Volatility vacation over — Week of December 12, 2022

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Fun week for headlines and price moves.

Strategy and Positioning written by Steve Orr, Chief Investment Officer; and Essential Economics written by Mark Frears, Investment Advisor

index	wtd	ytd	1-year	3-year	5-year	index level
S&P 500 Index	-3.35	-16.18	-14.36	9.64	10.11	3,934.38
Dow Jones Industrial Average	-2.74	-5.95	-4.40	8.52	8.93	33,476.46
Russell 2000 Small Cap	-5.06	-18.96	-17.97	4.54	4.70	1,796.66
NASDAQ Composite	-3.98	-29.09	-28.48	9.42	11.01	11,004.62
MSCI Europe, Australasia & Far East	-0.19	-12.43	-10.85	3.01	2.95	1,978.88
MSCI Emerging Markets	0.48	-18.18	-18.99	0.38	0.23	978.28
Barclays U.S. Aggregate Bond Index	-0.44	-11.84	-11.72	-2.27	0.33	2,076.40
Merrill Lynch Intermediate Municipal	0.38	-6.33	-6.22	-0.20	1.47	299.85

As of market close December 9, 2022. Returns in percent.

Strategy & Positioning

— Steve Orr

Disconnect

The usual midterm election rally script worked well through Thanksgiving. Most equity indices are still sitting on double-digit gains this quarter. December — not so much. U.S. indices are down 3% to 5% and Europe is flat. China was the star for the first two weeks. Since Halloween, visions of China’s economy reopening have pushed offshore shares higher by one-third. We would cast doubt on those gains holding for long, given the struggles parts of the country are experiencing with COVID.

The recent rally is quickly dissolving into just another Bear cycle attempt at the 200-day moving average. The S&P 500 spent exactly two days above that intermediate trend measure. The Dow Industrials is the only index that has managed to stay above its 200. The rest of the crowd took a short vacation above the 200 and last week broke lower. From a chart perspective, there are plenty of resistance levels preventing a run higher to Santa Claus. There is some support at 3,900 for the S&P 500, but be aware that there is not much standing in the way of a 5% drop to 3,706 or the late September lows of 3,585.

Stocks have the fundamental and technical (Bearish) trend correct. There is just not a lot of support for rising earnings right now. Rates are headed higher and prices in most of the economy continue to rise. We are a bit frustrated with the disconnect between earnings projections of 5% or more growth next year and the steady deterioration in our outlook.

Take note: every regional Fed business survey and the Conference Board’s Leading Economic Index have fallen for at least six months and will again in December. Four months down is a good recession call in the coming months. These surveys correlate well with future stock returns. When the economy trends rend down, earnings will trend down, and prices follow. These surveys are part of our monthly indicator ranking process. They are keeping us firmly in the Neutral camp and on the sidelines.

Ahead

December’s lackluster start was accompanied by falling volatility in both stocks and bonds. Lower daily price swings and implied lower swings from options are a bit surprising. Rising uncertainty from a cloudy earnings picture, declining commodity prices, and the fact that over half of the items in inflation measurements are still rising should be drivers of higher volatility. Rather than go in deep weeds about Treasury funding, sources of liquidity, etc., let’s just say the volatility vacation is over.

This week kicks off with the Consumer Price Index on Tuesday, Fed meeting and Powell’s presser Wednesday, Retail Sales (Black Week) Thursday, and the Federal Government going broke on Friday. CPI should dip slightly to a 7.3% year-over-year run rate. Anything above that should cause Powell to ratchet up the hawkish language in his press conference. Expect to hear “rates higher and longer than markets expect” over and over.

By chance if CPI comes in below estimates, stocks should be happy that a Fed pause, or at least smaller increases in 2023, will be in their stockings. Regardless, we have a tough time buying the economic models that suggest Fed Funds peak in mid-2023 and fall through year-end. We take Powell and team at their word; they will keep rates high and through most, if not all, of 2023.

Congress is back in D.C., but at least they are mostly focused on funding the government. An Omnibus bill funding the government through several years would give markets certainty. Fat chance. The best we should hope for with a lame duck session is a fiscal year continuing resolution that funds flat year-over-year through September 2023. The worst case for markets would be the uncertainty of a two- or three-month funding bill that would kick the can to Valentine’s Day. Then we go through the whole shutdown threat routine again.

Not enough for you to reach for the Tums? How about Friday’s triple witching close? The last quarterly expiration of options and futures should jolt prices. Our handy Stock Trader’s Almanac says the S&P 500 has risen on December’s triple witching day 26 of the last 39 years. Any press conference rain provided by Powell could be drained by portfolio managers squaring up year-end exposures.

