When I was growing up, which was before internet and cell phones, children would often watch cartoons on TV, especially on Saturday mornings. One of my personal favorites was Looney Tunes since I was amused by the improbable gags, especially falling anvils and pianos. Sure, sometimes I felt bad for Wile E. Coyote but I was always entertained (and amazed) how Bugs Bunny could brush it off and carry on, almost as if nothing had happened. Over the past year many people might feel as if a heavy object has been dropped on their retirement savings. You might be asking yourself what you can do to protect yourself from such events.
Last week the major averages were higher for a second consecutive week, with the S&P 500 and Nasdaq reaching their highest levels in a month. Year-to-date these two indices are higher by about 4% and 6%, respectively. This is a sharp contrast to a year ago when markets began their precipitous fall. The stock market received support from increasing odds of a soft landing after last week’s Consumer Price Index (CPI) report showed a sixth-straight monthly decline with the annual increase of 6.5% being the lowest in 14 months.
On the heels of the CPI report, odds have now increased that the Fed will raise interest rates by a quarter of a percent at their next meeting in two weeks versus raising a half percent as had been the expectation immediately following their last meeting in December. Lowering the magnitude of interest rate hikes and lowered expectations mark a shift from the somewhat unprecedented path of accelerated rate hikes we saw last year and show we are likely nearing the top of the interest rate cycle. A divergence on the path of short-term interest rates continues between investors and the Fed. Markets are predicting the Fed will pivot and lower rates by year-end, while Fed officials remain steadfast with their messaging, insisting they plan to continue to raise rates but will eventually pause. Our thought is that despite moderating and moving lower, inflation remains elevated and above the Federal Reserve’s comfort level so there is little reason to think they will reverse course anytime soon.
Since we seem to be nearing the top of the interest rate cycle, the outstanding questions are how long will we remain here and what events could lead to current intentions being altered? Our thoughts are that if there is risk to what was just mentioned, it might be to the upside – rates are more likely to move higher than expected, not lower.
What’s Up, Doc?
The upcoming recession seems to be the most anticipated and predicted recession in history, or at least in our memory. Despite these predictions and the seemingly foregone conclusion from many economists, the economy shows signs of resilience and continues to grow, for now. Employment conditions remain quite robust and wages are growing, albeit not at a pace to keep up with inflation. But since inflation is slowly subsiding and showing some indications we might see much lower readings later in the year, the probability of a soft landing for the economy seemingly are increasing. This does not necessarily mean we will avoid a recession completely, and that scenario is certainly a possibility, and as of now any recession looks to be relatively mild.
Undoubtedly the Fed and interest rates will still garner larger than usual attention going forward, at least over the next few months, but we are likely to see a shift to earnings being the primary driver of the direction of the stock market. Earnings season kicked-off last Friday with major banks reporting strong earnings but with cautious outlooks and most signaling they were building reserves in anticipation of deteriorating credit conditions and a recession later this year. More earnings reports are on deck for this coming week before they really begin in earnest the week after. It is likely earnings from the last quarter will end up being decent, but we will be watching for future guidance and whether analysts continue to reduce forward-looking estimates.
This coming week brings retail sales numbers from December, the Producer Price Index (PPI), and various housing reports. Retail sales are expected to show a decrease in activity from November since the holiday shopping season had a very strong start, but these numbers have the potential to move the market if they come in better or worse than expected. PPI tends to have much less of an impact on the markets than CPI but is still watched as a gauge of inflation and can foreshadow future months’ CPI. However, this relationship is not currently as strong as it has been in the past given current drivers of economic conditions. If we do indeed experience a soft landing and manage to avoid a recession, we are very likely to experience an increase in overall demand for products and PPI could be the first place this will show up but that likely won’t happen for at least a few months.
The strength of the markets, both stock and bond, over the past few weeks have given investors hope that better days are ahead. But this is not a time to be complacent, but rather maintain patience and a disciplined investment approach. The fact remains that risks still remain and returns are likely going to be much harder to come by in the next few years than they were in the previous decade. Be sure your portfolio is protected from heavy falling objects; your retirement savings is not a cartoon where characters can simply walk away. Please give us a call if you would like help identifying what risks may lie ahead and what you can do to protect yourself.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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