July 28, 2022

Things will Change

 This week has seen a lot of buying, which is not surprising since the current correction is nearly overbought (and human nature is too often to buy high and sell low). I’m also not surprised by the modest change in investor sentiment. But I also don’t want to be cynical about the real events that data is providing, showing some economic slowdown. I accept the value of the data and the message it sends, it’s the markets I’m a little skeptical about maybe, but that’s why a good question to ask about the past two weeks of market activity is, how did we get here?

Markets

The markets opened the week after a strong finish last week, only to trade lower in anticipation of yesterday’s Fed rate hike (1.75% to 2.5%). However, coming into today the broad indexes, Dow Jones, S&P 500 and NASDAQ, have added 2.0%, 2.8% and 2.8% respectively, all adding to an increasingly overbought condition. From a technical view, the said indexes also saw a constructive move with prices going above their 50day moving average. This is a good start suggesting real buying is taking place and not just Pindudes and Algochums. But for now, the longer term averages remain in their own negative state, suggesting it’s too early to call an end to the bear market, but worthy of paying close attention.

Economics

I’ve always said that I know when I’m in a recession when it nears an end. Privileged perhaps, but I always find the reality of a bear market is easier to recognize than a recession. The current bear market officially began March 2022, but the signs were there, presented by both the rising interest rate market and the unpleasant growth in inflation. Both messages were also followed by what I’ve referred to as choppy economic data. In the first quarter production declined, housing was moderating and the consumer still had the appetite to buy, but was little less hungry. In the end, the first quarter measured a negative -1.6% GDP thereby revealing that the declines outweighed the increases in growth leaving the second quarter to confirm both the bear market and the aggressive Fed activity, but not the recession, yet. Second quarter GDP data came in today showing a decline in growth of -0.9%. Economists were forecasting a lower number, and the markets are continuing to rally. But in my opinion, a negative GDP is a negative GDP regardless of those narratives that may disagree. Yesterday, the Fed increased the interest rate that tracks the transactions between depository institutions (banks), an anticipated 0.75%. In his customary remarks, Fed Chairman Powell also provided guidance that clearly focused on the moderating economy, suggesting the continued aggressive posture might have to reconsider on a data by data basis. They won’t meet again until September, and in the meantime the broad indexes can give up some of their recent gains as easily as they may continue higher. In my opinion, the picture is getting clearer, and I’m okay with that.

External Events

It's always worth pointing out that every shift from bear to bull market over the last four decades of recessions, has occurred before the recession officially ends. As far as when recession begins, the familiar uncertainties have added to some of supply constraints in the EU that were exacerbated by the recent data showing that Germany, the EU’s largest economy, may already be in recession. That could be made more difficult to navigate as the EU has also been slow to battle inflation, and their dependence on Russia for natural gas poses uncertain risks. Also, rarely discussed is the impact of Fed raising rates on the relative value of the US Dollar. The strong dollar has the dual effect on both companies doing business internationally and the challenges to domestic exports. Over time, in my opinion, the dollar will resume its longer term decline in relative value, but in the meantime, it’s effect on the global economy isn’t to be ignored. All of this is what keeps us tactically invested, ready to act constructively when, or if we enter a recession, modest or otherwise, that will likely first be recognized by the voting members of the Federal Reserve Board. When that happens, things will change, and for the better.


July 21, 2022

Opinions Matter

     Although I don’t always agree, in my customary tendency towards skepticism, with the investment community burdened with opinions over beliefs, I always prefer the former over the latter. To note put, I prefer to own my predictive strategies then simply share them with the beliefs of others. I bring this up because converging views on every uncertainty from inflation to recession, to Covid and war in Ukraine, sharing a belief is too easy, especially when so much is at stake. The broad indexes have been moving impulsively, as opposed to decisively, higher this week and I’m beginning to have the opinion that uncertainties are being diluted into a less relevant distraction. Point of note, I never shy away from being skeptical even of my own opinions. So, what are they?

    The current economic state has been uneven to say the least, that is until a new twist came in today. The Department of Labor (DOL) released the weekly data tracking Unemployment Claims, and the number showed a small increase. This has followed similar increases since April, and with plenty of slack to move higher, what would be the trigger? The technology companies have been especially vocal in the freezes on new hires. Huge names such as Apple (AAPL), Alphabet (GOOGL) Tesla (TSLA) and Meta (FB) all point to tightening Fed policy and concerns regarding recession. Actual layoffs off are occurring as well, but that’s where the numbers are small compared to past action by corporations looking to reduce operating expenses on their balance sheets, thereby increasing their net profit and staying in the good graces of the street analysts. All of this will come into better focus when the Employment data for July is released on Friday August 5th. Earlier in the week further data showing declines in both Existing Sales and New Housing Starts is often seen as the result of higher interest rates. In my opinion, rates, even at current levels are still historically low and have room to move even higher. My technical trigger on rates going higher is when the 10yr Treasury, currently at 2.94%, breaks 4.25%. Unlikely, but not impossible.

