@theMarket: Macro-Economic Data Indicate a Soft Landing
The economy grew faster than most expected in the fourth quarter. Unemployment continues to remain tame and corporate earnings, while not stellar, have been good enough to support financial markets this week.
Good news on the economy has been bad news for the stock market at least since the Fed has been tightening interest rates. The reasoning has been that stronger growth and employment would feed the inflation rate forcing even further tightening by the U.S. central bank and ultimately choking off the economy.
Now that inflation appears to be coming down, a bullish case is building that says we might get away with just a mild (as opposed to a full-fledged) recession. If so, corporate earnings would slow, but not fall off a cliff. Unemployment would rise, but not decidedly so, and a quarter or two of flat to slightly down GDP growth could suffice to continue pushing inflation lower. I call that the Goldilocks Scenario.
This week's macro data appeared to support that theory. U.S. fourth-quarter Gross Domestic Product for 2022 came in higher than expected at 2.9 percent versus an estimate of 2.6 percent. But that was down from the third quarter's 3.2 percent gain. Unemployment claims for the last week of 2022 fell by 19,000 to a seasonally adjusted 204,000. However, the number of temporary jobs, which usually leads to the overall unemployment rate is starting to decline.
The Fed's favorite inflation gauge, the Personal Consumption Expenditures Price Index, (PCE) came in a bit cooler in December. And corporate earnings, while not great, are still good enough for most stocks to maintain price support.
Most readers know that the quarterly earnings reports are a dance where the Street reduces earnings estimates low enough that most companies can "beat" estimates. Future guidance is therefore the focal point for investors. Coming into this week, traders were positioned for a "worst-case" scenario for most earnings announcements.
Microsoft is one of the most important stocks in the equity universe. It announced so-so earnings, but the stock leaped higher by 6 percent after the announcement because it could have been much worse. In the discussion after the announced results, however, management guided investors to expect fewer sales and profits in the quarters to come. The company's stock swooned in the after-hours. It dropped even further the next day and took the entire market down with it.
Traders decided at some point during the next day that the bad news was fully discounted and preceded to bid the stock back up to close even on the day. The same exercise occurred several times throughout the week on many stocks that announced earnings. On a macro level, the same thing happened on Thursday after the positive GDP quarterly data was announced. The markets spiked higher, but then gave it all back as the "good news is bad news" crowd reasserted themselves. In short, investors are grabbling to find a happy medium between the strength in the economy, the Fed's intentions toward future tightening, and the proper level for the markets given these unknowns.
It had been my view that the stock market could retest or even break last year's lows as early as February. I had predicted this unraveling as far back as early November of last year. It has now become the consensus view, which has made me increasingly uncomfortable.
If the bearish view were to come true, equities, as well as commodities and precious metals around the world would decline, interest rates would spike higher, and the U.S. dollar would skyrocket. I believe that would be a fantastic generational opportunity to buy the dip. Materials, gold, and silver as well as miners, would be high on my list of areas to accumulate. China and emerging markets would also be up there.
If, on the other hand, my prediction fails to materialize, and the market continues to grind higher, we could ultimately see 4,370 on the S&P 500 Index, which is another 300 points higher from here, before all is said and done.
In the end, it all comes down to what the Fed will decide to do in its February FOMC meeting next week. The problem is that the higher the markets climb, the more dovish the Fed would have to be to support the market.
A continuation of their hawkish stance will disappoint the markets while sending the U.S. dollar and interest rates higher. If they moderate their message and hint at a possible pause to assess the results of past tightening, markets will continue higher. I wish I had a crystal ball, but I don't. However, either way, in the longer term, it seems that we end up in the same place, which is higher going into the second half of the year.
@theMarket: Markets Are Stuck in Chop City
Welcome to a new year of financial markets. But while the dates have changed, stocks continue to disappoint.
The S&P 500 Index has been caught in a range with the mid-point around the 3,800 level. Next week, we could see a minor break higher to the 3,920 level, but it probably won't last. That is because Wall Street experts are as confused as the rest of us. Forecasts for 2023 are all over the place with some strategists predicting an up year while others believe the declines of last year will continue.
The confusion stems from a variety of unknowns including the path of inflation, interest rates, and the economy overall. Currently, the markets are focused on the labor market, specifically job and wage growth. That is understandable given the Fed is also focusing on this area as a 'tell' on whether their tight money policy is working.
