· Stocks continued to nudge their way higher during this seasonally strong period on the backs of declining Treasury yields. However, that tailwind may have come to at least a short-term end on Friday, as November delivered a stronger than expected jobs report pushing up interest rates.
Regardless of the short-term direction of stocks, the landscape over the intermediate-term 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.
Why then you might ask has the labor market remained relatively strong? Several reasons, to include, continued concern regarding the health risks as they pertain to the pandemic; the savings accumulated by Americans during the pandemic has allowed them some financial leeway in regard to returning to the labor market; a changed outlook by workers regarding the workplace, especially as it pertains to return to office and lifestyle; and finally, the fact that labor is a lagging indicator.
The bottom line – a new bull market is most likely forming/evolving, but not yet here.
· Something to watch – over the last three months, gold as represented by the SPDR Gold Shares ETF (GLD) has turned positive, notching a return of 5.02%, outperforming the S&P 500 which has risen 3.76%. The longer inflation remains a concern the more bullish this is for gold as well as other precious metals, but also most likely for industrial commodities such as copper.
· According to data released from the Commerce Department, the personal savings rate as a percent of disposable income fell to 2.3%, the lowest since 2005. According to Sal Guatieri, senior economist at BMO Capital, “households continue to mine mountains of extra funds piled up during the pandemic. This extra piggy bank could last another year.” As we noted above, this also bodes well for an eventual return to the labor force.
· The yield curve continued to shows signs of a pending slowdown in the economy as the inverted spread between the two-year U.S. Treasury Note as compared to the ten-year as well as the three-month in relation to the thirty-year are near current economic cycle highs.
· Natural Gas corrects off its recent high as the Biden Administration steps in to avert a rail strike. Also, the fact that the energy sector is the worst performing ETF over the past three weeks, begs the question as to whether or not energy stocks have at least hit a short-term wall?
· This past Wednesday the yield on the 2-year U.S. Treasury Noted exceeded that of the 10-year note by 0.78%, the widest negative gap since 1981. Generally, longer-tem rates are higher than shorter-term rates. However, when investors are worried about economic growth, the demand for longer-term maturities rise, pushing down yields. When that yield exceeds shorter-dated maturities, the curve is said to have “inverted.” Historically this is an indicator of potentially slower future economic growth.
· 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.
· To those that are fortunate enough to have a Cash Balance Pension Plan and are nearing retirement, one must take into consideration the fact that, given the recent rise interest rates the lump-sum figure will decline substantially the next time it is recalculated. We would anticipate this number dropping 15% to 25%. However, the monthly income will not be affected.
· As we enter the final month of 2022, please note that for clients with non-qualified accounts, when beneficial, Fagan Associates will begin tax loss harvesting through a process of realizing unrealized losses, to include sales into cash, sales and then 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 during 2022, when appropriate we will also take a similar course of action with fixed income.
· The coming week is chock full of economic releases to include, on Monday October Durable Goods Orders, October Factory Orders and the November ISM Services Report; on Tuesday, October Trade Balance; on Wednesday, the Second Estimate of Q3-Productivity; on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance; and on Friday, November Wholesale Inflation as measured by the Producer Price Index (PPI) and December Consumer Sentiment as reported from the University of Michigan.
· The earnings season has begun to wind down. That said, of note are reports from Autozone (AZO), Mongodb (MDB), Caseys General Stores (CASY), GameStop (GME), Campbell Soup (CPB), Lululemon (LULU), Costco (COST), Broadcom (AVGO), Vail Resorts (MTN), Docusign (DOCU), RH (RH), Ciena (CIEN), Chewy (CHWY) and Oracle (ORCL).
· 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 4.42% and 3.85% versus 3.68%. 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 14.69% 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 11.60%. 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 11.38% year-to-date.