Essential Economics

— Mark Frears

Shopping

You may think this topic is brought about by the great Christmas buying binge, but it’s broader than that. This weekend I headed out of the house a couple times for different purposes. Once was out to eat at a local restaurant and the other was to replace the bag on my pool vacuum (lots of leaves). So, one was for services and one for goods.

Economy

One way to look at Gross Domestic Product (GDP), or the economic strength of a country, is dividing up consumer spending into goods and services purchased. Two-thirds of GDP is driven by you and me. During the pandemic, people pulled back on their services spending, as they were quarantined at home, and devoted most of their spending to goods like food and basic needs. Post-pandemic, there was pent-up demand for going out to eat, vacations, and living a normal life. Much of that spending is services related.

This week we had the Institute of Supply Management (ISM) Services Index showing an increase in spending on services for the 30th month in a row. This jumped to 56.5%, up 2.1% from October, driven by increases in business activity and employment. Consumers are still spending; we don’t see a recession here.

It cost how much?

The latest indicator we had on the inflation front was the Producer Price Index (PPI). While the month-over-month numbers were a little higher than expected, the year-over-year change continued its downward trend. The 7.4% change was down from 8.1% in October and well below the high back in March of 11.7%. While goods prices increase a bit, the monthly increase was driven by services.

The trend in spending on services and associated higher costs is evidence that the consumer has not received the message that a recession is coming, and they should change their behavior.

Jobs

The primary driver of this trend continuing can be found in the labor market. The unemployment rate is very close to historical lows at 3.7%. There are over ten million job openings in the U.S. Weekly jobless claims are only increasing at a very slow rate.

All these point to a strong (for the employee), tight (for the employer), dynamic job market. The share of workers quitting their jobs had been falling (better sign for employers) but is starting to rise in the leisure and hospitality sectors. An increased share of workers quitting their jobs can put upward pressure on wages as employers try to retain and attract workers.

In the last employment report, we did see wages increase 0.6% on a monthly basis, confirming this observation. Also, the Atlanta Fed’s wage growth tracker increased in November.

Fed

As we have shown in previous write-ups, the Fed always has a difficult job, but the job market is making the inflation fight especially challenging. The meeting this week should be a non-event, if the Fed delivers a 50-basis-point (bp) increase as expected. The good news is that this will be less than the previous four 75bp increases. The message expected from the chairman in his press conference will be that while this move is smaller, they are not done. Two things to keep in mind.

First, the very fast and furious prior moves take some time to filter through the economy. So, a pause is reasonable. Second, while they don’t want to push the economy into a recession, they will do what is needed to slow demand, which will most likely cause some economic slowdown. So, increases will continue as long as needed.

Current futures markets show the Fed stopping raising rates following another 50bp (on top of this week’s), peaking around 5.00% for the Fed funds rate. If that in fact is the case, the next question is how long they will leave it there. It will stay there, at least, until the inflation rate falls below that level.

	Upcoming Economic Releases:	Period	Expected	Previous
13-Dec	NFIB Small Business Optimism	Nov	90.5	91.3
13-Dec	Consumer Price Index MoM	Nov	0.3%	0.4%
13-Dec	CPI ex Food & Energy MoM	Nov	0.3%	0.3%
13-Dec	Consumer Price Index YoY	Nov	7.3%	7.7%
13-Dec	CPI ex Food & Energy YoY	Nov	6.1%	6.3%
13-Dec	Real Average Hourly Earnings YoY	Nov	N/A	-2.8%

14-Dec	Import Price Index MoM	Nov	-0.5%	-0.2%
14-Dec	Export Price Index MoM	Nov	-0.5%	-0.3%
14-Dec	FOMC Rate Decision (Lower Bound)	14-Dec	4.25%	3.75%
14-Dec	FOMC Rate Decision (Upper Bound)	14-Dec	4.50%	4.00%

15-Dec	Empire Manufacturing	Dec	(0.5)	4.5
15-Dec	Retail Sales MoM	Nov	-0.2%	1.3%
15-Dec	Retail Sales ex Autos MoM	Nov	0.2%	1.3%
15-Dec	Initial Jobless Claims	10-Dec	232,000	230,000
15-Dec	Continuing Claims	3-Dec	1,650,000	1,671,000
15-Dec	Philadelphia Fed Business Outlook	Dec	(10.0)	(19.4)
15-Dec	Industrial Production MoM	Nov	0.1%	-0.1%
15-Dec	Capacity Utilization	Nov	79.8%	79.9%
15-Dec	Business Inventories	Oct	0.4%	0.4%

16-Dec	S&P Global US Composite PMI	Dec	46.8	46.4
16-Dec	S&P Global US Manufacturing PMI	Dec	47.9	47.7
16-Dec	S&P Global US Services PMI	Dec	46.5	46.2

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here.

Mark Frears is an Investment Advisor, Executive Vice President, at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas – Dallas.

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