 Sizing things up
The week started slowly, as expected, with markets mulling over the inflation data from the previous week and letting off a bit of steam as we recorded new all-time highs. Things picked up on Wednesday following the release of the Federal Reserve’s latest meeting minutes and anticipation of earnings from NVIDIA, the darling of the AI boom. But not even blowout earnings from NVIDIA could stem the bleeding last Thursday, as we had the worst day for the Dow so far this year. The culprits? Lower-than-expected unemployment claims and a stronger-than-expected manufacturing reading. Both data points signaled that the jobs market is still robust and the economy may not be getting weaker as expected. The situation was made worse by the Fed minutes, which showed some of the voting members were open to keeping rates higher for longer and possibly open to further hikes. All of this was enough to send markets spiraling downward. The jobs and manufacturing readings pointed to inflation continuing to be sticky with no concrete signs of approaching the 2% level the Fed would like to see. The talk is that we may even see an uptick before inflation falls further; if we do, it would put any rate cuts in July out of reach unless we see inflation drop further. Markets modestly recouped some of their losses on Friday before we limped into the long weekend. It is also important to note that the Friday before a long weekend is notoriously plagued by lower volumes as traders generally take the day off. I would not say we are out of the woods until we see two or three solid sessions of gains, but with Personal Consumption Expenditures (PCE) data this week, we may have another bout of volatility. The 10-year Treasury is stubbornly clinging to the 4.5% yield level, and until it starts marching steadily downward. the markets will be nervous. The Feds’ own Greek epic Remember Homer’s Ulysses (aka Odysseus)? At one point in his journey, he and his crew had to sail through the Strait of Messina near current-day Calabria, Italy, to get home. In Greek mythology, that would involve running a gauntlet. On one side of the straight was Scylla, a six-headed monster that eats men passing on ships. On the other is Charybdis, a giant whirlpool that destroys everything in her reach three times per day. Let’s apply that dilemma to Fed Chair Jerome Powell and the Fed’s current situation. On one side, Powell has proven to be a little less independent than we would like. He seems very open to cutting rates to help spur the economy, which might be helpful to incumbents in the upcoming elections but would also increase inflation. However, this approach could mean less of the crew would get eaten by Scylla. On the other side, if the Fed keeps rates higher for longer or even raises them more to tame inflation, it might send the entire economy into recession. That would be the Charybdis option. How did Ulysses handle it? He sacrificed six of his crew to Scylla but saved the rest and his ship by avoiding Charybdis so they could continue on their journey home. If this situation sounds familiar to you, in today’s colloquialism we would say Powell is “between a rock and a hard place.” Cutting rates too soon may help the political fortunes of some, but cutting too soon will also keep inflation higher and hurt many in the long run. But keeping rates too high might suck everyone down into the whirlpool of recession. The entire economy and the whole country, politicians included, would suffer. That’s where Powell and the Fed find themselves. Will they sacrifice a few in the near term for the good of the many longer term? We have heard that Powell needs to channel his inner Paul Volcker, who famously tamed inflation back in the late ’70s and early ’80s. I would argue he may need to channel a little of his inner Ulysses this time around as well. Coming this week
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On May 26th, 1896, Charles Henry Dow, publishes the first Dow Jones Industrial Average.
Editor of the nascent Wall Street Journal, he added twelve prices of leading companies together and divided by twelve to arrive at 62.76. The components of the index changed fifty-two times in coming years. In 1916, it expanded to include 20 stocks; in 1928, it grew again to 30 stocks, a composition that remains. The 1929 stock market crash led to the Great Depression, with the DJIA losing nearly 90% of its value from its high in 1929 to its low in 1932. During the mid-20th century, the DJIA reflected the post-WWII economic boom and industrial expansion in the United States, surpassing 500 points for the first time in 1956 and briefly hitting 1,000 points in 1966 before falling back. The DJIA continued weighting its components by their price per share, and the title “Industrial” remains despite a few modern components being involved in heavy industry. Little could Charles Henry Dow have imagined how his arbitrary index, now available with constant updates instead of once per day, would affect generations of future investors. Last week, during intraday trading, the DOW approached and briefly bypassed a milestone at the 40,000 level. Approaching a milestone of my own this summer (I turn 50 in June), I’m wary of giving arbitrary numbers too much attention. And a deeper dive into the DOW backs up the theory. First, given the history of the DOW, the composition has obviously changed dramatically throughout the decades. So, are you really comparing apples to apples? Or, in this case, Apple (AAPL) to Apple (AAPL)? And the price weighting leads to some oddities in calculating the index. For instance, can anyone name the largest component in the DOW right now? Apple? Microsoft? Goldman Sachs? All good guesses but incorrect. Right now, United Healthcare is the largest component in the DOW at just over 8.6%. The fact that a healthcare company is the largest component after a huge run-up in technology shares over the last year should tell you that for better or for worse, the old DOW is much less sensitive to change than its counterpart, the S&P 500. Indeed, those tech companies we listed with ties to the booming AI industry are 8th (MSFT) and 19th (AAPL) in weightings inside the index. The Dow's recent run past 40 (thousand) is no more significant than my own survival of the decade of my 40s. Longevity is preferable to the alternative. But let’s not make more of the story than it deserves.  New week, same concerns