However, both wages and jobs data thus far seem unaffected by higher interest rates and the Fed's attempt to slow the economy. That may change soon since we are seeing more and more companies announce layoffs and other cost-cutting actions. Goldman Sachs, Salesforce, and Amazon, for example, announced layoffs this week.
This week's non-farm payroll report illustrates the confusion. The number of job gains in December surpassed expectations (223,000 jobs versus 200,000 expected) but the average hourly wage growth fell slightly (from 0.3 percent compared to 0.4 percent expected). The headline unemployment rate, which politicians tend to focus on, declined from 3.7 percent to 3.5 percent.
This is the second month in a row where wage gains fell while employment gained. This is the best of all worlds for the Fed's battle with inflation. If jobs continue to grow, but wage gains, which are a big component of future inflation, continue to decline that may give some hope to traders the Fed may not need to tighten as much this year.
The macroeconomic data continues to give conflicting signals on economic growth as well. Some sectors appear to be slowing, while others are continuing to grow at a reasonable pace. Most economists believe we will be entering a recession in the first half of the year but how deep and long is subject to endless debate.
Other smart people I follow believe we will see a series of rolling recessions among various sectors as the year progresses as opposed to a traditional decline in sectors throughout the economy. If so, any recession will likely be moderate as some areas continue to do well while others sink.
Over on the inflation front, the data appears to be indicating further price declines, but how much and how soon is unknown. While everyone has an opinion, no one knows for sure. In essence, both investors and the Fed are in a wait-and-see environment on how monetary policy will impact the economy in 2023. All this conflicting data has created what is called a "chop city" in the stock market where markets gain and lose from data point to data point sometimes on the same day or even hour.
Speaking of the market, the other area that will surely impact stock prices will be fourth-quarter corporate earnings, which are just around the corner (Friday, Jan. 13). Most analysts believe that earnings estimates, and future guidance will be disappointing. If so, it will trigger further sell-offs in stocks.
In the past, I have written that until the "generals" start to fall, stocks have a long way to go before this decline will be over. The good news is that has begun to happen. The bad news is that these top 5-6 stocks are destroying investors' portfolios and the market with it. The FANG stocks, which had represented 24 percent of the major indexes, are seeing major declines but still represent 19 percent of the overall market. Names such as Tesla, Apple, Google, Microsoft, and Amazon are seeing unrelenting selling, followed by short-lived bounces that indicate to me substantial liquidation from both retail and institutional investors. For the markets to finally bottom these stocks must catch up or even exceed the losses sustained by many other growth stocks.
As readers are aware, my forecast over the last month was that the S&P 500 index would trade between 3,700-3,800 through December and into January. That has come to pass. This week's bullish sentiment reading of the AAII Sentiment Survey ranks among the 60 lowest in the survey's history. Bearish sentiment continues to build, which is no surprise given how negative many financial players feel about the markets. Still, as a contrarian indicator, that likely indicates we are due for a bounce soon.
I can see the markets rally into mid-next week if the dollar remains weaker, and interest rates remain stable. At that point, Thursday, Jan.12, the Consumer Price Index for December will be the focal point, followed by bank earnings on Friday. Those events could either goose markets higher or tear them down again.
Longer-term, I believe that we will see lower lows in February through March 2023 that could take the S&P 500 Index down to 3,200 or lower. Disappointing corporate earnings, a Fed that is unmoved by improving inflation rates, higher interest rates, and a stronger dollar will be the triggers for this. That's the bad news.
Sometime in March, however, I think the markets will bottom. We could see a substantial rally into the spring, and maybe even into the summer. I will flesh out that forecast as we go along so stay tuned.
@theMarket: Good News on Economy Is Bad News for Stock Market
The good news on the economy has been bad news for the stock market. That's been the name of the game for the last several months. This week, we had more of the same.
The third and final revision of the U.S. third-quarter 2022 Gross Domestic Product came out on Thursday, Dec. 22. It was revised up to an annual rate of 3.2 percent from 2.9 percent. That's a sizable increase. The engine behind that growth was consumer spending and U.S. exports.
On the unemployment front, jobless claims for last week were roughly flat versus the previous week. That indicates that employment is still running hot. Neither of those data points gives the Fed any reason to relax its tightening schedule.
