Inevitable
By Crest Capital Advisors on June 23, 2023
Dow: (1.67%) to 33,727.43
S&P 500: (1.39%) to 4,348.33
Nasdaq: (1.44%) to 13,492.52
Russell 2000: (2.87%) to 1,821.63
10-Year Yield: 3.74%
Outperformers: Healthcare 0.24%
Underperformers: Real Estate (4.03%), Energy (3.45%), Utilities (2.59%)
US equities were lower this week as the S&P 500 broke a five-week streak of weekly gains and the Nasdaq broke an eight-week streak. It was inevitable that stocks would see a pullback after such a significant run, but that doesn’t make it any more enjoyable for investors.
This week’s lead story was the focus of central banks on fighting inflation and the accompanying narrative they are trying to convey that the fight is far from over and rates are likely to stay “higher for longer” (more on this below). The Bank of England raised rates more than expected, which follows hawkish decisions and rhetoric from other central banks around the world, including the Fed this week in Jerome Powell’s testimony to Congress (more on this too, below). And yet, even though markets were lower, the look and feel of the decline felt more like a yawn than a panic. This just goes to illustrate the use of jawboning as a policy tool is not as effective for equities as it was in 2022. So, the big story remains declining volatility and volumes despite the hawkish central bank rhetoric. Expectations for a quiet summer in stocks are gathering steam.
On the economic front, data this week mostly offered support for the soft-landing narrative. Friday’s flash manufacturing PMI missed, but input prices fell at the fastest pace since May 2020 and selling price inflation was the slowest since the inflationary cycle began over three years ago. The flash services PMI was in line, with business confidence the highest since May 2022. Strong housing data was also in focus with June NAHB builder confidence the highest since July 2022,
Next week should be a bit busier. Data includes Tuesday’s May durable goods and new home sales, as well as June consumer confidence. Data Thursday includes final Q1 GDP and pending home sales, while Friday’s data includes the Fed’s favorite measure of inflation (the PCE). All of this as we close out the end of the month, the second quarter, and the first half of the year!
Broadening Out
One of the key bearish talking points to throw cold water on this year’s market rally has been to focus on the narrow sub-set of stocks that are driving all of the YTD gains within the major indices. To be fair, while we don’t see it as reason to ‘dismiss’ a move, we too want to see the market broaden out as a sign of health and sustainability. When markets are appreciating broadly, it is a sign that money flows are supportive of equities from a fundamental perspective. Contrast that to a an environment characterized by a narrow sub-set of the market leaving the majority behind…this has historically been a condition based on speculation and thereby unsustainable.
Well on this front, we are pleased to report the market is indeed broadening out. As of mid-week, we have moved to 66% of stocks in the S&P 500 trading above their respective 200-day moving averages. This is still lower than we saw in early February (79%), but it is well of the recent levels around 45% and higher than the April high of 63%.
We Don’t Believe You
Last week’s so-called “hawkish pause” (or “skip”, depending on your persuasion) was accompanied this week by additional “hawkish” rhetoric from Chair Powell in his testimony to Congress. Here is the key quote:
“The process of getting inflation back down to 2% has a long way to go.”
- Jerome Powell (In testimony to Congress on 6/21/2023
Really? We still have a long way to go, Jerome? Let’s look at some facts:
CPI peaked in June 2022 at 9.06%.
The latest CPI report released in June for May 2023 was 4.05%
That means, we are 76% of the way to the Fed’s target of 2.5% CPI (which translates to 2% in PCE terms on average) in just 11 months.
But wait, there’s more!
When the June CPI data is published on July 12th, we will be dropping from the calculation a massive 1.2% month-over-month inflation. So, due to base effects, economists best estimates for the next inflation report is we will in a range of 3.1% – 3.3%.
That means we will be 88% back to the Fed’s target!!
And, this trend is expected to continue into the August CPI print (July data) which could bring headline CPI all the way down to 2.51% before the next FOMC meeting on September 20th (after the late July meeting).
This goes a long way towards explaining why the market hasn’t really budged all that much in response to the hawkish rhetoric and the overt threat of additional rate hikes from here. It’s because strategists and economists know the data is heading back to the Fed’s target zone, and fast. It’s why the futures market for Fed fund rate expectations have moved only modestly and it’s why stocks haven’t taken the hit they otherwise would have had the calendar said 2022.
In short, the market may have a message for Jerome Powell. And that is….
Just How Long Might of a “Pause”?