Inflation isn’t budging. The producer price index (PPI) for March was revised downward from its original reading of 2.1% to 1.8%. Then, final demand (PPI minus food, energy and trade services) increased by 3.1% for the 12 months ending in April. It’s the largest increase since climbing 3.4% one year ago. Long story short: Inflation isn’t going anywhere. Despite some weakness from the initial first-quarter gross domestic product (GDP) reading and a soft April jobs report, all that did was take any potential rate increases off the table. Top-line consumer price index (CPI) ticked down a bit in April to 3.4%, but that was enough to drive markets to new highs (see next section). Markets are still banking on rate cuts, and with inflation stuck in the 3.5% range and showing no sign of further meaningful declines, the recent euphoria in U.S. stocks may be short-lived. Until we see consistent declines, we cannot expect any cuts. In fact, the Federal Reserve may be so preoccupied with watching inflation that it might be taking its eye off the slowing economy and job growth. If those deteriorate much more, we will see rate cuts — but only because the Fed will feel panic that we’re maybe sliding into recession. The markets grind higher Remember when the Dow was at 30,000? That was back in November 2020 — less than four short years ago. We dipped below 20,000 briefly in March that same year. Last Friday, the Dow closed above 40,000 for the first time in history. Meanwhile, the S&P 500 crested above 5,300 that same day, ending at 5,808 for another new record. Same story for the Nasdaq: It also hit a new record on Wednesday but slid a bit to end the week. Records are great, but they’re only mile markers. What markets are telling us is they are optimistic that we can still tame inflation, avoid recession and get rate cuts. That’s why a meager 0.1% decline in CPI was enough to boost us to new highs. The markets are in a good mood, and when markets are in a good mood, they want to go higher. How much higher is going to be a data-point-by-data-point process and will result in some volatility. However, until we see actual rate cuts, it’s wise to avoid getting overextended and exceeding your risk tolerance. Stay the course and maintain discipline. Enjoy the new highs, but be prepared for new challenges this year. Coming this week
On May 16th, 1860, a contentious Republican convention begins in Chicago.
Held in Chicago from May 16 to May 18, 1860, the convention marked the emergence of the Republican Party as a major force in national politics and set the stage for the election of Abraham Lincoln as the 16th President of the United States. William H. Seward, a prominent senator from New York, emerged as the front-runner, but his perceived radicalism made him a controversial choice. After two days of debate and on the third ballot, the Republicans selected the former Congressman and little-known lawyer from Illinois as their candidate for President of the United States. Elected later that year with less than 40% of the vote, Lincoln brought former rivals like Seward, Salmon P. Chase, and Edward Bates into his cabinet to shore up support. Instead of surrounding himself with like-minded individuals, Lincoln appointed rivals and political adversaries to his cabinet, aiming to create a diverse team that could help him navigate the challenges of leading the nation during the Civil War. In the words of historian Doris Kearns Goodwin, Lincoln created a “Team of Rivals.” This unique approach to leadership, where diversity and dissent were embraced, is a significant aspect of Lincoln's legacy. You see, Lincoln wasn’t just fighting the Civil War; he was fighting Confirmation bias, a term introduced by English psychologist Peter Wason, referring to the inclination of individuals to prioritize information that aligns with, reinforces, or validates their existing beliefs or values. Once established, confirmation bias becomes entrenched and challenging to dislodge, shaping how individuals perceive and interpret new information. Instead of succumbing to the allure of confirmation bias by surrounding himself with ideological clones, Lincoln embraced dissenting voices and conflicting viewpoints. Instead of retreating into ideological echo chambers, Lincoln and his cabinet engaged in rigorous discourse, challenging each other's assumptions and perspectives. Through this process, they arrived at more robust solutions to the nation's complex problems, particularly during the tumult of the Civil War. Today, thanks to social media and the algorithms that show you more of what you like and less of what you don’t, we are living in the golden age of confirmation bias. I’m not saying social media has no place in an investor’s life. Just be sure to recognize it is a rival to good decision-making when you add it to your team. On May 12th, 1925, Lawrence Peter Berra is born in St. Louis, Missouri.
