Updated: Dec 26, 2022
Merry Christmas and Happy Holidays! We hope that everyone is having a wonderful break. We have a light week ahead in terms of earnings and economic events. Remember that the stock market, bond market, and futures will be closed tomorrow (Monday).
Last week brought us key data in the housing market, which continued to show signs of slowing, as well as PCE, which is the Fed's favorite flavor of inflation econometric data.
Headline year-over-year PCE came in a bit hotter than expected, but what really caught my attention was the durability of services-based inflation. An area that Fed Chair Powell and ECB President Lagarde have identified as being of high concern, as it tends to be more sticky and can help to drive further wage increases, which can then lead to further price increases (aka a wage price spiral).
The good news is we are seeing a healthy drop in goods inflation and a slowdown in the pace of consumer spending increases, but the bad news is that services remaining as high as they are is likely to continue to feed into more durable, structural inflationary pressure that could plague the US (and EU) into at least the first half of 2023.
The increases in services spending were driven by housing, utilities, financial services, insurance, food services, accommodations, other services, and yes, even healthcare. While we're likely to see some reprieve from housing and utilities in early to mid-2023, other areas could prove to be more sticky. A concern that has the Fed increasingly tempted to continue their "higher for longer" monetary policy mantra as they view the risk of doing too little as higher than doing too much.
As a result of the PCE data, we saw Fed Funds Futures decrease the probability of a 25 bps hike in February to 65.9% from 75%, and increase the probability of a 50 bps hike from 25% to 34.1%.
Fed Funds Futures are continuing to price in the first 25 bps cut in later 2023, now showing a 33.5% chance of that cut occurring first in the November meeting, and followed by another 25 bps cut in December of 2023.
The terminal policy rate range is expected to be 4.75% to 5%, despite the Fed's December Dot Plot showing that the upper bound rate may indeed be higher than 5%.
Once again the Dow Jones proved itself to be the most resilient index. A theme that's been relatively consistent since the October lows, as larger and higher quality blue chip companies, particularly energy, industrials, and defensives have been leading the way. The Dow closed the week up just shy of 1%.
The NASDAQ was the weakest again, down 1.9%, and it's lost almost four times what the Dow has year-to-date, down 32.9% during that time. The tech-heavy index is suffering from mega cap leadership and longer duration risky tech companies underperforming the broader market as rates have risen and business conditions have deteriorated.
The US stock market suffered three weeks of back-to-back declines, causing some consternation that the most recent rally may be ending, or at least taking an extended breather to consolidate gains.
Oil closed the week up 7.2%, while bonds dropped 1.4%. Concerns about inflation may begin to percolate within the minds of asset managers if oil continues to rally, as it tends to drive up other costs with it as it is such a critical component of our every day lives.
Due to the recent extreme winter storm, we may see both natural gas and oil prices rise due to a surge in power generation demand. Some regions, such as New England, are utilizing more oil for power generation out of necessity as they struggle with demand.
Inside the S&P 500 we saw large declines across much of tech, but TSLA was a stand out, again. This time dropping 22.86% in a single week. Nearly shedding a quarter of its value and underperforming all of its major peers in the tech and growth space as troubles continue to pile up.
Energy, staples, utilities, healthcare, and financials showed impressive relative strength, providing some shelter away from the declines seen elsewhere for diversified portfolios and those with concentrated holdings in those sectors.
S&P forward P/E ratios dropped 26.5% so far during 2022. As Ayesha has pointed out there is likely to be an earnings recession in the year ahead, making the E in P/E much more likely to fall as we see inflation and the economy slow, compressing both top and bottom lines for many companies. A falling forward P/E ratio also indicates that growth expectations are in jeopardy, and a fall to this degree hasn't been seen since the Great Financial Crisis.
Balanced portfolios have taken a major hit in 2022, falling 17% year-to-date. Recovering from their lows, but still in territory that suggests a lot of retirees may have lost nearly 20% of their savings during the year when using this allocation model.
Unfortunately that is the sort of wealth destruction that this Fed wants to see in order to entice early retirees to reenter the workforce and alleviate some of the tightness in labor markets.
We also observed a propensity for asset managers to put cash to work in more defensive parts of the market, particularly toward the end of 2022. An end cycle allocation strategy that suggests many believe a recession may be coming and they are therefore moving to more resilient, less risky parts of the market. Bond buying was also at the highest levels we've seen since early 2009 in the last month.
The economic calendar for the week ahead is quite light, but we do have some important data coming in that's worth watching.
Retail inventories are an important econometric, as we've seen that during 2022 many retailers had a significant overhang of inventory, particularly more discretionary goods. If that inventory isn't being drawn down during holiday sales it portends to even more hardship ahead for the already struggling retail sector. Particularly stores that cater to merchandise instead of staple goods.
We will also get more housing data, which I suspect will continue to show that the real estate market is slowing. I believe that the real estate market may be the next shoe to drop, so to speak, as it takes longer for price changes to happen because transactional activity is less frequent and occurs over a longer time horizon.
The Treasury auction schedule is pretty significant for a holiday-shortened week. $120 billion of 2, 5, and 7-year notes are on offer on Tuesday, Wednesday, and Thursday respectively.
I expect that these auctions may be well bid, but it will be very important to watch as if they are not that could drive significant volatility in rates markets as liquidity will be very constrained.
There's not much to talk about in earnings land, as we have three only companies reporting that are well watched, Greentree Hospitality Group, Cal-Maine Foods, and Uxin Group.
After this week we approach Q4 earnings, with JP Morgan set to report on lucky January the 13th. Their earnings could provide some interesting insights into what's going on within the broader economy and financial system. An area that Ayesha is watching closely for clues about what we may see from other companies during their fourth quarter.
We could have a volatile week ahead with very light liquidity, some sizable Treasury auctions, and a few key econometrics to watch. I will be trading lightly, and focused more on learning, researching, and preparing for the year ahead.