So, if we’re right, and the Fed has indeed truly arrived at the “Pause” moment, how long might that last? Well, for those expecting the Fed to go on an extended pause, here’s how long prior pauses after tightening cycles have lasted since 1994. 15 months was the longest from June 2006 – September 2007.
We Love It When the Strategists Finally Catch Up to Us
We found it interesting this week when BCA Research, a leading independent provider of global macro research, released a new report questioning the current narrative on “sticky inflation”. Here’s the key excerpt:
“We are coming to the conclusion that inflation might have been one of the many results of the pandemic shock … In our opinion, high inflation may turn out to be relatively transitory rather than persistent as widely feared … the core CPI inflation rate has been mostly boosted by the rent component of the CPI, which accounts for 34.6% of the total CPI and a whopping 43.5% of the core CPI … As rent inflation continues to moderate, so will the core CPI.”
Hmm…now only if we could recall where we’ve heard this line of reasoning before.
So Much for Quality
So far, 2023 has been the worst relative year for the “Dividend Aristocrats” since 1999! Dividends stocks, broadly speaking, haven’t been in vogue given the rise to prominence of stocks associated with artificial intelligence and technology stocks more broadly YTD. However, the relative performance (or lack thereof) for S&P 500 dividend aristocrats relative to the S&P 500 hasn’t been this negative since the height of the dot-com bubble in 1999. For those that piled into quality stocks as a safe haven in times of uncertainty and market stress (a perfectly logical reaction), be patient. While you may be lagging the market indices so far, quality attributes (such as predictable dividends) tend to win out over the long run.
Economic Funnies
Discussion overheard at the latest FOMC Meeting
Crazy Stat(s) of the Week
Here are this week(s) crazy stats!
- The Apple App Store Turns 15. After growing between 27% and 29% annually since 2019, Apple’s App Store now generates $1.1 Trillion in billings and sales on a global basis. Fifteen years after its launch in 2008, total sales in the App Store are larger than the annual GDP of all but 16 countries and are larger than the GDP of countries like Saudi Arabia, Turkey, Switzerland, and Taiwan. (Source: Apple & Wikipedia)
- The 10-year/3-month Treasury yield curve has now been inverted for 154 trading days (as of mid-week). If it stays inverted through mid-September, this will be the longest streak of days with an inverted curve since at least 1962. How long can the economy sustain an inverted curve?
Quote(s) of the Week
“We forecast ‘further deceleration for both payrolls and inflation’ … If our forecast for CPI is realized, the Fed’s forecast for inflation will have to get revised down, and … Powell’s insistence that the ‘July meeting will be live’ will likely be rendered moot.”
-Morgan Stanley Economic Research
Calendar of Events to Watch for the Week of June 26th
The week ahead will have a series of more meaningful economic and inflation reports to help inform the near-term direction of stocks. The highlights will be May Durable Goods on Tuesday and the Fed’s favored measure of inflation (PCE) on Friday. Along the way, we’ll get new and existing home sales data for April. In the interim, a small handful of earnings reports will get some attention (notably led by Nike).
Finally, markets are often susceptible to wide movements as we approach month and quarter end weeks such as will have next week. So we expect a fair amount of activity before we start looking ahead to Q2 earnings season in mid-July.
Monday 6/20 – The Dallas Fed Index for June is expected to remain in contractionary territory at -21.0 v. -29.1 in the prior month.
Tuesday 6/27 – May Durable Goods Orders (preliminary) are expected to slip into contraction at -1.0% vs the prior month’s 1.1% increase. We’ll also get New Home Sales for May which is expected to decline -0.36%. And finally, June Consumer Confidence is expected to post a slight uptick to 103.8 from 102.3 last month.
Wednesday 6/28 – US Wholesale Inventories for May are expected to decline by -0.1%, the same rate as the prior months decline.
Thursday 6/29 – Final Q1 GDP figures are expected to be unchanged at 1.6% year-over-year. May Pending Home Sales are forecast to remain roughly flat with April’s data and the Initial Jobless Claims data is expected to remain in check at 270k new claims v. last week’s 264k.
Friday 6/23 – The highlight of the week will be the May Personal Consumption Expenditure (PCE) report. The headline rate is expected to increase 0.1% month-over-month to a 3.9% year-over-year rate, down from 4.4% last month. The Core is expected to remain elevated at 4.7% year-over-year and unchanged from the prior month’s report. Looking overseas, we’ll also get Flash estimates for June CPI which is expected to come in at 5.6%, down from 6.1% in the prior month.
Source: FactSet
