October 17, 2022

Nolte Notes

October 17, 2022

Investors were singing “Flip, Flop and Fly” after the market close last Thursday. The CPI report earlier that day was certainly not what the market was expecting. Before the release, the markets traded higher as expectations grew that a good number would be seen. The report dropped a much higher than expected number, with little to cheer up investors. The S&P500 went from a 1% gain to a 2% drop within minutes. After trading lower in the early going, the markets reversed and finished up over 2%. The reason for the flip and fly is pure conjecture as Friday’s market erased much of Thursday’s gain. Upon further review, the Fed will likely hike rates 0.75% in November and again in December with more coming in 2023. There is little reason for the Fed to stop hiking rates given the strength in the data. The weekly jobless claims remain historically low for this time of year. The monthly jobs report is averaging above historical averages and inflation remains an issue. Housing and manufacturing data are showing some weakness, however, services remain a “hot” part of the economy. Travel-related prices remain high as do food-related items. It is expensive to move about the country.

The biggest issue with the inflation data was that many of the “sticky” prices remain high and some rising even further. Rents continue to show strength, even as apartment rents are beginning to soften. It is a quirk in how rents get calculated and those softer rent prices are likely to put downward pressure on inflation mid-year next year and beyond. The Fed hikes are getting priced into the markets and are part of the reason for the large daily swings in stocks. It is also true that the Fed will hike rates until something breaks, which may be happening in the currency markets. Real estate prices may finally come down as mortgages touch 7%, however, a 2008 crisis is not likely as homeowners are not as extended as they were then. From an economic perspective, the coming weeks will be quieter as corporate earnings take over the spotlight. How are companies faring passing costs along? Are their margins shrinking? Are their sales growing faster than prices? It should be an interesting few weeks leading up to Halloween.

Not surprisingly, interest rates rose on the news of higher inflation. However, the difference between the “safe” treasury and “risky” high-yield bonds narrowed during the week. This dichotomy may be due to investors believing the Fed is close to “breaking something”, from which they will have to not only stop hiking rates but begin cutting them. For bond investors, who have suffered one of the worst years of the past forty, a pause in rates would be a welcomed relief. Higher rates are a boon to new bond investors, as they are getting yields not seen in a decade. Inflation and the Fed should be their only concern heading into year-end.

The month has already felt like an eternity, with stocks flipping and flopping nearly every day. That said, the broad averages are higher in October, albeit ever so slightly. Could stocks be finally bottoming and sunnier days are ahead? Thursday’s flip, flop, and fly are one of only a handful of days since 1993 that saw stocks decline by 2% on the first trade (gap down) only to finish up by more than 2%. Of the four occurrences, only early 2008 finished down a year later. This is a small sampling to hang your hat on, but too, seasonal factors are favoring the bulls. So too is the nine-month decline of 25%, leading some to posit that while “the” bottom may not be in, it may not be too far off. Small stocks, especially value, are leading the charge, up over 4% this month while the big growth sector is down over 1%. That difference in returns is now over fifteen percentage points this year. Given the large outperformance of large growth since 2008, there may be years to go in the value-beating growth trade.

Earning season gets started in earnest this week. Along with housing data, the markets should continue to be on their toes and just as volatile as they have been over the past few weeks. The persistent decline in stocks over the past 20 weeks could lead to a large “pop” higher that lasts longer than last Thursday’s rally

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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