That was bad news for the stock market. All the main averages promptly declined between 2 percent-3 percent on Thursday. On Friday, the inflation index most watched by the Fed, the Personal Consumption Expenditures Price Index (PCE) for November, came in as expected (0.2 percent versus 0.3 percent in October), which the markets took in stride.
Investors, however, are so skittish that every data point is an excuse to run markets up or down. As I have warned readers in the past, selecting one or two data points and extrapolating a trend from them is a dangerous game, but that is exactly what the markets are doing.
As a result, stocks are ricocheting up and down on each announced data point. This becomes even more ludicrous when you realize all this data is not only highly inaccurate but will undergo revisions that many times are the opposite of the original announcement.
The most important event of the week happened overseas earlier in the week when the Bank of Japan finally joined the world's central banks in dumping its loose monetary policy stance of the last few years. After keeping its 10-year Japanese government bond yield below 0 percent, surprised global investors by allowing that yield to move 50 basis points on either side of its zero percent target. That sparked a sell-off in bonds and stocks around the world while driving the yen up and the U.S. dollar down.
Unfortunately, things are looking rocky for that Christmas rally promised by so many talking heads on Wall Street. Many investors believe that because a Santa rally has happened so often in the past that one is just about guaranteed this year. But thus far, I would call this week a Santa Claws event. The problem is that these rallies are often momentum-based, meaning markets already in an uptrend, continue to trend higher. That has not been the case this year. If anything, looking at the year's performance, the momentum has all been to the downside.
The AAII Sentiment Survey tracks the opinion of individual investors on where they think the market is going. It is often used as a contrary indicator. This week the index hit the highest level of bearishness among investors in nine weeks at 52.3 percent, while the number of bulls registered was a paltry 20.3 percent. The spread between bulls and bears is negative at minus-32 percent. The dour readings should give bulls some encouragement that at some point soon we may see another relief bounce.
I expect that we continue our journey down toward my 3,700-3,800 target on the S&P 500 Index. If we reach that level soon, we could see an up day or three during the upcoming, holiday-shortened week ahead. But whatever upside we may get should not be confused with the primary trend, which is down for the first quarter of 2023.
My advice is to set aside the market for the next three days, and instead, focus on family, friends, and loved ones. Merry Christmas and Happy Hanukkah.
@theMarket: Markets at Odds With the Fed
"Don't fight the Fed" is an oft-quoted market saying that has remained sage advice for the past decade or two. Recently, however, it appears investors are thumbing their noses at that advice.
This week, Fed Chairman Jerome Powell and his FOMC members released yet another warning that they see a long drawn-out battle with inflation that will last well into next year. Given the decline in bond yields and the rise in equity indexes, the financial markets appear to disagree. Who will turn out to be right has major implications for what happens to financial markets into the New Year.
The recent good news on the inflation front — lower monthly Personal Consumption Expenditures Price Index (PCE) and the Consumer Price Index (CPI) data — has convinced investors that inflation is on the run. The expectation that core inflation could fall as low as 2.6 percent by the end of 2023 is the bull case. They argue that global supply chain disruptions were the main cause of the inflation spike. That problem is disappearing quickly and as it does, so will inflation.
If so, inflation could fall to the Fed's target rate of 2 percent within the next 12 months. Some investors believe that the Fed will not only need to back off from raising rates but likely begin to cut interest rates to avert a serious recession. As such, the bulls have been bidding up stocks and buying bonds.
The Fed is on the opposite end of the spectrum. Chair Powell has remarked on several occasions that headline inflation, as represented by the Producer Price Index and the Consumer Price Index, is not a good indication of the true rate of inflation. Why?
It is because energy, durable goods, and shelter are three areas heavily represented in those indexes and are strongly influenced by supply chain disruptions. The Fed is looking more at variables like service prices, which are labor-intensive, and have more to do with aggregate supply and demand. That puts employment squarely in the central bank's cross hairs and they see little in the way of a slowing down in job growth.
Despite two monthly declines in the rate of inflation as represented by the CPI, the Fed has raised its forecast for inflation next year to 3.1 percent, and its core inflation (ex-food and energy) forecast to 3.5 percent from 3.1 percent.
The Fed also sees meager growth in GDP (plus-0.5 percent), while many economists had been predicting at least a moderate recession beginning in either the first or second quarter of 2023. Now, it appears that there is a growing consensus among a group of bulls who think a mild recession at most will reduce the inflation rate quickly as supply chains continue to recover and expand.
