Nolte Notes – 8.29.22
August 29, 2022
“To swipe from Peggy Lee, is that all there is to Jackson Hole? After Powell’s very brief speech, it was time to break out the booze, since the markets spent the rest of the day falling into the close. Powell did not mince words and backed other Fed governor’s comments of the past few weeks. Inflation is a problem and the Fed will continue to raise rates until inflation starts to move meaningfully toward this 2% target. Even Fridays release of the Feds favorite indicator, the personal consumption (PCE) that showed a modest decline did nothing to assuage the selling. The rate hikes that have been pushed through so far this year are only now starting to have some modest impact. Most of the impact thus far has been in the housing sector as mortgage rates have topped 5.50% and buying activity has slowed dramatically. Although a lagging indicator, employment is still at very low levels. The weekly jobless reports are only now modestly above the same period in 2019. Investors should stay focused on inflation data, as it will be the only thing that will give the Fed reason to pause their rate hiking cycle.
The economic reports during the week along with a few lingering earnings reports show the economy is slowing. The housing market is at the front end of the weakness as home builders get very cautious about the outlook for housing. The combination of still high prices and rising mortgage rates are making it difficult for buyers to step up. The employment report will be watched for wage gains. Are wages rising due to inflation or due to lack of workers? In what is becoming a chicken or the egg discussion, the Fed will want to see increases slow down and may be fine with the unemployment rate ticking higher. Combined with the employment data will be surveys of services and manufacturing companies on their outlook. Here too, a bit weaker over the past few months, but nothing dire. Powell’s comments indicated the Fed will be fine with slowing data and will not be likely to “pivot” to a more market friendly monetary policy.
The trading activity over the last few weeks has slowed to a crawl as many are on vacation and volumes are not likely to rise until after Labor Day. Over the prior few weeks, there were a few days that saw lopsided buying, where more than a 9-1 ratio of rising to falling stocks and volume. That came to an abrupt stop with Friday’s decline. The SP500 also stopped rising just as it hit its long-term average price. The key question is whether the summer rally was just a respite from the selling of the first six months or the beginning phase of a new leg higher for stocks. Valuations of the markets have been a long-term concern, as the markets have rarely ever been “cheap” over the past 40 years. Low and falling interest rates gave rise to “TINA”, there is no alternative to stocks. Today, even short-term bond yields are well about 2%, providing some return for investors. As rates continue to rise, they should provide some competition for investor dollars.
Given the Powell pronouncement, interest rates are not likely to stop rising and based upon recent history, technology stocks will likely suffer. Over the past few years, the tech sector has moved inversely to interest rates, as rate rise, tech declines and vice versa. The better performing sectors may be more value driven, like healthcare, consumer staples and yes, even utilities. International stocks remain under the pressure of the higher dollar. The yield spreads between two- and ten-year bonds remains firmly in “recession” territory as the two-year yield is above the ten year. High yield bonds are a good signal for investors desire to take on risk. The spread to treasuries has not gotten even close to prior highs, indicating investors are still not yet fearful of the stock market. Further declines in stocks, as a result, may be in the offing.
Chair Powell made it clear that rates are going higher and won’t likely stop until inflation begins to trend lower for more than just a month or two. This week we’ll get the employment data and inflation ahead of the next Fed meeting later in September.
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.