With the recent weather being warmer than usual, including a rare February rainstorm last week, ask anybody in the Upper Midwest what season we are in, and they may be apt to tell you it is Fool’s Spring – the season between Winter and Second Winter. The change in sentiment over the past couple of weeks might have investors wondering something similar about the stock market – did we experience a bear market rally, sometimes referred to as a Sucker’s Rally, in January or was it the beginning of a longer-term trend?
Market strength early last week was whittled away later in the week by economic data and hawkish commentary from Federal Reserve officials. The S&P 500 was marginally lower and logged its second consecutive weekly decline. The Dow Jones Industrial Average also fell slightly while the Nasdaq eked out a small gain, but none of the three major averages made significant moves and all remain near where they traded in late January. Bond yields moved higher with Treasuries reaching their highest levels since November. The difference in yields between 2-year and 10-year Treasuries remains at the deepest inversion since the early 1980s, which many economists continue to believe foretells a recession later this year.
The heavy schedule of economic releases last week gave pause to the disinflation narrative. Analysts have stressed that the deceleration would likely be bumpy, but these reports nevertheless seemed to inject a note of caution into the debate. The January Consumer Price Index (CPI) was largely in line with consensus expectations while the Producer Price Index (PPI) came in hotter than consensus expectations. Retail sales from January surprisingly surged, showing consumers remain resilient but causing concern strong demand could lead to continued inflationary pressures. Robust spending combined with stubbornly higher-than-expected price increases are likely to keep the Federal Reserve on a hawkish track, continuing to raise interest rates for the foreseeable future.
The threat of a major winter storm impacting the Upper Midwest this coming week is a reminder that winter is not yet over and despite the reprieve felt the past couple of weeks, it may indeed be time to hunker down for Second Winter. Investors are trying to figure out if they should also be hunkering down or if the worst is behind us. The debate continues whether we will see a “hard” landing, where the economy falls into a recession as the result of higher interest rates, or if we will experience a “soft” landing with the economy slowing but avoiding a recession. Thanks to the U.S. economy outperforming expectations, as is evidenced by strong labor markets and consumer spending, investors are now contemplating a third outcome – a “no” landing scenario where the economy does not slow, and the stock market continues its upward trajectory.
The fallacy with the no landing scenario is that if the economy continues to expand, inflation is not likely to abate and will remain above the Fed’s price stability targets, increasing odds they will continue to raise interest rates. Higher rates lead to higher borrowing costs, which hinder economic growth and therefore would increase the risk of a hard landing. This would also bring back uncertainty about inflation and Fed action, which markets do not like, likely leading to volatile market action as we saw in 2022.
While the stock markets ended the week in nearly the same place they started, bond yields moved higher as did the probabilities of a higher terminal Fed Funds rate. The “higher for longer” mantra previously discounted by the markets is now gaining greater credibility. Some Fed officials have now openly declared that a half-point interest rate hike may be a possibility at their next meeting in late March. Looking back at history, stock markets tend to reach their low points about the same time the Fed pivots and begins to move rates lower. If history is a guide, we have not yet seen the bottom of this cycle and are probably not likely to see it until sometime later this year. We continue to be cautions when it comes to the markets in the short-term but remind investors to maintain a long-term perspective.
The week ahead will be highlighted by earnings reports from retail giants Wal-Mart and Home Depot, which will offer further updates on the health of consumers, as well as the release of the Personal Consumption Expenditures (PCE) price index. The PCE is the Fed’s most closely watched assessment of how quickly prices are rising. If this report comes in as expected, slightly lower than a month ago, it will lend support to recent indications inflation is not falling at the pace and extent investors were hoping for. Prices seem to have stabilized somewhat, as evidenced by inflation now growing at less than the rate it was during most of 2022, but they still are increasing at a pace above the comfort level of most consumers as well as the Federal Reserve.
The strong returns of the stock market in January provided hope that better days are ahead, but the volatility of the past year remains fresh in investors’ minds. The past 14 months have been a reminder markets do not always move in a positive direction in the short-term and do pull back from time-to-time as part of the normal market cycle. Historically markets have performed better over longer time periods. This is why it remains important to maintain a long-term perspective as well as have strategies in place to protect your hard-earned savings from short-term fluctuations. The market often gives false signs and as we’ve emphasized in the past, trying to time the market rarely works in one’s favor. Be sure to have a reliable income plan in place so you can weather all storms the markets might bring and sustain the lifestyle you desire during retirement
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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