There are a couple of flies in that ointment, from my perspective. Even if inflation was solely the result of supply chain disruptions, why are the bulls so sure that supply chain problems will disappear, never to return?
China, the main cause of those disruptions, is giving up its zero COVID-19 policies, but as a result, the infection rate among the Chinese population is skyrocketing with a real possibility that supply chains may come under pressure once again. Our own country is not immune to another resurgence of COVID and possible supply chain issues.
Omicron BQ, and XBB, are COVID subvariants that are currently causing 72 percent of new infections in the U.S. They are the most immune evasive variants of COVID-19 thus far. Present vaccines and boosters are "barely susceptible" to neutralizing the disease, according to the U.S. Centers for Disease Control. The holiday season might usher in a big spike in infections with all the lost productivity that could entail.
In my opinion, it seems far too early to claim victory on the inflation, interest rate, and growth front. The disappointing FOMC meeting this week may convince investors that stocks are ahead of themselves. We have not been able to break the top end of my target range (4,000-4,100) thus far on the S&P 500 Index. "Don't fight the Fed" seems good advice to me.
I am sticking with my cautious forecast and believe that the markets need to pull back to test the 3,700-3,800 level on the S&P 500.
@theMarket: Is the Market's Holiday Rally on Track?
Fed Chairman Jerome Powell delivered a bagful of gains this week for investors. Stocks roared to life as "Santa" came to town. And then the job numbers on Friday spoiled the mood.
"The time for moderating the pace of rate increases may come as soon as the December meeting," said Powell in his opening remarks at the Brooking Institute on Wednesday, Nov. 30. The word "moderating" was all the algos needed to hear.
It was equivalent to striking a match to a kid's backyard toy rocket. The U.S. dollar fell, stocks across the board exploded and the main indexes racked up gains of 3-4 percent-plus by the end of the day. Commodities also roared higher led by precious metals.
Thursday the Personal Consumption Expenditures Price Index, a key inflation data point that the Fed uses to monitor inflation also came in cooler for October. The PCE rose 6 percent in October versus last year and down from September's 6.3 percent annual increase. Overall prices rose 0.3 percent, which was the same monthly increase as in each of the previous two months. It could be that Powell had an inkling that the inflation numbers were improving, which could have contributed to the slight shifting of goalposts this week.
However, Friday's monthly jobs report for November came in "hot." Non-farm payrolls came in with a 263,000 gain versus the 200,000 expected. Average hourly earnings on a month-to-month basis rose 0.6 percent versus the 0.3 percent expected. That data may be good for the continued growth of the economy, but also means that the Fed has no reason to relent in its hawkish stance. As a result, markets gave back about a third of their gains for the week.
Does that mean we should expect hotter or cooler Consumer Price Index (CPI) on Dec. 9, and Price Producer Index (PPI) data on Dec. 13? Given the inaccuracy of macroeconomic data, I would say that is at best a crap shoot.
The most important events that investors face are the OPEC-plus meeting on Dec. 4, and the European Union (EU) Russian oil embargo and price cap on oil the following day. This could prove to be a disruptive event on world energy prices. What happens to the oil price has a direct bearing on future inflation, so financial markets will react to these events.
If an EU ban on purchasing Russian oil leads to the removal of up to 2 million barrels per day of oil from the market, we could see a spike in energy prices. To prevent that from happening, the U.S. and G-7 nations have devised a price cap scheme where that oil can be sold to non-European nations but only at a lower price. The question is the price.
The latest number was $62 a barrel cap, but Poland, Estonia, and Lithuania are arguing that the price is still too high. The facts are that if India or China ignore the whole price cap ban, which is a distinct possibility, then what could happen is that most of this spare Russian oil will simply be rerouted to these two large consumers of oil.
Bottom line: next week could see some wild swings in oil based on geopolitical headlines from various players so be prepared.
Last week, I wrote that my target for the S&P 500 Index of a high between 4,000-4,100 had been met and it was time to take profits. This week we hit the top end of my range before falling back. Could it climb higher? It could, but it seems to me that market action tells me that we are closer to a top, not a bottom. I will be taking profits as we climb higher.
If I am right, what is the potential downside for the markets? I expect a 125-to-250-point (up to 6 percent decline) to as low as 3,700 on the S&P 500 Index.