October 3, 2022

Nolte Notes

October, 3 2022

Will the final quarter be any different than the first three? The close on Friday, putting stocks at a new yearly low, has been death by a thousand cuts. It is little wonder that investor sentiment is so negative. For example, just over a quarter of the trading days this year, the market has declined by 1% or more. Nearly 60% of all trading days have been down, usually nearly 60% are higher. Hiding places have been hard to find last quarter, as only energy and consumer staples saw gains. Every asset class fell during the quarter. Bonds were just as bad as stocks, as the bond benchmark fell 4.7% on the quarter vs. the SP500 down 4.93%. The steady stream of Fed governors last week was in unison on interest rates, higher for longer. The economic data continues to surprise in its strength as jobless claims fell while the Fed’s favorite inflation gauge was above expectations. Good news? Yes, there is some, but it all comes with a very large asterisk. Seasonally, we are entering the best part of the year that extends into the first quarter. Mid-term elections usually see a low in September. So just maybe, the Fed has overdone the hiking and we should see lower inflation and weaker economic data that may give the Fed a reason to pause.

The aggressive hiking by the US, especially in relationship to other countries has created a very strong dollar, which in turn, has increased inflation overseas. Much of the global trade happens in the dollar, and a stronger dollar creates a need for countries to have plenty on hand. That demand pushes the dollar higher still. The dollar has gained 25% vs. a global basket of currencies since May 2021. The rate of increase has only gathered steam over the past six months with the dollar up over 13%. The rate increases in the US are breaking international currencies, which is requiring action by other central banks. The story has been for quite some time that the Fed hikes rates until something breaks, whether it is 1987, emerging market currencies in the 1990’s, technology in 2000 or real estate and the financial system in 2008. Each instance has created a firestorm in the markets that eventually gets rectified, most often with plenty of pain. That pain may not yet be over, but the end of aggressive Fed policy may be at hand.

What has been interesting in the rates market has been the “orderly” decline in bond prices and the lack of “freak out” by Fed comments. The yield curve has been negative since mid-year and high yield spreads have failed to signal concern. Yes, prices have declined as yields have increased, but without the usual freezing up of trading in various bond instruments. One other point of interest is the Fed’s balance sheet and how much they are reducing their holdings. Since the peak in their balance sheet size in mid-April, the Fed has reduced their holdings by less than 2% over the past nearly six months. Other than removing themselves from being a permanent bond buyer, the Fed has not really had an impact upon the bond market. Their jawboning and talking up rates are all that have been necessary.

The economic data from the service and manufacturing to employment this week will carry its usual importance. However, the inflation components will be watched very closely. The coming week will be a set up for the deluge of earnings that will start in another week. The companies will be chatting on supply chains, wages, sales, and overall conditions for their businesses. It will be instructive to see how they are handling inflation and the impact upon their bottom lines. Within the market, the cheaper portions should hold up well, which includes value stocks. Small US stocks are included as well, with their valuations among the lowest over the past decade. They also tend to be sheltered from the strong dollar as their sales tend to be within the US and some of their components for manufacturing come from overseas, which are costing less with the strong dollar.

The markets are beginning to get into the territory that is cheap and provide long-term value. They can get cheaper still, but over the next 3-6 months should be a good time to pick out companies with strong balance sheets, good cash flow and dividends that can weather the short-term storm and provide good long-term returns

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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