Yogi Berra, born on May 12, 1925, was an American professional baseball catcher, coach, and manager. He is best known for his long and successful career with the New York Yankees, where he played from 1946 to 1963. Berra was a key player in the Yankees' dynasty, winning 10 World Series championships as a player, the most in baseball history. He was renowned for his exceptional catching abilities, quick wit, and memorable phrases, known as "Yogi-isms.” After his playing career, Berra transitioned into coaching and managing, leading both the Yankees and the New York Mets. He continued to be a beloved figure in baseball, known for his affable personality and contributions to the sport. Berra was inducted into the Baseball Hall of Fame in 1972. He passed away on September 22, 2015, leaving a legacy as one of baseball's greatest players and personalities. The ‘fork in the road’ bit supposedly described to Joe Garagiola how to get to Yogi Berra’s home in Montclair, New Jersey. However, the saying predates the sage and can be found in print as early as 1913. As Berra admitted in the title of his 1998 book, “I Really Didn’t Say Everything I Said.” At least not originally. Here are some of Yogi's most memorable sayings, original or otherwise, and their lessons for investors.
 Calm before the storm?
Last week was quieter after the Federal Reserve meeting and the most recent jobs report. Markets resumed their upward march as the narrative of two to three rate cuts in 2024 was resuscitated. After a soft first-quarter gross domestic product (GDP) reading, Fed Chair Jerome Powell wasn’t as hawkish in his comments at the conclusion of the most recent Fed meeting, and he reiterated that there were no expectations for rates to go up from current levels. In addition, the April jobs report surprised to the downside as unemployment ticked closer to 4%. That all seemed to calm the markets as we plowed ahead. Remember: Powell wants to cut rates and the markets want to push higher, so there is plenty of fuel to ignite the market. The fact that we are within a day or two of fresh all-time highs (except for the Dow, which has its quirks), pretty much tells you all you need to know about markets right now — and the word to describe the mood is definitely not “pessimistic.” We are seemingly beginning to tread over familiar territory. The market will likely notch a new high and then begin to fret about the economy slowing, with the usual talk of “soft landings” and the Fed’s ability to manage a slowdown of the economy without driving us into a recession. That seems to be the nature of markets; in the absence of news, worry will fill the vacuum and volatility will creep in. Here’s what we know: Consumers are still spending and earnings have been better than expected (more in the next section). But the economy is slowing and inflation is still a problem. Counting on the Fed to negotiate these cross-currents is pretty ambitious. The Fed can either raise rates or lower them, but there isn’t some sort of Fed mission control room that monitors and tweaks markets and the economy. It’s an election year and people are uneasy for several reasons. We have international tensions and markets will react to any developments, good or bad. The markets want to run right now, and until the news turns negative there seems to be no reason for concern. We aren’t close to recession territory, and the markets appear content with slower growth and the possibility of a rate cut or two. The closer we get to the election, the more the Fed likely will sit on its hands and hope things work out. All this talk of engineering a soft landing — given that the Fed has never been able to achieve one — is probably just that … talk. Six months is an eternity for the markets. Stick to your plan, and if you are nervous, pull back into a more conservative allocation when we hit new highs. If your allocation is out of whack, rebalance. Focus on the long game. We could possibly see more volatility soon, but don’t let that distract you from your goals. Earnings matter — and they always will Earnings haven’t been a source of pain for markets. Instead, the linear relationship between interest rate expectations and inflationary data has caused market turmoil over the past month. Despite all the handwringing over rate cuts (how many, how soon), earnings have weathered higher rates and appear to be doing pretty well. As of May 3, 80% of the S&P 500 has reported first-quarter results. About 77% reported positive earnings per share (EPS) surprises, while 61% reported a positive revenue surprise. EPS for companies in the S&P 500 now look to be up 5.2% from a year earlier, better than the 3.4% analysts expected at the end of March and marking the strongest growth in nearly two years. That’s pretty good, given short-term rates are around 5%. Earnings kept the markets from dropping off aggressively last month, and now that we are perhaps seeing weakness in the economy and job growth, it may finally lead to the Fed cutting rates. It seems fair to say that barring a collapse into recession (which appears not to be the case), the news for companies can only get better if we see the Fed begin to lower rates. Coming this week Most of the Fed speakers last week stayed on message, which is some form of a) “it’s too early to commit to cuts” or b) “we need to see the data that confirms what we are doing is working” or even c) “we need to keep rates higher for longer so inflation doesn’t come back.” We’ll hear from more speakers this week, and we’ll see what their tune is after the latest inflation data is released. Speaking of inflation data, we’ll get the latest Producer Price Index (PPI) and Consumer Price Index (CPI) numbers this week. CPI came in hotter than expected last month and inflation has been trending upward over the past few months. Needless to say, a cooling in the inflation readings will fuel more talk of cuts and get the market cranking upward. Other data this week includes retail sales, inventories and MBA mortgage applications (Wednesday) plus weekly jobless claims, the Philly Fed manufacturing survey, building permits and housing starts (Thursday). We will close out the week with leading economic indicators. Year-over-year growth remains negative but is on an upward trend.  Fed stays put
