Market and Economic Update

Switzerland has been known for its high-end watches and high-end banking, contributing to its reputation for quality, reliability, and security. Last Sunday, one of Switzerland's largest banks, Credit Suisse, was forced by the Swiss banking regulators to be taken over by Swiss bank UBS. It is believed that had the banks not merged, Credit Suisse would have failed. This follows several U.S. regional bank failures and fears that more will come. 

It is reported that billionaire investor and owner of the Carolina Panthers, David Tepper lost $17B in contingent convertible bonds as the Swiss government wiped out Credit Suisse stock owners and bondholders.

Monday – The average national retail gas price is $3.53, down 18.46% year over year. Falling gasoline prices and demand can indicate a slowing economy unless the decline is due to increasing supply which has not occurred.

• Portfolio Change – Underweight the Energy Sector.

Tuesday – In February, U.S. existing home sales increased by 14.5% to a seasonally adjusted annual rate of 4.58 million; however, they are down 22.64% compared to the previous year. This data is not as indicative of the economy's direction as usual. Most homeowners with mortgages have interest rates below 4%, and if they were to sell their current homes and obtain a mortgage for a new property, they would face higher interest rates. This factor discourages homeowners from selling, lowering the inventory of available existing homes on the market. Consequently, home builders may benefit, as a more significant percentage of home sales will likely consist of newly constructed properties.

• Portfolio Change – Allocation to the Homebuilders sub-sector.

Wednesday – The Federal Reserve's Federal Open Market Committee (FOMC) increased its rate by 0.25%, as anticipated, and maintained its 2023 rate outlook at 5.1%, implying another rate hike is expected. The written statement noted, "some additional policy firming may be appropriate," while removing the phrase, "ongoing increases in the target range will be appropriate." During the press conference, when asked about a potential rate cut in 2023, Chairman Powell responded, "rate cuts are not in our base case." Nonetheless, the bond market remains unconvinced. The Fed Funds Futures market is factoring in four quarter-point rate cuts in 2023 and an additional four in 2024. If the Fed reduces rates as aggressively as the bond market suggests, it could indicate a recession in the latter half of 2023.

• Portfolio Change – Reduced fixed income duration with an allocation to T-Bills. 

Thursday - Initial claims for unemployment insurance dropped by 1,000 from the previous week, reaching 191,000, which further supports the notion that the labor market continues to be tight. The Federal Reserve perceives a tight labor market as contributing to inflation since employees can request higher wages. These increased wages are then passed on to consumers through higher prices for goods and services.

Friday - St. Louis Federal Reserve President James Bullard increased his terminal Fed Funds rate target to 5.625%. He believes that banking system stresses will diminish in the coming weeks and months, and the robust economy may cause the Fed to need to raise interest rates further.

There is much uncertainty regarding the future path of markets and the economy. I will continue to monitor the market and economic data and adjust portfolio models accordingly.

Economic and Market Update

The S&P 500 bounced off its 200-day Simple Moving Average, ending the week up 1.9%, fueled by positive economic data indicating continued economic growth, although at a slower pace. Federal Reserve Bank of Atlanta President Raphael Bostic's recent comments to reporters also contributed to the market's upward trend. Bostic supports a cautious approach to monetary policy, stating that "slow and steady" would be the most appropriate course of action. Bostic's comments follow other Fed Presidents who suggested that a return to 0.50% rate increases could be appropriate if future inflation data is hotter than expected.

Below are some highlights from this week's economic data.

Monday:

US Durable Goods orders showed a 4.5% decline in orders for manufactured goods, but if we exclude transportation, durable goods orders grew by 0.69%. Passenger airplanes are big ticket items illustrating how much Boeing contributes to US manufacturing.

Tuesday:

Case-Shiller Composite 20-City Composite Home Price Index showed that year over year, home prices grew by 4.67% compared to 18.51% a year ago. The long-term average is 5.32%.

Wednesday:

Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index was 47.7 compared to 47.4 a month ago, showing an overall contraction in the manufacturing sector for the fourth consecutive month. A number above 50 indicates growth, and below 50 indicates contraction.

Thursday:

Initial Claims for Unemployment Insurance were 190K lower than the 192K from the week before. Though lay-off announcements are increasing, it would seem those losing their jobs are quickly finding new jobs. Next Friday, we'll get a new Jobs Report from the Bureau of Labor Statistics (BLS). Last month showed a surprising monthly gain of 517K jobs and an unemployment rate of 3.4%. This was lower than expected and considerably lower than the longer-term average unemployment rate of 5.9%. The Federal Reserve views the tight labor market as inflationary. Another big jobs number would suggest that there is little slack in the job market and the Fed has much more work to do.

Friday:

The Institute for Supply Management (ISM) Services Purchasing Managers Index dipped to 55.1 from 55.2 the month before, showing expansion in the economy's service sector. A number above 50 indicates growth, and below 50 indicates contraction.

 

Summary:

There is a disagreement between the stock and bond markets regarding what comes next for the markets and economy. Stock market participants see evidence of a strong economy and job market and see equity prices going higher. The S&P 500 trades at 18 times 2023 expected earnings; the historical average is 16. Fourth-quarter earnings were better than feared, but many companies lowered their 2023 guidance suggesting that earnings estimates may come down, making the S&P 500 more expensive at current levels.

 

Interest rate traders are pricing in at least three more Fed rate hikes, and the Fed Funds rate staying above 5.25% through January 2024. The impact of earlier rate hikes are only now being felt in the economy. I struggle to believe we will see significant economic expansion while the Federal Reserve is raising interest rates to slow the economy.

The Federal Reserve Bank of New York increased the odds of a recession in the next 12 months to 57.13% from 47.31% last month.

 

The spread between the yield on the ten and two-year Treasury bonds, a reliable recession indicator, is more inverted than it's been in forty years.

Portfolio models remain defensively positioned. I am not anticipating a deep or pronged recession but rather the Fed winning the battle against inflation by contracting the economy. The S&P 500 is 15% below its all-time high and 13% above last October's lows, and I expect the S&P 500 to remain in this range. If the data changes, we'll adjust.