October 10, 2022

Nolte Notes

October 10, 2022

“Hear me now, believe me later” seems to be the relationship between Wall Street and the Fed. It is becoming increasingly clear the Fed is not here to “pump (Wall Street) you up”. Some of the economic data last week showed some economic weakness, however the “big” employment report shill showed a too strong economy. In fact, a couple of Fed governors indicated rates will be higher into yearend in their comments last week. So, the Fed has not really changed their message since March. It is only recently that the markets are starting to believe the Fed is serious. Whether they will have the fortitude to keep hiking rates when much more of the data has turned lower remains to be seen. It was only a year ago that the Fed was still in the “transitory” camp when it came to inflation. Things can change quickly, but the markets have been calling for a Fed pivot without much evidence of inflation getting under control. This week will have plenty of Fed governors chatting (again!) about the economy and their inflation fighting chops. Inflation data will be front and center this week. Both consumer and producer prices will be reported along with retail sales that may show consumers pulling back on their spending last month. Finally, earnings season gets started with the banking sector on Friday. Will this mark the bottom for the markets, or will they be “flabby losers?” Fed commentary will be the key this week.

The markets were looking pretty good heading into employment Friday, however the strong report and Fed chatter made the week feel like a loser. In more normal times, the jobs gain would be seen as robust. Today, when the markets are looking for some weakness, the numbers remain strong. The recent three-month average gain is the slowest since the “re-opening” of the economy, however it is the strongest since coming out of the 2008 recession. There have been some announcements of lay-offs and slowing of hiring, however here too, the mass lay-offs and weekly jobless claims are not pointing to employment weakness yet. The hope of investors will now be pinned on the inflation reports this week. Signs do point to some easing of inflation. Housing is beginning to buckle under the higher mortgage rates. Housing does lead into rents, which comprise nearly 40% of the inflation figures. Commodity prices have been falling for months. Food prices are starting to moderate, but not yet falling. Without inflation showing signs of rolling over, the discussion will continue to be about how high and how long does the Fed keep hiking rates. For now, the expectations are for between 0.50% and 0.75% in November and another 0.50% in December. The Fed was late to the inflation fight, will they be late to the realization the economy and inflation are heading down?

Interest rates continue to rise at a calm rate, without the stresses. The Fed will hike rates until something breaks, and we are beginning to see something breaking in the currency market. The dollar has been strong putting pressure on international economies. Much of international trade happens in the dollar. Many emerging markets have debt denominated in the dollar. A higher dollar makes goods/services more expensive and debt costs higher. England’s announcement a few weeks ago that they would be engaging in bond buying might be the first crack in the “things break”. Higher rates in the US could keep the dollar strong, putting additional pressure on international markets and economies.

The markets continue to show the rotation toward value. Even though both growth and value rose last week, nearly everything “value” did well vs. their growth counterparts. Historically, the “favored” asset tends to change around recessions. The recession in 2002 marked the end of the growth run of the 1990s. The financial collapse marked the end of value and the “coming” recession seems to be ending the growth run. The strong dollar has made international investing nearly impossible, so a weaker dollar would make the already inexpensive overseas markets a good buy. The dominant theme is higher rates that may put a minus sign in front of the returns, just smaller numbers for value vs. growth.

Inflation and the Fed should dominate this week. If the discussion of higher rates remains front and center, the markets are likely to stay on their heels

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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