September 26, 2022

Nolte Notes

September 26, 2022

Hike it until you break it. The new mantra for the Fed is catching the markets off guard, as they figured the Fed would cave once the economy weakened. That thought was disabused multiple times during Chair Powell’s press conference following their decision to hike rates by 0.75%. The 2% hike over the past three meetings is the fastest since 1984, well before the Fed started announcing its rate policy. Rather than doing the limbo, the Fed is on its way to see how high it can go. The economic data remains mixed, with employment data still strong and housing beginning to show cracks. The weekly jobless claims are at levels that are lower than any period save one going back to 2000. Housing is beginning to slow, but prices remain elevated even as mortgage rates cross above 6.25%. General commodity prices have been declining, led by oil. However, whenever the administration decides to rebuild the petroleum reserves, oil prices may stop declining. Prices are moderating too for cars and travel, but apartment rents continue to rise. The long and variable lags of monetary policy have yet to hit the economy in full force, so many are now expecting a recession in 2023.

Now that the Fed has dusted off their “whip inflation now” buttons, little other economic data will matter outside of inflation. This week will be loaded with Fed governors speaking. This could move the markets depending upon how aggressive their discussion is around rates. This week will also see the Fed’s favorite inflation indicator, personal consumption expenditure, or PCE released to much fanfare and scrutiny. The next Fed meeting is scheduled just ahead of the midterm elections and there will be just one additional datapoint for many economic reports. It is expected that they will hike another half percent in November. Although there is some history of the Fed standing aside in front of elections to maintain their veneer of independence. Investors have been steadily heading for the door over the last few weeks, despite the fact that Friday’s selling may have been a “capitulation “, that may allow stocks to bounce this week. The very strong dollar may be the key to the markets turning around. While the dollar helps with US inflation, it is pressuring other countries as trade is done mainly in the dollar, costing everyone else more to buy stuff. The dollar has not been a focus for investors, but that is beginning to change.

When stocks decline, bonds historically have provided a nice offset, rising in price as investors seek a port in the storm. That has not been the case this year with many bond indices and bond funds declining by over 10%, It is better than stock averages that are down 20+%, but hardly a consolation. For the first time in over a decade, investors are finally getting paid to hold short-term bonds. There is now an alternative to both stocks and bonds, and it can be found in 3–6-month treasuries that are now yielding over 3%. It is not exciting, but it is better than the carnage we’ve seen in both the stock and bond markets.

Some investors that look at long-term opportunities within the markets and tend not to bounce around in their holdings. Then there are short-term traders looking for “quick hits” garnering short term returns. Finally, there are the outright gamblers that look to the options market to juice returns and make very short-term bets on the direction of the market. Friday saw the largest number of “bets” on further declines in history. The good news is these investors tend to pile into these positions well after the horses have left the barn. The last time there was a record high in these positions was late June, just ahead of the two-month 15% rally in stocks. If the past is indeed prologue, the markets may see at least a short-term bottom soon. Last week’s winners were the very defensive staples, while the formerly high-flying technology stocks took it on the chin. International stocks continue to suffer on the back of a strong dollar. To make a strong case for international at this point, we would need to see the dollar decline by roughly 10% from current levels.

The market is not out of the woods yet there can be a good case made for a short-term and sharp rally. That may come if some of the inflation reports begin to show some easing in prices over the coming weeks. The flip of the calendar to October means the beginning of earnings season as well. No rest for the weary

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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