    As for company data, the earnings season has begun and with the exception of the banks, are showing reasonable returns while at the same time all are providing cautious guidance into the rest of the year. My strategy will continue to be guided less by the depth of the current signs of economic slowdown but more on how companies are prevailing. If earnings hold up despite inflation, it will have a positive impact on stock prices as we begin moving into the fall. But if earnings estimates prove too high, analysts will likely lower estimates, which in line will lower investor sentiment, not suggesting a new low, but more likely an increase in negative volatility. 

    The stock market is predictive, which is why stock prices tend to begin a new upward cycle during a recession, before it ends. That’s why, in my opinion, watching the economy is more important than the uncertainties we have little control over, and less information coming from those in power. But those uncertainties can’t be entirely ignored and therefor, maintaining room for new opportunities still makes sense, especially if the more certain outcome is also short lived, as uncertainties usually end.


July 14, 2022

Anyone Paying Attention?

Having skin in the game has always been the best way to gage the value of present and impending risk. I’ve personally been responsible for managing billions of dollars in bonds and stocks over the last 35yrs, most of it was bonds, which require sharp focus on economics, currency and monetary policy. I bring this up because with all the jargon infested narrative claiming expertise, much of it from those with little direct experience and a few with experience, I always pay more attention to the latter. These days the latter is questioning the Fed from the perspective that the current inflationary environment we find ourselves in is 1: not the same as 40yrs ago, and 2: increasing interest rates will have little impact if spending and money printing isn’t addressed with fiscal discipline. That’s where the government comes in, and that’s where government has failed in at least the last two decades, and these days doesn’t seem to be paying attention. How did we get here?

        In the early 1980’s the economy had become more disposed to inflation, for reasons unrelated to monetary policy. During the period preceding the rise in inflation, any aggressive actions on the part of the Fed Chairman that may slow the economy was not politically advantageous. I bring this up because after Fed Chairman Paul Volker, against all predecessors, crushed inflation by raising interest rates to historic highs, he entered the economy into a severe recession. From that time during the period from the mid 1980’s to 2022, the GDP Implicit Price Deflator measure saw the lowest inflation averaging around 3.0% on an annual basis. That came at the expense of near zero interest rates and the historical printing of money (M2), all occurring during the super growth of technology, capping the half century transition to a service economy from an industrial economy. All of this fueled consumer spending, government and corporate debt growth and a weak dollar. All good for economic growth, but also all inevitably inflationary. So now, Fed Chairman Powell needs to convince the capital markets that he is in control. 

      So, what else is happening? This week both the Consumer Price Index (CPI) and Producer Price Index (PPI) showed inflation through June at 9.1% and 11.3% respectively. This week’s decline in in the broad Indexes of nearly 4% also strongly suggest in anticipation an interest rate increase of 1% at the next Fed meeting (07/27), the highest since 1994. But from an economic point of view last week saw data from June such as the ISM Manufacturing Index decline to 53.0 and the ISM Non-Manufacturing Index declined to 54.0, in each case a move below or above 50 signals economic contraction or expansion respectively. Tomorrow the Retail data is expected to rise with Friday’s Employment data showing wages rose 1.4% over the last three months, more money in the consumer’s pocket. Next week’s Housing data is expected to show negative effects of the recent mortgage rate increases and slowdown in new purchases. 

      Inflation is real, and so too should the Federal Reserve Board be real. But one piece of data that got attention this week is the ongoing inversion of the yield curve (the 10yr treasury 2.97% minus the 2yr treasury 3.0%). In my opinion an inversion is a good thing, because if we really enter a recession in the near term, the Fed would have to stop raising rates, and inflation would certainly take a hit. As long as the government doesn’t engage in its usual mischief. Luckily the 2.4 trillion dollar Build Back Better bill has so far failed reconciliation and probably would’ve made energy inflation even stronger and also give away too much newly printed money, another reckless increase in the budget deficit. But for now, Congress is doing nothing with the exception of investigating the Jan 6 riot, and Powell appears hesitant even as other members of the Fed voting board are making far more aggressive statements, in my opinion, to get Mr. Powell’s attention. Whether or not it works is key to ending the inflation dilemma. In the meantime, waiting out the markets need for certainty requires patience and focus, diversification has kept portfolios less volatile, and cash remains ample for value, when it shows up.