Do you think the madness will end when March is over? Do you think the madness will end when March is over? http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\basketball-hoop-shoot-small.jpg March 18 2022 March 18 2022

Do you think the madness will end when March is over?

Like the NCAA tourney, uncertainty reigns in markets.

Published March 18 2022
My Content

A lot of busted brackets (including the Mister’s) thanks to 15th-seeded Saint Peter’s University. Recalled my senior year at UPenn. The “Cinderella” Quakers reached the Final Four before losing to eventual champion Michigan State and star Magic Johnson. Later, I met a young “Spartan” on his first day at our accounting firm who, learning of my alma mater, teased me relentlessly. “What a jerk,” I thought. Married him three years later. Go green! Putin’s being called a “madman” with his invasion of Ukraine. The war is further stressing global supply chains, dislocating industrial and commodity markets, and adding to the Fed’s challenges. Chair Powell’s resolve this week that the economy can withstand an aggressive hiking path (the dot plot puts policy rates on a path to reach 2.8% in 2023-24, 40 basis points above the Fed’s own estimate of neutral) runs counter to history. Whenever the fed funds rate has approached, let alone exceeded neutral, the economy has weakened sharply. That’s why futures are pricing in rate cuts by late 2023. The yield curve and credit spreads don’t offer much clarity. On one hand, the gap between 2-year and 10-year Treasury yields is just 20 basis points, and the difference between the 2-year and 10-year U.S. dollar swap curve is near inversion. Flattening and inverted curves often signal recession, making for an extremely narrow “just right” path for the Fed. On the other hand, high-yield credit spreads remain relatively well behaved on minimal defaults and strong earnings (upward revisions are slowing but remain above average, with forward S&P 500 earnings down somewhat but still up 12% year-over-year). It’s madness.

Strong retail sales, housing, the Philly Fed (more below) and continuing jobless claims at a 52-year low confirm the economy was running hot going into Fed liftoff. This reinforces profit growth is likely to remain strong despite rising rates and points to the power of massive liquidity—M2, a broad measure of the nation’s money supply, ballooned by 42% over the past two years. Looking at 70 years of hiking cycles, Deutsche Bank says equities tend to have a good run for 9-10 months after the initial hike. But then, on average, the S&P goes the next year without a positive move. That’s because tightening’s impact operates with a lag. Many argue the Fed is so far behind the curve that this historical playbook should be tossed. Never has inflation been this high this early in an expansion. And the Fed has never been able to get inflation back under control without a recession! It may be that the only way out is for commodity prices and finished goods prices to cool, and/or for wages to slow as the participation rate increases and base effects take hold. We’re not there yet on any of those fronts. The strong post-Fed bounce provided technical relief, pushing the Nasdaq 100 and the S&P to meaningful trendlines of resistance. A move above 4,420 on the S&P would suggest conviction. Where to put money is less clear. The energy trade looks very crowded, while big-cap growth stocks are starting to look attractive on more reasonable valuations and flushed positioning.

I enjoyed some March madness fun in Hartford, Conn., this week. An advisor, so successful you’ve got to have a reference to meet him, has roots in my birthplace, McKeesport, Pa.—a modest mill-town suburb of Pittsburgh. He “loves a down market,” as it gives him investment opportunities. He tells his clients, “If you loved spending one month in Florida, and two months even more and three months even more, why not buy a place there?” “When you’re younger, you should save more; when older, spend more!” Who can be my reference to this advisor?! Next meeting, a hybrid luncheon, with clients in person and others on Zoom. My “Cryptocurrencies Demystified” presentation was received by a live audience where half the attendees (younger and older) already were invested in crypto. When I told this hip advisor that my next topic of study will be the metaverse, he said, “Sign me up, I’ll get an audience for you!” At an advisor/client dinner, I met a Swedish gentleman who’s now a citizen (“I love America!”). He helped design the software that caught the Boston marathon bomber and fingered Jesse Smollett (“in 10 minutes”). A “recovered” lawyer turned real estate magnate and once-college football star turned advisor, he knows some Steelers and Penguins personally. He’s not giving Antonio Brown a pass for “too many hits in the head.” Mister was right back in the day—UPenn had no business being there. And A.B., why the way he walked off the Bucs game was madness.

