· Stocks rallied this past week as the dollar slipped and stocks hit technical support. All post-bear market rallies begin as just that and either build from there or revert back to the downtrend. This week will be important in partially determining at least the intermediate direction of stocks as, in addition to movements in interest rates, there are a slew of earnings on deck, especially in the tech sector (see below).
· The Open Market Committee of the Federal Reserve (FOMC), the body that determines the direction of interest rates, meets again November 1-2. Up until recently many considered a 0.75% hike in the Fed funds rate a fait accomplish. However, the Fed might want to pay attention to the continued warnings from economically sensitive companies such as Whirlpool and Knight-Swift Transportation.
For its most recent quarter, Whirlpool reported lower than expected sales and earnings along with the following observation from Chief Executive Officer, Marc Bitzer. “In particular in the U.S., but also in other markets, we saw consumer sentiment dropping off massively in June, July.”
From trucking firm Knight-Swift Transportation CEO David Jackson. “These muted trends have continued into October as supply chains appear to be catching up and adjusting for uncertainty in consumer demand. If these trends continue, we expect truckload supply to rapidly exit the market.”
In our opinion, a best case scenario would be for the Fed to raise interest rates at its upcoming meeting by 0.75%, but within its Press Release following the meeting make note of the weakening economy. This would go a long way in assuaging the concern of the financial markets that the Fed is out of touch. It will also allow the Fed to retain its credibility as an inflation fighter. Should this occur, stocks should respond favorably.
· For those that are considering selling at this point, according to data analytics firm YCharts, over the past seventy years, the S&P 500 has always been higher three years after it has fallen 25% from all-time highs. What many investors do not realize is that stocks bottom well ahead of the economy.
· President Biden has authorized an additional 15 million barrels of oil to be released from the Strategic Petroleum Reserve (SPR) beginning sometime in December which will bring the total released to 180 million barrels or approximately 25% of the 714 million barrels held in the SPR. The announcement which “ironically” comes just a couple of weeks prior to the mid-term elections pushes the number of barrels still available in the SPR to a forty-plus year low. The Biden Administration said it plans to restock the reserve should oil prices fall to between $67 and $72 per barrel. Our opinion – time will tell as given the administration’s current position on domestic production the only way we see oil getting down to this level is via demand destruction.
· The yield on the 10-Year U.S. Treasury Note continues to chug higher closing at 4.21% this past Friday as compared to 4.00% one week ago and 1.52% at the close of calendar year 2021. That means for every $100,000 invested a holder of this note will receive additional interest of $2,690 per year and $26,900 over the life of the note when compared to one purchased at the close of last year. (FYI, U.S. Treasury Obligations are sold as bills which are purchased at a discount and mature at face value in one year or less; notes which are purchased at a discount or premium, pay interest and mature between one and ten years and bonds, which are exactly the same as notes, but mature in ten to thirty years.)
· For those receiving Social Security, benefits, as a result of the rise in inflation over the past year as measured by the Consumer Price Index (CPI), expect an 8.7% increase in benefits beginning in January 2023. Please note that this cost of living adjustment will also apply for those under the Civil Service Retirement System (CSRS) as well as those under the Federal Employees Retirement System (FERS). Should the Fed be able to bring inflation under control, real, inflation adjusted income gains will occur.
· Welcome to the fourth quarter. Please note that for clients with non-qualified accounts, when beneficial, Fagan Associates will begin tax loss harvesting through realizing unrealized losses to include sales into cash, sales and waiting thirty days to avoid the wash-sale rule or swaps to similar but not exact securities (for example, FedEx to UPS). Given the rise in interest rates, when appropriate we will also take a similar course of action with fixed income.
· This coming week will be somewhat light in regard to economic data. However, of note is – on Tuesday, October Consumer Confidence; on Wednesday, September New Home Sales; on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance as well as an Initial Look at Third Quarter Gross Domestic Product (GDP) and on Friday, the final read on from the University of Michigan on Consumer Sentiment.
