October 24, 2022

Nolte Notes

October 24, 2022

Doesn’t have a point of view, knows not where he’s going to.” If this sounds more like the Fed than another Beatles tune, you may be right! More Fed governors were on the stump last week, highlighting their continued push to hike rates to slay the inflation dragon. On Friday, there was a trial balloon released that might indicate the Fed is thinking about halting rate increases. That was all that was needed to blast stocks up over 2%. The Fed has indicated they remain “data dependent”, however much of the data they look at is in the rearview mirror. Their singular focus upon inflation reports skips by the data at hand that would argue the worst is likely in that rearview mirror. Whether commodity prices, transportation costs and even real estate, all are looking lower today than a month ago. This week will have plenty of “big” economic reports to compete with earnings reports from the “big” SP500 companies. Housing, economic growth (GDP) and the Fed’s favorite, “personal consumption expenditures” (PCE) are all likely to move markets. Fortunately, the Fed governors go into their “quiet period” ahead of their meeting next week. “(Fed’s) as blind as t(he)y can be, just sees what t(he)y wants to see”. The Fed missed the inflation call last year; will they also miss the slowing inflation story?

The markets have continued to be extremely volatile with 2% daily swings since the CPI report from two weeks ago. The Fed talks up rates, the markets decline, some good earnings reports, the markets rally. These “all or nothing” days have been piling up over the past month or so. Historically, there have only been five times when 80%+ of the stocks in the SP500 trade higher or lower more than ten times in five weeks. In those five instances, the markets were within six months of a bottom and all traded higher a year out. The daily swings are certainly a reason to “invest” in Tylenol and Tums, but it may also be a good time to look long-term and cautiously begin adding to equities over a 6–12-month timeframe. If the economy is indeed in or heading into a recession, the economic reports are likely to continue to be poor, creating that much more volatility in both stocks and bonds.

The real “problem” for the markets has been in the bond market, where long-term interest rates have increased every day but three over the past month. Just since the start of October, interest rates have increased by 0.50% across the yield curve. The Fed has been by far, the most aggressive central bank in hiking rates around the world. It has been that aggressiveness that has kept the dollar rising, creating higher costs on other countries as global trade happens primarily in dollars. One other issue that may get more press is that the huge treasury market is becoming “illiquid”. Regulations put in place following the financial crisis limits big bank’s ability to be a market maker for treasuries. In the US, a perfect storm of higher issuance by the government and a reduction in the Fed’s holdings of bonds should keep pushing yield higher. Internationally, central banks are beginning to sell treasures to get dollars to buy their “home” currencies. The crisis in 2008 was centered in the banking system. Today, it may be with the central banks themselves.

For all the daily market swings, stocks are higher so far in October, keeping in the presidential cycle path in place. The top sector continues to be energy, even as prices remain well below their peaks of a few months ago. Outside of energy, the value and smaller asset classes are winning the performance derby this month. The long-term shift away from technology and “growth”, toward value, small US and (when the dollar finally declines) international has been a theme all year. Small US stocks are selling for 10-12 times earnings, while the SP500 is well above 16x the past 12 months of earnings. Smaller stocks are not as subject to the stronger dollar as much of their production and sales are within the US borders. International investing will likely make a comeback once the dollar begins to decline. The dollar remains well above its long-term average price.

Volatility is not going away soon as investors try to “game” the Fed and when they will either stop hiking (and holding rates) or pivoting toward cutting rates in the face of weaker economic data. This game of chicken makes for wild daily activity but can be a positive for the patient investor willing to slowly accumulate the cheaper parts of the markets.

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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