Six months ago, major stock averages were at similar levels as today. The Dow Jones Industrial average has been the strongest since then, with a ~2% advance since June. Rotation has occurred, with funds flowing out of mega-cap technology leaders and into commodity related areas, but for the most part, stocks have gone nowhere.
However, taking a step back, the investment landscape is quite different. Six months ago, Fed Funds were below 1% and they were just about to start the first of four, 75bps rate hikes. The 10-year Treasury rates were sub-3%. Now we are getting back below 4% this week. 30-year mortgage rates were 5% in June; recently they are over 7%. Consumer pocketbooks were flush with cash, but today we see record credit card debt piling up, intimating that the consumer is getting pinched by inflation and Covid-handouts are being depleted. Job gains were plentiful, while today layoffs are accelerating across industries. The yield curve inversion has spread across the entire curve today, which has a near 100% correlation to a recession over the coming quarters. As bad as things were in June, the headlines today are even worse.
Six months ago, June’s lows proved to be a great trading opportunity. These quick bursts higher are common occurrences during bear markets. The S&P 500 jumped 19% and the Dow Jones advanced 15% in under two months. That rally proved to be short-lived as major averages went to new lows, yet again, into October. From there, we have now advanced 15% and 18% in the S&P and Dow Jones, respectively, in the past month. With economic conditions (see above) worse now than before, are we to expect this rally to keep going?
Market pundits continue to pound the table, noting that once results are known during election years, stocks almost always advance. However, many of those occurred during bull markets. The data is not very encouraging during a bear market:
As you can see, most rallies happen after an October low, but forward movement from November is not overly encouraging unless you are in a bull market. Clearly, we are not. Beware of bullish historical tendencies and projecting them into this environment. Bear markets do not follow a calendar. History might suggest that a great seasonal entry point is here, but digging deeper tells a very different story. What one must concentrate on is the earnings picture looking out to the second half of 2023.
Retail Earnings Week:
The consumer is still two-thirds of GDP in the United States. As the consumer goes, so does growth. This week we heard quarterly earnings reports for some of the major players in the industry with varying results. Walmart# benefitted from middle to high-income consumers trading down to their stores and from their massive exposure to non-discretionary items like food. On the other hand, Target#, which has a lot more discretionary categories in their sales funnel, suffered as discretionary funds continue to collapse. Home Depot & Lowe’s keep benefitting from home projects that were the result of home purchases and favorable refinancing terms from earlier in the year. 2023 looks okay for housing, but 2024 is the major question mark. Almost all of this week’s retail reports showed rising revenues that are below the rate of inflation. This means that consumers keep buying, but the basket of goods they leave the store with is less than what that same dollar amount bought them last year.
It is becoming quite clear; more and more consumers are feeling the inflationary pinch. Lower-income consumers feel the most pain. Living paycheck to paycheck and seeing grocery bills go up by double digits is a horrible scenario. Now that excess savings are being depleted, the pain broadens out. Further, Fed rate hikes take ~9 months before hitting the economy. Loans are becoming harder to obtain, especially to families that truly need them. Even if they are available, interest rates make it even more uncomfortable. Yes, inflation is coming down, but there is a lot more pain ahead for the average consumer. When you are spending 10% – 20% more for life’s necessities, that does not leave much room for other areas of the economy. Remember, slower inflation does not mean prices go back to 2019 levels. Some items will take time to get back to those ranges, if ever.
On top of rising prices, it is becoming quite clear that our job market is also peaking. Jobs and wages have a bullseye on their backs with the Fed being laser focused on fighting inflation with little regard to the other half of their proposed mandate. The Fed is supposed to promote full employment and wage gains. Apparently, that does not matter when inflation is 7%+. What happens when a tapped-out consumer starts to fear losing their job in 2023? Spending will obviously come down, helping to beat inflation. At what cost? To say the Fed is in a difficult position would be an understatement.
End result, it is going to be tough sledding for corporate profits in 2023. While markets will rally following a clearer sign that inflation is going to be beaten, the side effects have to be considered. Again, inflation will be beaten, but at what cost? Going forward, this selectivity will be crucial. Investors are going to consider the alternatives. Is this next stock investment better/safer than a 6%+ high-quality corporate bond? Can they survive higher rates and a tougher consumer environment?
For now, momentum is on the bull’s side. We are in the middle of a 3,600 – 4,300 S&P 500 range. Inflation metrics are consistently improving. The Fed is slowing their aggressiveness, reducing the chances of a massive policy mistake. History says that it is a good time to be long stocks, especially those that have been crushed by higher interest rates and have priced in the direst scenarios. A rotation gives opportunities. Lastly, there are over $2 trillion of options expiring today. One can expect wild intraday action for specific stocks.
Owen Wilson turns 54 today, and Megyn Kelly is now 52.
James Vogt, 610-260-2214