Market Moment Monday November 14, 2022
The two primary factors dictating the direction of the financial markets are inflation data and commentary by Federal Reserve Officials. This past Thursday the inflation data came in softer than anticipated (7.7% reported vs 7.9% expected) …lower is better for markets. Rhetoric also came to the forefront as it was reported that 3 FED officials have been speaking more dovish (loosening the rate hike posture) vs prior hawkish statements (maintaining or increasing rate hikes). What followed was the largest stock market rally since 2020 and led to a +5.54% increase in the S&P 500, +3.7% for the DOW, and a NASDAQ Composite rise by +7.35%.
Treasury rates also fell which is a significant and constructive “tell” about how the market participants view lower CPI/Inflation figures. While the FED and their rhetoric are front page news; it’s the underlying mechanics found within the treasury complex that provides the barometric pressure that controls the jet stream for the stock market temperature. The 10-Year Treasury fell 30bps (more than ¼ of a %) to 3.81% and the 2-Year Treasury fell (also) 30bps to 4.32%. These are “telling” (lower rates are better for stocks) because market participants believe that the FED will lighten up on their rate hike posture. I’d also speculate that more FED officials will acknowledge that inflation is cooling off. Such words of recognition will lead to further increases in stock market prices and falling treasury yields. The challenge is the cryptic Swahili cipher code that FED officials use to signal how they feel. If you don’t speak Swahili and don’t have the Count Chocula Cereal decoder ring…well then what they say will not be understood.
I’ve noted in prior Market Moments of the way the CPI/PPI are calculated using backward looking data that is mathematically dominated by data from 12 months to thru 3 months ago. And the most accurate data is what happened in the past 60 days; but it only has 1/6th of the weight to the average. However, the most recent data is starting to pull down these higher months from Fall / Winter of last year. Shelter’s increase slowed to +0.6% from August and September readings of +0.7% and +0.8%, Durable Goods -8.4% annualized and Used Cars -2.4% for the past 30 days alone. However, one of the best examples of how unaligned the CPI index is with reality is the use of the Health Insurance Average. The method by which this metric is used is perplexing and infects CPI. Why? It’s not a monthly adjustment but an annual adjustment. Regardless, it’s been used for the past 12 months and skewed the CPI up but finally the annual adjustment has arrived, and it will now detract from CPI with its new -4.0% factor. Lots of other softer data has been apparent since the June CPI peak at +9.1% and it’s more prevalent now and this is good for stocks and lower bond yields.
Rhetoric of FED officials are a soft tool used by the FED and it’s been used aggressively by Jerome Powell since January 2022. Former NY Federal Reserve Economist, Dr. Ed Yardeni, has said it best recently referring to Jerome Powell as living on Mars. He wasn’t saying this as being derogatory of Jerome Powell but was saying it as being in stark contrast to Cleveland FED President Loretta Mester (who he said she also lives on a different planet from Powell). I don’t know why FED speak must be so cryptic, but I have the decoder ring and what Dr. Yardeni was suggesting is that Powell (male) and Nester (female) were following the relationship book from 1992 “Men Are From Mars, Women Are From Venus.” His point, in FED Speak, was that Powell has been stubbornly hawkish in his rhetoric about extinguishing inflation and will “vote” to keep rates higher for longer (markets hate this). Nester, is changing her tune and has been speaking like (my words) “chill out Powell, inflation is cooling, and you are acting like you have all the votes; you don’t.” Fact: Chairman Powell only gets 1 vote as there are 11 other voting members. Until about a month ago, it was Powell who was getting all the attention from the media (he is the most visible and the loudest voice). But in addition to Nester, we’ve heard St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari both make their own Swahili statements alluding to the fact that rates are likely high enough. This rhetoric is not unnoticed and is now brought to the forefront with the softer inflation data. The markets like all of this.
What to expect for the December FOMC (Federal Open Market Committee) meeting regarding rates? Prior to the CPI of this past week, there was a high probability that rates would increase by another 75 basis points. After this last CPI report, it’s now a higher probability that rates will go up by a lesser hike of 50 basis points. The markets like this. But this gets pressed further as there is perpetual dialogue in business media that the FED should stop NOW and not raise rates any further. Oh, there are no lack of people who think the world is coming to an end and that the FED must keep raising rates by 75 basis points and then again in the February 2023 meeting by another 25bps-50bps. BUT it’s this talk (about stopping the rate hikes now) that has entered market narrative. No one can say what the next rate hike will be (or won’t). There will be a lot of theatre with more FED speakers between now and next month, PPI and another CPI report will be released prior to the next FED meeting. Some say that this recent CPI data point is not enough to change the course of the FED because one inflation report can’t change everything. I AGREE, one report can’t. What doesn’t get said enough, is that in June we were at +9.1% and inflation has not ticked up since then, it’s gone down over the course of 5 additional CPI reports.
Strange as it may be, realize that bad news is good news for the financial markets. Housing market slowing (bad for home builders), interest rates high (bad for mortgage companies), apparel prices falling (bad for retailers), used car prices falling (bad for car dealers), layoffs rising (bad for workers). Also realize that this data (and many other CPI components) show that inflation is slowing and that FED rate hikes are changing consumer behavior (for now). But this bad news is good news for financial markets because it allows the FED to pause, stop, slow down or end their rate hikes. Therefore, the market responded favorably last week. I point to a Market Moment written earlier this year for the reality of bad economic conditions and how the S&P 500 respond to them:
- Eisenhower Recession – Jan 58 (market bottom), May 58 (economic bottom)
- Stagflation – Sep 74 (market bottom), April 75 (economic bottom)
- Double Dip Recession – July 82 (market bottom), Jan 83 (economic bottom)
- Savings & Loan Crisis – Nov 90 (market bottom), April 91 (economic bottom)
- Global Financial Crisis – March 09 (market bottom), Aug 09 (economic bottom)
- Global COVID Pandemic – March 20 (market bottom), June 20 (economic bottom)
Read these 6 recessionary points again. Do you think that at the market bottom that things simultaneously got better for Americans? That as stocks and bonds began to behave favorably again that Americans felt better, and that the media spoke of unicorns and rainbows? They did not, when the market bottomed it has historically been shrouded by bad news on Main Street USA. But….
This time it’s different! No argument here. It’s ALWAYS different. But what is the same? History shows that the bad news and economic conditions continue to deteriorate for 4 to 7 months after the market hit’s it’s low point. You can absolutely anticipate that the media and your own observations will view bad news as ….. well…. bad news. It is bad news, and it will continue. Yet the lens the market views this bad news is different from the human lens. It’s part of the recalibration for financial markets that is favored by the markets. This continued bad news is viewed by the FED as “we beat inflation” and they can pause, stop, and pivot from hiking rates. The markets respond favorably to this.
Last and not least. Naturally past results are not a guarantee of future results. We had a mid-term election last week. I hope your candidate(s) won. The lesson from financial markets AFTER the mid-term election night thru the next 365 days. The S&P 500 data compiled from all mid-term elections from 1950 thru 2018. The results from history; an average of a +15.1% rate of return for the S&P 500 for the following 365 days.
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