-6.11%-11.1%
US Treasury 10yr Yield3.45%  
Source: YCharts, Yahoo! Finance, WSJ

Market Recap

A very volatile week in markets saw the major indices rally on Friday to finish the week only modestly lower.  The week was highlighted by the Federal Reserve decision announcement on Wednesday to hike the federal funds rates by 0.25% to 5.0-5.25%.  While the rate increase was largely anticipated, remarks by Fed Chair Powell skewed more hawkish than the market had hoped.  Powell signaled to the market that the Fed intends to remain “data dependent” and will keep the flexibility to continue to hike rates should inflation remain high. 

As depicted in this week’s Chart of the Week, the market has a very different expectation than the Fed.  The current futures pricing reflects a 99.9% probability that the Fed will cut rates at least once by the end of the year and a 97% chance that the Fed will cut by at least two 0.25% decreases.  The median expectation is for the Fed to cut by 0.75% by year-end.  Consistent with market prognostications are economist forecasts; the Atlanta Fed GDP Now forecasting tool estimates that the economy will grow at a 2.7% pace in Q2, vs economist expectations of no growth.

Market rate-cut expectations and economists’ call for stalling growth paint a stark picture for near-term risk assets.  The Federal Reserve has acknowledged that its actions impact the economy through “long and variable lags.” The ongoing bank turmoil and credit crunch may be early indications of building stress in the financial system, however, the Fed has drawn its line in the sand and is messaging that, while a pause may be justified, it has yet to see the case for rate cuts.  Moreover, and under-reported in the financial press, the Fed has been unflinching in its ongoing balance sheet reduction.  History tells us that “Mr. Market” is usually more prescient than the Fed, but, in our view risks to near-term asset prices are mounting.  Investors will be well-served by employing a disciplined approach that is structured around their unique investment time horizon and financial plan. 

What We’re Reading:

Non-Farm Payroll Data Surprises with Strong Performance

WSJ: The Covid-19 Crisis is Officially Over.  Everything changed.

Coucil of Economic Advisers: The Potential Economic Impacts of Various Debt Ceiling Scenarios

Chart of the Week:

Source: CME Group

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Market In a Snap! April 24th – April 28th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,169.480.87%8.59%
Nasdaq Composite12,226.581.28%16.82%
Russell 2,0001,768.99-1.27%0.54%
Crude Oil76.65-0.22%-4.37%
US Treasury 10yr Yield3.45%  

Source: YCharts, Yahoo! Finance, WSJ

Market Recap

Strong earnings results from Meta, Microsoft and Alphabet pushed equity markets higher this week, with the tech-heavy NASDAQ leading gains.  On the economic front, a drawdown in business inventories led to a weaker-than-expected estimate of US economic growth for the first quarter of the year.  Partially offsetting the drawdown in inventory was a strong rise in consumer spending as purchases of motor vehicles and hospitality categories showed a still-tight labor market is encouraging spending.  Included in the GDP data, PCE inflation increased from a 3.6% pace in the fourth quarter to a 3.8% pace at the end of the first quarter.  Core PCE, which strips out food & energy, rose at a 4.9% pace.  Both estimates were above the level that had been anticipated by economists and confirmed to markets that the Federal Reserve is likely to raise short-term interest rates by 0.25% at the conclusion of its meeting next week.

What We’re Reading:

Bloomberg: Americans Go Deeper Into Debt as They Use Buy Now, Pay Later Apps for Groceries

Reuters: Sluggish growth and high inflation leave ECB in tight spot

Reuters: Yuan overtakes dollar to become most-used currency in China’s cross-border transactions

Chart of the Week:

Source: Jefferies

Market breadth has deteriorated, with just 32% of stocks outperforming the overall index.  In a similar fashion to 1999 & 2021, mega-cap tech names have led.   A market rally with such low participation, however, suggests increased market fragility.

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Market In a Snap! April 17th – April 21st, 2023

By: Dave Chenet, CFA, CAIA®

 CloseWeekly returnYTD return
    
S&P 5004,133.52-0.10%7.66%
Nasdaq Composite12,072.46-0.42%15.34%
Russell 2,0001,791.510.61%1.85%
Crude Oil77.80-5.81%-3.10%
US Treasury 10yr Yield3.57%  

Source: YCharts, Yahoo! Finance, WSJ

Market Recap

Mixed corporate earnings, political negotiations over the US debt ceiling and signs of a deteriorating US labor market contributed to a mixed week in equity markets.  Worse-than-anticipated results from Tesla and AT&T, combined with a warning about the health of the US consumer from American Express in addition to a pick-up in both initial and continuing unemployment claims brought into-picture dual headwinds of slowing economic growth and a Fed that is anticipated to raise rates an additional 0.25% in early May.  Overseas, European markets continued to push higher, and China’s GDP estimates beat forecasts and showed continued economic acceleration as it emerges from its “Covid zero” restrictions.

Next week will bring a slew of corporate earnings and important end-of-month reports to which the markets will pay close attention as it attempts to discern what the Fed will do at its May 3rd meeting.  Current estimates favor a rate hike, with only a 14% probability of a pause.  Looking out into the future, however, the market is pricing in two rate cuts by year-end. 

What We’re Reading:

FT: Blackstone president warns market is overestimating chance of Fed rate cuts

Reuters: When will US hit its debt ceiling and what happens if country defaults

Chart of the Week:

Forward-looking manufacturing surveys in the U.S. have deviated from those in China.  Strong GDP growth, credit expansion and lower rates are spurring optimism amongst Chinese manufacturers and very strong retail spending is supportive of continued economic expansion, while US indicators point to slower growth.