As of market close February 10, 2023. Returns in percent.

 Investment Insights

 — Steve Orr 

Higher, sorta

January’s rally ran into the first two trading days of this month. Since then, the big indices have inched lower and sit about a half of a percent above their January closing levels. Not bad for February, which is usually a flat month. Earnings for the fourth quarter are coming in at lackluster levels, but not as bad as some predicted. 

Since the October lows, U.S. stock indices have rallied about 15%. As the economy plods toward an apparent recession, it’s instructive to look at what has changed since Halloween. Short-term rates are three-quarters of a point higher, 10-year Treasury yields are unchanged, the dollar is 7% lower and S&P 500 forward earnings are 5% lower. So why are stocks higher? The short answer is investor sentiment. Institutional sentiment moved into positive territory in late January. Retail sentiment in particular turned Bullish last week. Short-term, investor sentiment is usually a contrarian indicator. When folks get too excited, stocks tend to do poorly. 

Longer sentiment periods do have some information for us, however. According to Bespoke, three times in the modern era retail Bearish sentiment has lasted longer than 20 weeks. The most recent period lasted 44 weeks from early last year until last week. When Bearish sentiment sticks around for longer than 10 weeks, stock returns over the next several weeks are mixed, at best. Six months after turning positive, the S&P 500 was higher, and 12 months later, returns were over 30%.

Who’s right?

January’s consumer price index comes out tomorrow morning. Street expectations are for a 6.2% rise over last January. Core housing and health care continue to rise, but at a slower rate. Food and gasoline still grab the headlines. Gas prices have thankfully come down recently, more on lack of demand than bulging supplies. Note that recent consumer confidence numbers have improved; they are heavily influenced by pump prices. 

Food prices remain a problem and the full effects of less fertilizer and grain exports from Eastern Europe will be felt over the next couple of years, not next month. Down the road, gas prices will be heading higher. Near-term refineries will be shifting over to more expensive summer blends. Further out, Russia and Saudi Arabia do not have ready reserves that are easy to tap. Our Permian-based drillers face higher costs for tooling and an ongoing labor shortage.

We expect headline inflation to decline over the next several months, due to the big jumps in CPI from last year being subtracted from smaller increases this year. Regardless, prices are not going down anytime soon. Do not be surprised if, in the fall, CPI starts inching higher. The Dallas Fed’s monthly business survey shows respondents are still concerned about high materials and labor costs.

Higher, longer

That is not a sports tagline. This week seven Fed speakers will be out on the lecture circuit. All will be beating the “higher rates for longer” theme. Chairman Powell has yet to walk back his “disinflation has started” comment from his February 1 press conference. Rest assured, the speakers this week will emphasize that the Fed is not done raising rates and once the highest rate is reached, it will keep them there for a while. Our forecast coming into the year was between 5% and 5.25% for the balance of 2023. We think once inflation gets past the easy comparisons in the spring, price levels will justify the Fed’s higher stance. Last week New York Fed President John Williams told a Wall Street Journal event that “We’re going to need to maintain that (higher level) for a few years to make sure we get inflation to 2%.” That does not sound like someone cutting rates at the end of this year.