November 16, 2022

Nolte Notes

November 16, 2022

“Is this the real life? Is this just fantasy?” Another week for the record books as investors are now betting that inflation has finally peaked AND the Fed will soon stop their aggressive rate increases. Never mind that various Fed governors were on the circuit chatting up the need to remain very vigilant regarding inflation. Rumors also circulated on Friday that China was going to be finally opening after various Covid lockdowns have shut their economy out of the global picture. Somewhere in the milieu last week was the mid-term elections that have yet to fully decide the fate of the Senate. Rising nearly 6%, the SP500 once again are giving investors hope that the nasty bear market of 2022 is finally over. Indeed, the presidential cycle is right on target, as stocks rose immediately following the election and could embark on a two-year run. The huge drop in bond yields gave life to the technology sector, which had been suffering from the stress of higher rates. Even bond investors rejoiced at the possibility that interest rates have finally peaked and their returns would improve in the months ahead. This week comes the producer price index, which could lend support to the notion that inflation is peaking. Or the real life of higher prices could be with us a while longer.

The weekly gains were indeed impressive; however, they were not even the best of this year! There have been three other weeks with gains that were better, only to see stocks eventually roll over to new lows. Will this time be different? For the SP500, a rise above 4200 would break the 2022 downtrend. This year has been marked by very strong rallies that eventually peter out before the market could get above prior highs or even long-term average prices. That said, the number of stocks making new lows has shrunk dramatically as those above their long-term average prices have now expanded to multi-month highs. Given the past disappointments, it is easy to give the benefit of the doubt to the bearish bunch, until the bulls can prove their mettle. The Fed could throw some gas onto the fire if they begin chatting about pausing sometime during the first quarter. A calmer producer price index release later this week could give the market rally some additional fuel.

The drop in the 10-year treasury yield following the CPI report, was the 17th most extreme move since 1980. Yet, the inverted yield curve did not really budge too much, as it remained deep in negative territory. The difference between high yield and treasuries has also been remarkably calm, indicating investors are very willing to take on risk and are not worried about a recession. The bond rally has nearly turned the bond model positive, for only the fourth time this year. The bond market has been a mess all year as bond returns have been negative in eight of the ten months. The Fed chatter in over the next few weeks could (finally?!) light a fire under bonds. That could also mean better equity markets into yearend as well.

The weekly rally has moved many of the industry groups within the SP500 above their long-term average prices. Not since April have there been this many groups looking up. In addition to a better US market backdrop, the international markets have jumped back to life on the weakness in the dollar. The dollar decline is a direct result of lower interest rates in the US, again on the hopes the Fed will pause due to lower inflation data. International and especially emerging markets are extremely inexpensive compared to their US counterparts, but the strong dollar headwinds have kept them cheap. If the dollar, like interest rates, can stabilize or maybe decline a bit, sending money overseas will once again be a profitable venture. The rally off the recent bottom, fueled by lower inflation data, may continue through the end of the year. There is one large caveat though, the Fed does meet again just ahead of the Christmas and may not be the Santa Clause everyone is expecting.

The comments from last week still stand. The markets are now in the best portion of the calendar, from here to May. The CPI report, if followed up by a good/better producer price report this week should allow the Fed to begin discussing a pause in hiking rates. It does not mean that rates will fall, but merely stop rising at the relentless pace of the past year.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

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