The Proverbial Hook

 Having spent most of my career working on the institutional and corporate side of asset management, organization and focus have been handy skills. However, since I’ve come into a more retail setting, I’ve observed another skill, monetizing the hook. The hook is the one idea to hang the direction of the capital markets on, for a single day. I’ve also observed that this skill has created a bit of a quandary lately. Strong indicators of economic growth, employment growth, wage growth and consumption growth all suggest, in my opinion, the Fed isn’t finished raising interest rates. So why have the broad indexes started the year in a rallying mode, and can it continue?

 Markets

A commonly heard narrative is the markets are overbought and need to correct. This is currently true, in my opinion, however it’s important to stay focused on what that means. At this moment in time, a welcome start to the year is where some correction is being correlated. But where is the cause of that correlation within the broad indexes, is the Dow Jones correlating, yes, the S&P500, yes, the Nasdaq, not so much? First of all, last year the most beloved stocks helped the Dow Index perform substantially better than both the S&P500 and the Nasdaq. And the S&P 500 finished last year 10% better than the Nasdaq. So, what does this mean? In my opinion it means that the Dow needs to correct more than the S&P, and the S&P needs to correct more than the Nasdaq. And because the S&P500 and the Nasdaq share a number of influential stocks in the Technology Sector, and the Nasdaq has been the best performer starting 2023, its strength won’t keep the S&P from a necessary correction, but, in my opinion, it will keep it from collapsing, the probable hook the narrative is looking for.

 Economics

The usual mixture of data that has been released recently suggests the economy is slowing, but not the entire economy. For example, the U.S. Manufacturing Purchasing Managers Index (PMI) and the U.S. Services Purchasing Managers Index both came in at 46.6 and 46.8 respectively. I focus on any number below 50, which suggests a contracting sector of the economy. In the case of these two indicators, both have been below 50 since November 2022, a condition last observed in 2008. In addition, recent releases in Retail Sales falling 1.1% and Industrial Production falling .07%, in December, there is definitely some economic moderation taking place, and this explains, to some extent, why the markets interpret inflation as having peaked already. I agree with this interpretation, but I also need more proof. Today the Unemployment data for January showed very strong growth in Non-Farm Payrolls (517K) and the Unemployment Rate declined (3.4%) and naturally this was the hook for the opening day’s narrative. And while the numbers are concerning, wage growth, Average Hourly Earnings and Average Weekly Hours all came in static from the previous month. Another interestingly favorable outcome was the U6 Unemployment Rate, which includes a wider range of the unemployed that includes underemployed and discouraged participants, which came in slightly higher (6.6%). While a number of economists view the U6 data and more comprehensive, my takeaway is, it tells us the story isn’t over.

 External Events

In the past few weeks, the new majority in Congress has engaged its political agenda and the first legislation on the docket will likely be the Debt Ceiling. For now, In my opinion, the Debt Ceiling will likely be raised, but with some concessions, namely the promise of no further spending packages that got us into this problem in the first place. This week, the Federal Reserve raised interest rates again and the speech given by Chairman Powell reiterated that inflation is moderating but still too high and the Fed is intent to keep raising rates. While he gave no hint of today’s Unemployment report, I take the Feds actions and statements at face value. And for now, that’s my proverbial hook to hang my strategy on.

Tech Is Waking Up

 Employee layoffs have been growing more frequent, especially from companies in the Technology Sector. Some may recall, during the pandemic I wrote about a growing incentive to reimagine the corporate responsibility. The narrative was aggressively pushed by Marc Benioff of Salesforce (CRM), highlighting the goal to hire aggressively, pay handsomely and provide added capital to the working conditions and the needs of the community that hosts the business. The statements being released by companies leading the recent layoffs are the same ones that followed a narrative that was projected with sound intent but ended up creating more problems than benefits to the economy and the capitalism that feeds it.

