November 22, 2022

Nolte Notes

November 21, 2022

The Thanksgiving holiday is about gratitude for all that we have, including the typical family weirdness. Yes, even football and shopping have become part of the tradition. While this year may not be the black Friday of years past, it does mark the beginning of the Christmas shopping season. Investors and economists alike should get a good reading on how robust the consumer is given the high inflation rates this year. Will they still be spending, no matter the price? Will they hold off until retailers mark down prices? Or will they spend as usual with the credit card getting a workout? Based upon some of the comments from various retailers last week, the consumer seems to be in pretty good health, however, the credit card is getting more of a workout than usual. Retail sales and consumer credit both rose last month, with sales the strongest in six months. If the economy is hitting a recession, the consumer doesn’t seem to think so just yet. The other feature of the week was the Fed chatter about interest rates and the “terminal rate” at which they may stop increasing rates. The basic message was that interest rates will still be rising, although at a slower pace, until such time that inflation gets much closer to their 2% target. The Fed has one more meeting on December 14th, when they are expected to hike another 0.50% and wish everyone a Merry Christmas on their way out the door.

The markets did the Texas two-step during the week, one step forward, two steps back as investors reacted to better-than-expected PPI and retail sales data. However, the comments from the various Fed governors tossed cold water on the hope the Fed would not be as aggressive in hiking rates. The retailers’ earnings highlighted above, also marked the end of the earnings season. The most recent peak in earnings was the quarter ending 12/31/21. Earnings have fallen 5% through 9/30 and are expected to bottom with yearend figures (due to report in January). The decline is merely 8% with a return to “peak” earnings by the third quarter of 2023. This does not look like “the market” is anticipating much more than a mild recession and modest decline in earnings. Looking back at history, since 1990, earnings have generally fallen 20% in prior “earnings declines”. Something is going to have to give, and it may be the optimistic market sometime in 2023.

The discussion around the higher short-term rates vs. long-term rates as an indication of a pending recession has gotten very loud of late. Even the Fed Funds rate is above the 10-year rate, a very strong indication that a recession is likely in 2023. There have been signs since even 2021 a recession was likely, but that has been postponed due to the large amount of money injected by fiscal and monetary policies over the past two years. The very recent decline in rates is giving some hope that a peak in rates is close, but there have only been four weeks this year where the rate picture has been this bright, only to be dashed a week or two later. The Fed has been adamant that rates are going higher and have called the market’s bluff every time this year.

The modest decline last week was generally across the board and helped take some of the speculative fervor out of the markets. The path from here, through a potential recession to better earnings/economy/market on the other side, is not very clear. The volatility experienced so far is likely to continue in the weeks ahead as investors place bets as to when the Fed will back off increasing interest rates. There are a few indicators that have not yet signaled big stresses in the market that usually accompany a meaningful market bottom. One is the valuation based on the most recent peak in earnings. IF the SP500 hits 15x the most recent peak in earnings, it would mean a 20%+ decline from here. High yield spreads have been very calm, higher than the low of the year, but well below prior stress peaks. Finally, the stress index that the Fed measures is also well below historical levels, indicating an easy monetary policy rather than tight one.

As brutal as the market has been over the past year, there does not yet seem to be the panic that usually accompanies a meaningful market bottom. There is a point at which everyone wants to be in the safety of cash. That has yet to happen and may indicate that “the” bottom remains somewhere in that foggy future. The rotation toward financially sound companies with good cash flow, dividends, and revenue growth continues and likely will be rewarding investors in the years ahead.

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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