· The financial markets remained trapped under the thumbs and tongues of Fed Chair Jerome Powell as well as the other voting members of the Federal Reserve’s Open Market Committee (FOMC). This past week was no exception as stocks moved higher leading in to the meeting of the FOMC, one which concluded Wednesday at 2:00p with a 0.50% hike in the federal funds rate. After having stayed easy way too long, it appears as if Powell et al are hell bent on retaining a restrictive monetary policy despite the fact that the bond market as well as recent economic data is telling them that enough is enough. At the present, the futures market is indicating another 0.50% in interest rates hikes, 0.25% over each of the next two upcoming meetings, after which a pause is expected.
In addition to the Fed raising rates, they are also pulling nearly $100 billion from the economy monthly by executing either sales of Treasuries and Mortgage-Backed Securities or letting them mature and roll-off . Begun within the past few months, this procedure will also provide a headwind to economic growth.
Except for the labor market, which historically has been a lagging indicator, the economy is crying uncle. In our opinion, it is high time for the Fed to pause and assess the impact from the aggressive tightening all the while maintaining their hawkish tone. At this time, the most likely course for the Fed is two additional rate hikes and a softening of their jawboning.
Over the short-term, expect the financial markets remain in limbo, directionless, some weeks pushed higher by the same data (economic, corporate, Fed, interest rates) that pushes it lower during others. That said, as we noted last week, we believe that regardless of the short-term direction of stocks, the landscape over the intermediate-term which we would define as twelve to thirty-six months is becoming more favorable as the tightening of monetary policy has definitely slowed economic growth which if not too damaging will ultimately pair lacking supply with demand. The bottom line – a new bull market is most likely forming/evolving, but not yet here.
· In addition to the Fed raising interest rates, at the conclusion of its meeting this past Wednesday, the European Central Bank (ECB) voted 6-3 in favor of raising their key lending rate by 0.50% to 3.50%. Given their reliance on foreign energy, Europe appears trapped in a environment of stagflation as compared to the United States.
· Similar to the days leading up to recent meetings of the Fed, this week was no different as investors hoped for a softening of the tenor of the policy statement, but along with the press conference with Fed Chair Powell immediately after the conclusion of the meeting at 2:00p Wednesday, were served a dose of reality in the form of a stern rhetoric. The Dow Jones Industrial Average started the week at 33,476 and subsequently rose by 2.16% to 34,198 at the time of the release of the Fed’s policy statement. At the conclusion of trading on Wednesday, the Dow had given all of its gains for that day and then over the following two days, for the week and then some.
· We found the statement by Avi Salzman within Barron’s this past week quite perceptive. In describing the potential destruction in demand for energy he noted that perhaps “Powell has become more important than Putin.” (Barron’s, p. 7)
· On Friday, the energy department put out bids to begin replenishing the Strategic Petroleum Reserve (SPR) with the first purchase being up to three million barrels. The refilling of the SPR, the volume of which has dropped to a 38-year low, may put a floor under the price of oil.
· As China attempts to reopen from their strict COVID lockdown, cases soared by sixteen times to 22,000 in Beijing alone perhaps indicating that without an MRNA vaccine, the reopening will be fraught with both health and economic risk.
· Sam Bankman-Fried, the former Chair of FTX Chair, currently indicted for fraud as well as a variety of other charges, was once a darling of Wall Street media, even to the extent that he was referred to during interviews as “SBF.” Now, all of the talking heads have distanced themselves from him, referring to him now as Mr. Bankman-Fried.
· In our opinion, inflation will fall relatively quickly to the 4%-5% range. However, the next 2%-3% will take a long time, measured in years rather than quarters or months. The result should be meaningful yields on bonds and eventually include, Certificates of Deposits as well as money market accounts. With this in mind and if history is any guide, we consider the period 2010-2020 as more of an aberration rather than the norm with respect to the yields on 10-year US Treasury Notes.
· The coming week is chock full of economic releases to include on Tuesday, November Housing Starts; on Wednesday, December Consumer Confidence from the Conference Board and November Existing Home Sales; on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance, the Third and Final Estimate of Third Quarter Gross Domestic Product, and the November Index of Leading Economic Indicators. Finally, on Friday investors will receive the November Orders for Durable Goods, November Personal Income and Spending, November New Home Sales and the final December look at Consumer Sentiment as reported by the University of Michigan.
· The earnings season has begun to wind down. That said, of note are reports from FedEx (FDX), Nike (NKE), General Mills (GIS), Toro (TTC), Cintas Corp (CTAS), Micron Technology (MU), Paychex (PAYX), and Carmax (KMX).
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 and one-half 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 has continued to invert meaningfully. 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 4.33% and 3.75% versus 3.57%. 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 autumn, 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 recommend that our clients 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 15.19% 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 11.94%. 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 12.64% year-to-date.