· This week expect a slew of earnings, led by technology. We will pay particular attention to the forward guidance, the impact of the strengthening dollar and the reaction of investors. Of note are reports from Microsoft (MSFT), Alphabet (GOOGL), Visa (V), Coca-Cola (KO), 3M (MMM), Archer Daniels Midland (ADM), Pulte Group (PHM), Thermo Fisher (TMO), Meta Platforms (META), Amazon.com (AMZN), McDonalds (MCD), Apple (AAPL), Boeing (BA), Bristol-Myers (BMY), Norfolk Southern (NSC), United Rentals (URI), Caterpillar (CAT), Merck (MRK), Shell (SHEL), Mastercard (MA), AbbVie (ABBV), Exxon Mobil (XOM), Chevron (CVX) and Nestle (NSRGY).
· LONGER-LASTING ISSUES TO KEEP AT TOP OF MIND
o We are excited about the recent rise in the yield on fixed-income securities, especially U.S. Treasuries. With yields above three percent all along the curve, should the Fed succeed in reigning in inflation without inflicting too much long-term damage on the economy, real returns on treasuries will turn positive. This will provide conservative investors with a viable alternative to equities and allow them to reduce portfolio risk.
o We liken the aggressive policy of the Fed to rain. The ground (economy) can absorb a couple inches of rain over an extended period of time. However, it cannot absorb it over an hour or two. We believe that after this upcoming hike it would behoove the Fed to pay more than just lip service to their claim of data dependency or once again, run the risk of cooling off economic growth more than what is needed to quell inflation.
o Unlike the past couple of bear market where investors witnessed a V-shaped bottom, this should be more of a “U,” or a process rather than an event. Not to worry, as we believe this bottom will usher in a new, longer-lasting, more durable bull market, one in which the Fed will not be the center of attraction. However, prior to that, we will need to see inflation ebb and the Fed pivot.
o The yield curve (the difference between the yields on different maturities of the identical securities, in this case U.S. Treasuries) has continued to invert in a meaningful fashion. The curve, historically a predictor of an economic slowdown, measures the relationship between like bonds of different maturities. In fact, an inverted yield curve has predicted every recession since 1955. That said, it has also predicted recessions when one did not occur. This past week, the yields on the two- and five-year Treasury Notes were inverted or higher when compared to the ten-year U.S. Treasury Note at 4.49% and 4.34% versus 4.21%. Many market pundits will point to this as evidence of a looming recession. At this time, a technical recession brought about by the Fed raising interest rates is likely, the depths of which are most likely shallow as it will not have been caused by a collapse in the credit markets a la 2007-early 2009.
o Keep in mind that the stock and bond markets are anticipatory in nature, historically moving six to nine months ahead of the confirming data. It is precisely for this reason that investors hoping to “buy when things look better” never get the chance to do so. Unfortunately, by the time the economic data turns for the better, stock prices have already taken this into account. For example, during the pandemic, the stock market bottomed on March 23, 2020, just as the economy was shutting down. Three months later stocks had risen forty percent!
o A component to traditional, longer-lasting bear markets is the emotional strain it places upon the investor. Just as bull markets place pressure on investors sitting on the sidelines, bear markets exert the same force on those that have money in the market. Should the market remain choppy as we believe it will at least throughout the summer, you can count on a steady drumbeat from talking heads questioning the validity of long-term investing. We have regularly noted that unlike recent pullbacks, the recovery from this one will most likely be more of a process rather than an event and would recommend our clients to ignore the short-term and focus on your long-term objectives.
o The Fed has become too important in regulating the economy. Hopefully, when this is over, we can get to a more normalized economy with less overt Fed intervention. Recessions are necessary as they bring back into balance supply and demand. In addition, vis a vis creative destruction, recessions revitalize the economy, positioning it for a new era of growth.
o We continue to monitor the returns of the Vanguard Balanced Index Fund (VBAIX) to illustrate the extent of the selloff even in balanced accounts, including the bond market. VBAIX, somewhat of a proxy for balanced investors has fallen 19.44% through the close of business Friday, as in addition to the pullback in stocks, bonds, which comprise nearly 40% of the portfolio, have been under pressure. For example, the Vanguard Total Bond Market Index Fund (VBMFX) has fallen 16.79%. In fact, even the Vanguard 2020 (VTWNX), a mutual fund designed for “investors planning to retire or leave the workforce in or within a few years of 2020 (the target year)” has dropped 17.67% year-to-date.