Positives

  • Boomflation February retail sales were a little weaker than consensus but January’s already robust reading was revised up sharply, with sales running well beyond the pre-pandemic trend and discretionary nominal sales up more than price gains—signs inflation has yet to dampen demand. This so-called “boomflation’’ is evident in the New York Fed’s latest survey of consumer expectations as year-ahead spending plans surged to a record high and prospects of losing a job sank to a record low.
  • Capex and productivity are correlated Business equipment production expanded 1.9% in February, helping lift overall industrial production 0.5% despite declines in auto and utilities output. Overall, manufacturing rose 1.2%. Early reads on March were mixed: the Philly Fed survey surprised, rising 11 points versus expectations for a decline on improving shipments, new orders and employment. New York’s Empire surprised the other way, falling to a 2-year low on across-the-board weakness.
  • Housing inflation has yet to dampen demand February housing starts surged to their highest level since 2006 while permits slipped but remained near a 16-year high. Prices are accelerating (hurting affordability, a factor in February’s dip in existing sales) and National Association of Home Builders confidence remained elevated (just not as high as February) as buying traffic continued to increase. Evercore ISI’s propriety builders’ survey hit a 9-month high on a strong start to the selling season. In the latest week, the Mortgage Bankers Association’s survey of purchase applications rose to a 4-week high.

Negatives

  • Europe’s recession watch Germany’s Zew sentiment index plunged the most in its 30-year history as the Ukraine invasion, accompanying sanctions and inflation took a toll. The conflict’s fallout is more a European concern for now, though market odds of a U.S. recession over the next 12 months have creeped up to about 25%. Wolfe Research notes Michigan sentiment has fallen into recession territory, a sign consumers may be ready to pull back.
  • Peak inflation for real? If crude oil’s decline off its recent peak holds, January’s core PPI print of 8.6% annualized may represent the peak. It slipped to a still-elevated but lower-than-expected 8.4% in February on sharp increases in energy but the smallest increases in other core prices since late 2020. Consensus expects headline and core CPI to climb further this month—UBS forecasts both at a respective 8.5% and 6.5% annualized—before beginning to trend slowly down.
  • Not again! Global Covid cases headed higher a second straight week—they’re the highest ever in Germany, rising in many European countries (especially Switzerland and the U.K.), at new highs in Africa and higher in China than any time since the initial outbreak. Covid in wastewater, a good leading indicator of cases, suggests an uptick soon in the U.S.. The increases are being attributed to the more contagious omicron subvariant, BA.2.

What else

Shout-out to dividends Dividend payments set a record last year and this year, dividend-paying stocks as measured by the Dow Jones U.S. Select Dividend Index have handily outperformed the broader S&P 500 and S&P 500 Growth indexes. Strategas Research says shorter-duration equities, such as stocks that quickly return capital via dividends, should continue to offer potential outperformance in a high inflation, rising-rate environment.

Wanna getaway? ISI’s proprietary airlines survey rose an 8th straight week, with leisure bookings back to pre-omicron levels. Business and international activity's climbing, too, only more moderately.

I guess it saves on calories One way food companies are dealing with higher foodstuff costs? Smaller bags/portions for the same price. Doritos, for example, now have 5 fewer chips per single-serving bag.

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Tags Equity . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Dow Jones U.S. Select Dividend Index: Universe is defined as all dividend-paying companies in the Dow Jones U.S. Total Market Index that have a non-negative, historical, five-year dividend-per-share growth rate, a five-year average dividend earnings-per-share ratio of less than or equal to 60% and three-month average daily trading volume of 200,000 shares. Current index components are included in the universe regardless of their dividend payout ratio.

Growth stocks are typically more volatile than value stocks.

High-yield, lower-rated securities generally entail greater market, credit, and liquidity risk than investment-grade securities and may include higher volatility and higher risk of default.

Nasdaq-100 Index: Capitalization-weighted and includes 100 of the largest non-financial companies, domestic and foreign, in the Nasdaq National Market. In addition to meeting the qualification standards for inclusion in the Nasdaq National Market, these issues have strong earnings and assets. Indexes are unmanaged and investments cannot be made in an index.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

S&P 500/Citigroup Growth Index: An unmanaged capitalization-weighted index of stocks in the Standard & Poor's 500 index having the highest price to book ratios. The index consists of approximately half of the S&P 500 on a market capitalization basis. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.

The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.

The National Association of Home Builders/Wells Fargo Housing Market Index is a gauge of how well or poorly builders believe their business will do in coming months.

There are no guarantees that dividend-paying stocks will continue to pay dividends.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

The ZEW Indicator of Economic Sentiment polls financial experts to gauge whether they are optimistic or pessimistic about the subsequent six months.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

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