As of market close April 21, 2023. Returns in percent.

 Strategy & Positioning 

 — Steve Orr 

Dull 

Marketwise, April feels like August. Equity volatility and volume measures slid lower last week, approaching vacation levels of activity. Friday’s option expiration day should have seen lots of action. Listless action generated barely a six-tenth move from high to low in the S&P 500. Usually, expiration days are 1% or more swings. Most stock indices were flat one side or the other of zero for the week. The lone exception was the MSCI Emerging Markets index. Its 1% drop last week was fueled by Chinese manufacturers and Chilean mining stocks. On Friday Chile’s president announced plans to nationalize the country’s lithium mines. Chile is the second-biggest lithium producer behind Australia. The mineral is a key component of batteries used in a range of products, including electric vehicles. Latin American nationalization reminds us of the 1970s. 

Continuing the dull theme, stocks are down roughly 1% over the last two years and broadly unchanged from last May. Yes, we are 15% above last October’s lows, but struggling to get back to February’s highs. Little movement does give markets a chance to rebuild energy and work off overbought conditions. Despite the recent rally, the only sectors trading at overbought levels are the defensives: staples, utilities and healthcare. Take your pick: either a dozing cow or a hibernating bear cub.

Ducks

A dull market does not mean nothing is happening. Like ducks on a pond, there is plenty of motion under the surface. You may have heard about zero-date expiration options. A lot of hedging and speculating activity in options has moved to these instruments. Puts and calls expire at the end of the trading day. Goldman Sachs estimates that zeros account for over 40% of daily option volume dating back to last year’s third quarter. 

There is some concern that these contracts have taken away volume from traditional 30-day options. That timeframe is used for the VIX index, a measure of what daily price moves may be in the S&P 500 over the next 30 days. VIX has declined over the last several weeks into Bull rally range. Obviously, stocks have ignored this signal and continued their sideways crawl. 

Digging deep into option theory and its relationship to stock indices does not immediately help our client portfolio allocations. But it may serve as a warning that something is out of line and could cause markets to snap one direction or the other. VVIX, the index that measures how fast volatility will change, has moved sharply higher over the last week. In other words, post-earnings season in early summer, traders are worried some events may move stocks. 

Debt

Treasury Bill yields in June and July have spiked back above 5%. That makes sense from a Fed perspective. Recent speeches show they are committed to at least another rate increase at the meeting on May 2 and 3. Futures markets in short-term funds predict another quarter-point increase. If that is known and priced in, then what else is making options markets nervous out in late May? 

We suggest looking to D.C. and the budget negotiations. Speaker McCarthy has been circulating a debt limit bill and looking for a vote this week. The Biden Administration has said no budget negotiations and no budging on spending. We will save the exciting details for another week but leave you with this: McCarthy proposes to lift the debt ceiling for one year, while cutting a number of spending programs. Usually, a debt ceiling debate centers on how much they are going to raise the limit and nothing else. 

Sensing an impending impasse, Treasury Secretary Yellen has been pushing cash out of the Treasury’s general account, paying bills, etc. This has the effect of adding liquidity to the banking system, counteracting the Fed’s quantitative tightening program. Her efforts are of course temporary, as the government will run out of money at some point in June. Tax receipts for the big April 18 due date only amounted to some $108 billion, well below expectations. Please note we made our contribution. 

The last time the House and Senate debated/negotiated cuts and debt limit at the same time was 2011. That affair lasted well into the summer and resulted in S&P downgrading U.S. Treasury debt from AAA to AA+. The S&P 500 dropped 16% afterwards but later recovered in the fall to finish a preelection year flat, well below normal. 

Down

Recent economic data continues to paint a cloudy forecast for the coming months. Existing home sales fell last month for the thirteenth time in the last 14 months. The change in the size of the housing market relative to the economy is a good recession indicator. We are well into the red for housing. Jobless claims are finally starting to move higher. Last week’s 245,000 net new claims for unemployment were the highest in 17 months. Those WARN numbers are starting to find their way from the office to the state unemployment office. 

Regional Fed bank data are a good bellwether for national numbers. The Philadelphia Fed Business Outlook fell for the tenth time in the last 11 months. The Outlook surveys 125 CEOs about general activity and conditions. The Dallas Fed’s Manufacturing survey for March fell for the eleventh straight month. Monday morning’s release showed declines in almost every category, suggesting that Texas businesses are seeing less activity. 

Thursday’s advance reading on first quarter GDP should show a 2% advance. After months of lower activity and doom predictions, we wonder when the MARE* will finish eating her oats and start kicking the economy into lower GDP numbers.

Decline

Only 18% of the S&P 500 has reported first quarter earnings through last Friday. The index is on track for a -6.2% year-over-year decline in net income per share according to FactSet. Most of the decline comes from margin pressures: costs and wages rising faster than revenues. That compression shows up in profit margins. Recall in the heady rebound after shutdowns, margins for the S&P jumped above 13%, setting records. Margins for the first quarter are running at 11.2%, below the five-year average of 11.4%. Positive surprises, when companies’ earnings beat analysts’ estimates, are running near the historical average of 76%. 

The first ten days of earnings season usually focus on the big and regional banks. There will be more banks reporting this week, but traders’ attention shifts tomorrow to the mega-techs. Amazon, Google and Microsoft report this week. Other headliners: McDonald’s (layoffs), Dow, Texas Instruments all on Tuesday. Facebook, Pioneer and eBay Wednesday. Thursday sees off another 70 S&P names including Caterpillar, Hasbro, Eli Lilly and Southwest Airlines. Exxon and Chevron report Friday. Sorry, Apple does not report until Thursday, May 4.