As of market close February 17, 2022. Returns in percent.

Investment Insights

 — Steve Orr 

Coming around

Are markets finally coming around to the Fed’s reality? The “soft landing” theme on Wall Street since Christmas fueled a solid countertrend rally in stocks and shifted investor sentiment to Bullish levels for the first time in nearly a year. A lot of institutional and retail money heard what they wanted from Fed Chairman Powell and the FOMC. Two items stand out: 1) Powell’s “disinflation” comment and 2) the press release statement “…Committee would be prepared to adjust …monetary policy.” Both were interpreted to mean the Fed’s rate increases would end soon. Several firms were calling for rate cuts by the end of the year. 

Fed speakers were out in force last week, trying to get markets to see the inflation world through Fed eyes. The Fed sees steady, even strong, job growth (leaving out January) and continuing inflation. Recent economic data is lower year-over-year, but is not as bad as analysts were projecting. The same effect is happening in fourth-quarter earnings. Volumes and earnings were lower, but not as bad as feared. The Fed thinks the economy is not slowing enough in response to its rate increases and portfolio reductions. Our business clients on the front lines of the economy may disagree, however. 

Words and deeds

Since this rate increase cycle began, we have taken Fed speakers at their word. Chairman Powell appears to be speaking to Congress and the media. His tone is thoughtful, straightforward and at times a bit too revealing. His language is refreshingly clear compared to some earlier Chairs. The Committee members, however, appear to be speaking to portfolio managers. They are giving the Fed line but also their views. All seven speakers last week were consistent in saying that rates would have to be higher for longer and progress on whipping inflation is “slow.”

Both Cleveland Fed President Mester and St. Louis Fed President Bullard stated that they would have preferred a half-point increase at the February 1 meeting. Richmond Fed President Barkin said he was comfortable with quarter-point increases but “that means I’m comfortable raising rates potentially more often to a higher level.”

Three data points helped the Fed’s message last week. January’s Consumer Price Index reading of 6.4% was above expectations and the internals did not look good. Traders did not like the BLS modifying the shelter component either. Shelter was raised from the mid 30% portion of CPI to 44% of the index. Increasing the size of the home price and rents component just when those prices are turning lower makes us wonder a bit. Average hourly earnings fell nearly 2% in January and finally credit card usage is hitting all-time highs. Together, these numbers paint a picture of consumers struggling to maintain purchasing power. 

Message and move

The bond market got the message on Friday, February 3, with the release of January’s job report. Whether you believe the numbers or not, almost every detail of January’s employment report showed that the economy was still ticking along. Perhaps not as fast as mid-2020 but doing OK. That Friday, the two-year Treasury jumped nearly two-tenths of a percent and the 10-year Treasury an eight of a percent. In bond-land those are big one-day moves. Since February 2, the day before the employment report, twos are a full half-percent higher, and 10s rose almost as much. Hope you locked your new mortgage last month. Over the same two-week period, all of the major stock indices have dropped 1.7% or more. Wednesday’s volatility index (VIX) and Friday’s options expiration also added to the fun, helping push the S&P 500’s daily moves over 1% for four trading days. 

Fed Funds futures certainly heard last week’s speeches. They are pricing in quarter-point rate increases by the Fed in March, May and now possibly June. Often markets have traded against the Fed, making the Fed’s rate projections move toward market rates. For the first time in many moons, markets moved (up) to the Fed’s Dot Plot projections. Short-term rates are projected to be north of 5% this summer. Digging around in our dusty memory bins, the last time short rates stayed around 5% was from 1969 to 1980. Oh, and the S&P 500 was unchanged from 1969 to 1980. Ouch. 

Near you

The Conference Board’s Leading Index has a good track record of calling changes in the economy and recessions. January’s reading marked the tenth straight month of declines for the index. New orders, consumer expectations of business conditions and credit led the index lower. Job gains and January’s stock market rally were the only positive contributors. The coincident and lagging indicators also forecast continued weakness in the coming months. The chart below shows that each time the index has crossed zero, a recession was declared.  

Is a recession coming to an economy near you? What if the Most Anticipated Recession Ever is already underway? After 10 months of declines in the LEI, we may look back on the last several months as the recession. This week, the Commerce Department will release its second estimate of the fourth quarter’s GDP. Analysts project a slight increase to 2.9% growth. Nearly 3% growth in the economy makes a recession a tough call. Fourth-quarter earnings deserve a closer look. 

And finally

The level of interest rates and consumer spending translates directly into corporate earnings. Fourth-quarter earnings season, in the word of FactSet’s John Butters, is “subpar.” We would say subpar is better than bad, which is what we feared at the end of January. Only 68% of reporting companies have beat estimates, well below the five-year average of 77%. Overall earnings are on track to drop about 5%, marking the first negative quarter since 2022’s third. Wall Street estimates still call for earnings drops the first two quarters of this year and positive growth in the last two. 

About 70 S&P 500 firms will report over the next two weeks, so less than 15% of the index is left to report this season. The first week of the season is “big bank” week. This is “big retail” week, traditionally the end of earnings season. Walmart, Home Depot, Etsy and eBay are on tap. Plenty of investor attention will also be focused on Nvidia for gaming growth. Folks who make real stuff like Pioneer and Ingersoll Rand also report.