Published February 17, 2023
Below, our friends from Delta offer a summary of recent data which shows the economy being stronger than many expected. But that strength is pushing interest rates upward in a renewed push. The upward thrust in rates could well undo the stock market rally so far in 2023. Broad market analysts remain very split over the outlook for the economy and markets. We think now is a particularly important time to have a tactical approach to investing, with the ability to quickly adjust to changing conditions. Our models offer just such an approach. Here’s Delta’s overview:
“Normally, when consumption and growth reports exceed expectations, the news is good. In today’s market, better growth means higher potential inflation which means higher interest rates for longer. That is bad. Higher rates compress P/E multiples and may eventually corral the economy into recession.
In some sense, many analysts say we are facing a “lose-lose” scenario. As a base case, we are headed for recession, lower earnings and lower stock valuations. If the fundamental economy is actually stronger than expected, then rates will rise and we once again will be headed for recession, lower earnings and lower stock valuations. We seem to be in a Catch-22 paradox when all paths lead to a declining stock market.
Total retail sales increased 3% month-over-month (vs. consensus expectation +1.7%) in January. Consumers are spending despite inflation pressures. Every single sales category increased, led by a 7.2% surge in the most discretionary food services and drinking places categories. All-time highs in truck driver employment reinforces the strong sales activity data.
The NAHB housing market index increased in the last report. Future sales expectations and traffic of prospective buyers were up. All regions showed advancement. Optimism in the housing market is supported by all-time high construction employment.
The Atlanta Fed GDPNow model keeps climbing and is now showing a 2.5% increase in GDP for the first quarter (consensus is below 1%). As one might expect given the stronger economic data, the Producer Price Index (PPI – another measure of inflation) was up 0.7% month-over-month in January versus expectations of 0.4%. Higher inflation data caused the S&P 500 to open down by more than1% on Thursday morning and the 10-year treasury to rise by 1.6% to 3.87% – the highest level this year.
On January 23, the S&P 500 index closed above 4000. Since then, it has never closed below this level even though the 10-year treasury rate has climbed from about 3.43% to 3.87%. This suggests that the mix of better economic growth versus the worry related to higher interest rates may be more weighted toward better growth than higher rates allowing for higher stock valuations.
The primary indicator that the “lose-lose” stock market outlook for 2023 may be inaccurate is the stock market itself. Technically, the market has been resilient and is gaining strength. The S&P 500 completed a “Golden Cross” formation with the index passing up through the 200-day moving average followed by the 50-day moving average passing up through the 200-day moving average. Technical traders interpret the golden cross as signaling a definitive upward turn in the market.
Fundamentally, we will have to wait and see what happens with inflation as the economy keeps on trucking. For now, the stock market advance seems to be anticipating a goldilocks outcome. If ever there were a time to be both cautious AND optimistic, now is the time.
Investors faced the next round of inflation reports this week as well as the monthly retail sales report. Monday found stocks recouping the prior week’s dip with a +1% rise ahead of those reports. The inflation report issued Tuesday showed price levels continuing to moderate from the prior year’s reading. However, inflation came in a touch higher than forecast sending stocks gyrating wildly in Tuesday’s trade before settling flat on the S&P 500. A strong retail sales report sent stocks upward Wednesday with the Nasdaq rising +1%. A series of travel-related companies posted solid earnings reflecting a full recovery in travel since the pandemic. The good cheer carried forward into Thursday until a couple of Fed members splashed cold water on investors by saying the inflation and economic reports suggest the need for higher interest rate hikes. Stocks gave back -1.4% Thursday. Prices were weak through Friday as well until a late-day spurt of buying narrowed losses to -0.3% as interest rates gave up earlier upward moves.
The back-and-forth trading of the week left the S&P 500 (SPY) unchanged at -0.19%. The Nasdaq 100 (QQQ) held on to a +0.49% gain for the week. Smallcaps (IWM) added +1.48%.
Warm wishes and until next week.