 I bring this up because another familiar phenomenon is occurring as stock prices of these companies are going up, essentially rewarding them for preserving the future needs of the company and the balance sheet, over the present high Operating Expenses. In the case of Alphabet (GOOGL) and Microsoft (MSFT) the CEO’s each gave an unexpected apology for being too aggressive with the pandemic agenda. Now the economy is weakening to the impact of higher interest rates in the calculation of earnings per share (EPS) and the challenges to growing nationalization of infrastructure and technical select needs to fight ongoing supply trade disruptions, and a more serious focus on the balance sheet is needed.

 While this is happening, the economy as also measured by housing, retail sales and broad manufacturing, is experiencing multi month weakness. The offset that comes from strong employment is a nuisance observed by the Fed and that is a current uncertainty. Until the next meeting on February 1st, and their forecasted .25% rate increase, it’s the speech by Chairman Powell that follows that I’ll be focused on. As the Fed concerns become clearer, so to can the overall market takeaway. There is no reason yet, in my opinion, to not expect a recession in the second quarter, but it will take evidence from incoming employment data and its broader impact to feed the agony Chairman Powell has promised.

 The good news, in my opinion, is that the equity markets are opening the year moving higher. But the strength, and incoming investment, is clearly focused on technology, and not just the familiar names. To some extent this could be a short term shift from the more stable sectors that have been the recent winners in the markets, and in need of some pause.  But with much of the forementioned employment data dependent on continued cost cutting, coming from the Technology sector, the outcome is clearly good for the sector as a whole. In my opinion, this is an early sign that Technology is closer to the end of a very difficult 12 months. As far as where investment is focused, the growth in Artificial Intelligence, Robotics, Cybersecurity and Cloud Services, covers a lot of ground and we have some exposure to all. With that, the goal is to take advantage of volatility, probably from upcoming earnings reports, to increase our holdings.  For now, the overall technical condition is still overbought and when the markets work off some present steam, then it can move towards rising on a favorable outlook instead, and that’s the kind of market we like.

The Light Is Getting Closer

“When I look at the market behavior today, I'm a pessimist … but when I look at market behavior over history, I’m an optimist”

The opening of the year has been a good one for the markets. Rallies, even modest ones, are welcome, and the reason is the focus on inflation. The problem as I see it, ignores the fact that the markets left the previous year oversold, and a rally can be expected, just as they had infrequently occurred last year. To hear a narrative the concludes that inflation is under control and the Fed will have to slow down are still, in my opinion, too premature. However, I’m also not pessimistic, and push aside those in our industry who dispense a narrative that all too easily pervades individual thought and, in my opinion, mutates doubt into blind certainty. Here’s what I’m becoming more certain about.

Economics

Today the Data for the Core Consumer Price Index (CPI) was released and showed a modest December decline of .01%. The overall inflation number for the full year came in at 6.5%, a clear decline from the high of 9.1% last July. Without going over the other calculations, such as removing the more volatile food and energy data, it’s worth noting that the data clearly shows a slow decline in the overall inflation rate, but a number that would still have the focus of Fed concern as well.  This is important to me because I live a reasonably simple life and can experience inflation first hand. So, the question I keep asking myself is has the linear data that is reflected in the numbers already peaked, and my answer is yes. Now, will inflation at the grocery store continue per diem, my answer is also yes. In short, the data that reflects the monthly and yearly changes in inflation will continue to slowly move lower, but my favorite Pistachio Gelato is still going to be $9 a pint.

 Markets

The markets are definitely seeing some buying that is as much about short covering as it is about genuine buying. But the volume is good, going into a holiday weekend, and the only thing to wait for is what’s next. First of all, the markets finished the year marginally oversold in the short term. Hence, the rally we’ve been experiencing in the beginning of this year. As of today, that technical condition is starting to show the market somewhat overbought. Therefore, while the overbought condition could continue into next week’s Producer Price Index (PPI) release on Wednesday, it is also the start of earnings for the fourth quarter, and that could impose some relief on the rally. I bring this up because in the recent overall rebalancing of accounts the available cash will continue to find opportunity, and the reckless interpretation of earnings from our Algochums and Analysts should prove useful. Until then, the economy and inflation suggest, in my opinion, that the bear market is nearing an end and, sorry for the redundance, patience and focus are still the best strategy at hand.