Expectations for a rate cut going into last week’s Federal Reserve meeting were practically zero. Markets were anxious to see what Chairman Jerome Powell’s post-meeting tone would be in light of continuingly stubborn and sticky inflation numbers. We are nowhere near the targeted 2% the Fed would like to see before considering rate cuts; in reality, we have trended higher in recent months. Markets sold off hard on Tuesday, and it was the worst day for markets in over a year. In a brief four-month period, we have gone from expecting as many as six or seven rate cuts this year to anxiety that the Fed wouldn’t confirm no rate raises in the next few months. But Powell did indeed confirm the Fed plans to stay put (with the appropriate disclaimers, of course) and markets initially liked what they heard. The Dow was up over 400 points at one point during Powell’s press conference on Wednesday, swinging over 560 points and nearly recouping the prior day’s losses. Markets ended the day mixed, with the Nasdaq and S&P 500 both down and the Dow ticking up slightly. The markets rebounded the next day as they took comfort in the Fed’s confirmation that a rate increase isn’t on the table, at least for now. Another encouraging sign was the easing of some of the Fed’s quantitative tightening measures, which is a stealthy way of cutting rates. The Fed has been unloading Treasuries to shrink its balance sheet, removing money from the economy and keeping rates higher. On this topic, the Fed commented, “Beginning in June, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion.” In theory, that will increase the money supply and potentially lower rates. Markets were calm after the meeting, but what a letdown from where we were just a few short months ago. We went from six possible cuts to praying for rates to stay where they are for the rest of the year. But for the Fed to get us to 2% inflation, the amount of pressure would need to be immense and would lead to a recession. There are a lot of inputs to inflation that higher interest rates can’t quickly impact, like higher wages and housing. Pay cuts would do the job but that isn’t realistic, but if people lose jobs and their replacements are hired at lower wages that would also lower inflation. If people are forced to sell homes at distressed levels because they’re out of work and there aren’t many buyers to step in, that would drive down housing costs. All these are terrible scenarios in which the overall economy would have to suffer greatly. Driving inflation down from 3.5% to 2% will take a long time to achieve, given where rates are currently. Rushing to drive inflation to 2% via further Fed rate hikes would lead to a recession — and no one is up for that. Fed Funds futures are currently saying we have about a 70% chance of a rate cut in September and another in November or December. But after what we’ve seen in the first four months of the year, the prediction of a possible November rate cut is almost laughable and utterly useless. The only good news is the market seems to have woken up to the possibility of no rate cuts this year and has hung in there, so when we actually get a cut, it will really get the markets moving. Jobs come in soft, rescuing a nervous market The Job Openings and Labor Turnover Summary (JOLTS) report for March came in at +8.49 million job openings. That’s the lowest number in three years and was lower than estimated. Quit rates eased and hiring continues at a slower rate. The ADP employment number released on Wednesday was stronger than expected for the corporate side, adding 192,000 jobs versus a consensus 175,000. ADP’s report covers more than 500,000 companies totaling more than 25 million employees. We finally caught a break from the string of negative inflation readings on Friday. The Bureau of Labor Statistics (BLS) nonfarm payrolls reading for April came in at 175,000, well below the consensus of 243,000 and the range of predictions (190,000-303,000). Unemployment ticked up to 3.9% from 3.8%, and wage growth slowed more than expected while hours worked declined from the prior month. February’s payroll number was revised down from 270,000 to 236,000, while March was revised slightly upward from 303,000 to 315,000. Markets clearly welcomed the weaker jobs data, which broke with the recent trend of hotter inflationary data. We managed to salvage a pretty bad week on Friday and finished pretty much where we started the week. The weaker jobs number reaffirmed the Fed will not have a reason to raise rates. Plus, with the unemployment rate creeping toward the psychologically important 4% threshold, markets will begin to buzz about the Fed having to do something about its second mandate, full employment. So far, the Fed has been primarily focused on the first of its dual mandates, price stability or inflation. If jobs start to dry up, markets figure the Fed will need to pivot and cut rates to keep the jobs market healthy. Given the Fed’s posture of waiting on data before committing, we would need to see several more months of steady declines in jobs. The concern is that, just like the Fed was late to the inflation game, so too it may be late to bolster jobs because we may already be on the slide to recession. Coming this week
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Patrick HueyPatrick Huey is a small business owner and the author of two books on history and finance as well as the highly-rated recently-released fictional work Hell: A Novel. As owner of Victory Independent Planning, LLC, Patrick works with families and non-profit organizations. He is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Advisor in Philanthropy® and an Accredited Tax Preparer. He earned a Bachelor’s degree in History from the University of Pittsburgh, and a Master of Business Administration from Arizona State University. Archives
September 2024
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