Investment Insights

— Steve Orr

Consolation 

The pause that refreshes? We do not think so, at least not yet. Last Friday’s close marked the third down week for the S&P 500 in a row. Three weeks does not make a trend change. To investors conditioned to the steady march higher from last October, however, it may be disconcerting. Fundamental themes of sticky inflation and ongoing geopolitical tensions seem to justify share prices heading lower.

We would suggest an alternative view. Stocks tend to discount months and years ahead. Our economy is transitioning from one of productivity aided by tech to an on-demand information one. We should get a better idea of the timeline this week and next as most of the “magnificent 7” tech heavyweights report first quarter earnings.

The tech-driven artificial intelligence theme is dependent on several pillars. All of these are taken for granted to some degree or another. First, a stable and cheap supply of electricity. We can debate the case for “renewables,” but they are not as reliable or cost-efficient as base load gas, coal and nuclear. Chip supplies and assembly factories to produce servers comes next. Most of the world’s chip supplies come from countries being intimidated by China. Assembly factories are also predominately located in southeast Asia. Tech investors are realizing all these issues are going to take time to sort out. That could explain some of the recent selling. April is also tax time, and liquidity gets scarce this time of year. Less liquidity is not a condition Mr. Market tolerates for very long.

Two issues caught our attention in last week’s tape action. One, each day started with a gain by several of the stock indices. Through the day the Bears gained control, and all five days finished lower. A rare event to have five trading days in a row with that tape action. Friday was particularly interesting as the big tech names led the S&P 500 and NASDAQ lower. On the scoreboard, however, both indices were tallying more winners than losers. A 3 to 2 gain over loss day is not a big trend driver but does indicate that a whole lot of the other 493 stocks in the S&P 500 were doing all right. Consumer staples, financials and utilities have all caught and passed the tech sector in the past couple of weeks. A broadening of positive performance and the end of tax season are some consolations. 

Meanwhile

Back in the “real world,” our economy continues to rumble along in second gear. We think it is beginning to labor a bit as consumer spending cannot carry the load for an entire year. Recent small business and regional Fed surveys show hiring and business prospects turning lower. This Thursday, the Commerce Department will release its first estimate of first quarter GDP growth. Economists polled by Bloomberg estimate 2.5% growth from last year’s first quarter. That would represent a full 1% drop from 2023’s fourth quarter.

If that estimate proves to be low, then you can look forward to Fed speakers next week saying that there is no need to cut rates. Last week’s bevy of Fed members on the chicken circuit were hinting around that point. Chairman Powell, in an interview last week, all but took a June rate cut off the table. It is nice to see he is coming to his senses.

We have been pounding said table nicely this year that we could see no reason for the Fed to cut rates. Digging into history, we are not able to find a case in which sitting on rates at one level for a long time actually cut inflation. Cutting short-term rates when other measures of financial conditions are very supportive would invite more inflation. Want to kill inflation? Try raising rates — a lot. That would spark an equity correction. Oh, and add to bond price woes.

Fed members have to be a bit frustrated. They have pushed overnight rates from a range of zero to ¼ of a percent up to 5% to 5.25%. Consumers and home buyers have been hit, no doubt. The overall economy has defied recession calls and continues to lumber along, albeit at a slower pace. We think the key to diluting the rate effect on the economy is the continued waves of spending by D.C. The various industrial and re-shoring “Acts” and domestic program spending seem way out of proportion to need. Government withdrawal of liquidity from personal accounts and taxes is being redistributed to corporate holders. They in turn spend in the economy and buy back stock, helping equity markets. Interesting, but how sustainable is the present pattern?