Wentz Weekly Insights
Markets Rally but Uncertainty and Risks Remain
Last week’s move higher got the markets back to the levels they were at before the invasion of Ukraine by Russia. After trading down 9 out of 11 days and volatility, as measured by the VIX index, trading over 30 for 11 consecutive days, stocks experienced a strong rally the final four days of the week, ending those four days 6.78% higher. The rally could have been due to a combination of a number of things including China pledging support for its markets, short covering, particularly growth and Chinese stocks, optimism over a compromise between Russia and Ukraine, and easing concerns regarding Fed policy after the most recent meeting last Wednesday.
It was a rough start to the week for Chinese markets which saw major indices fall as much as 10% at one point. A lockdown in Shenzhen was announced after a spike in covid cases and with it being a major manufacturing hub, created concerns about additional supply chain disruptions that would cause more upward pressure on inflation. The rally started after reports said China would support its stock market and support overseas share listings which were threatened with delisting over not adhering to reporting requirements and potential sanctions. The rally continued into weeks end over reports China would attempt to control the spread of covid through less draconian measures that will have less of an economic impact. To us, China is still an extremely risky investment due to the continued uncertainty around its support for Russia, in addition to covid risks, its troubled real estate sector, and slowing economic growth.
The Federal Open Market Committee meeting, with its policy decision and updated Summary of Economic Projections, was the main event last week that added to the equity rally. The overall tone to the Fed’s statement, projections, and press conference was more hawkish, but unlike in previous instances, the market took it in stride. As expected, the rate setting committee voted to raise interest rates by 25 basis points (0.25%) with one member dissenting – James Bullard, who wanted a 50 basis point increase. The statement indicated ongoing rate increases and a balance sheet runoff that will be announced in the coming meetings. The war in Ukraine adds uncertainty to the economy, and the Fed believes it will add upward pressure to inflation.
Now the most anticipated part of the meeting – the Fed’s projections indicate seven rate increases this year, up from three when it concluded its December meeting, meaning one increase at each of the remaining meetings this year. Interestingly, the Fed sees interest rates at 2.8% for both 2023 and 2024, above its neutral, or “terminal”, rate of 2.4%. This is important as it indicates to us the Fed is willing to let rates run above its neutral level in order to tame inflation, despite the risks of slowing the economy. Inflation is expected to remain high longer than previously expected and not come down until next year, while economic growth is expected to be slightly lower.
Powell said in his press conference discussions on shrinking its balance sheet went well enough that an announcement could come at the next meeting and the plan of doing so will be previewed in the meeting minutes from last week’s meeting (typically released about 2 weeks after the meeting). Powell essentially said the balance sheet runoff would look similar to how it did over the last tightening process (began 2017) but occur at a faster pace. Based on the information provided, we believe the Fed will begin shrinking its $9 trillion balance sheet after the next meeting on May 4 and do so at a $75 billion to $100 billion per month pace.
Stocks had a favorable reaction to the hawkish meeting and we believe that came as a result from Powell’s comments on the economy. Powell described the economy as still being strong, but markets took notice when he said he still sees a very low chance of a recession through 2023, which, if rates rise above the neutral rate, would be a major concern for stocks. Treasury yields moved higher across the curve, with the short end seeing the biggest move resulting in a steeper curve and a tighter spread between short- and longer-term yields. The 2-10 year spread ended the week at 17 basis point, the narrowest it has been since the last recession in 2020, and that much closer to an inversion – when short-term rates are higher than long-term rates, also an early recession indicator.
While the markets rallied last week, it is important to keep in mind there are still many uncertainties that remain. Inflation expectations continue to increase which could lead to a self-fulfilling prophecy, leading to additional concerns about company’s ability to control costs. There are so many unknowns with what Russia could do in Ukraine and the world, and China could agree to the Kremlin’s request of offering military and financial support. The Fed’s attempt at a “soft landing” could fail and its policy could push the economy into a recession with being too aggressive, despite decades high inflation. At this point it appears the economic and market risk is not if the Fed hikes rates too much this year, but if they don’t tighten policy enough now to fight inflation and must do so at a more aggressive pace down the road, leading to a more severe recession. With all this, one thing we do know is we will continue to see volatility. We are continuously monitoring the markets and portfolios, but if there are any questions or concerns, do not hesitate to reach out.
Week in Review:
Stocks opened the week in the green, but like we have seen in recent days the higher open did not hold into the afternoon. Several worries dampened the mood for markets including the surge in covid cases in China leading to lockdowns in key manufacturing markets and news Russia is getting more aggressive with its push in Ukraine. Hong Kong’s Hang Seng index was down 4.97% while US markets finished mostly lower as well with the NASDAQ down 2.04% to enter bear market territory (a 20% pullback from the highs) but S&P 500 down just 0.74%. The volatility index (VIX) traded above 30 for the 11th consecutive day, the longest streak since March 2020 when the covid outbreak began. As investors wait for the Fed decision Wednesday, yields continued to move higher with the 10-year up 14 basis points on the day to 2.14%. Tuesday was a strong rebound day with all major indices finishing positive and all S&P 500 sectors finishing positive expect energy. The sector fell 3.7% on the day, following a decline in oil which dropped to $96/barrel after hitting $130/barrel just a few days prior. In the morning the producer price index was released that showed another acceleration in prices – up 0.8% in February and up 10.0% from a year earlier. The S&P 500 closed 2.14% higher while the NASDAQ gained 2.92%. Chinese stocks had a massive rebound Wednesday with Hong Kong’s Hang Seng Index up 9.1% after China pledged support for the markets and economy. The optimism carried over to the US, helped by reports from Ukraine’s President Zelenskyy that peace talks were sounding more realistic but still warned they are no where close to a deal. In the morning February retail sales showed sales grew 0.4% in the month, but mostly driven by higher gasoline sales due to higher prices. In the afternoon the Fed released its statement and updated projections that included a 25 basis point increase in interest rates, a hint that quantitative tightening through shrinking its balance sheet could be announced at the next meeting, and update to projections that shows higher rates, lower growth, and higher inflation than expected in its December meeting. Stocks initially moved lower but recovered during Powell press conference after he said he believes US will not be in a recession next year. Stocks closed near the highs of the day with the S&P and NASDAQ 2.24% and 3.77% higher for the day, respectively. Asian stocks continued Wednesday’s rally on Thursday, while US stocks opened in the red, possibly due to comments from Russia describing progress in peace talks as “wrong.” However, the sentiment reversed with stocks making solid gains in the afternoon on finishing in the green on Saint Patrick’s Day with the S&P 500 finishing 1.23%. Stocks started Friday by taking a breather after three straight days of gains. It was reported that US intelligence believes Russia will threaten nuclear attacks if the war continues to drag on, while Biden met with China President Xi to warn him there will be consequences if China provides Russia with weapons, per Putin’s request. The losses for the day were again short lived with stocks reversing and moving higher for the day with the S&P 500 gaining 1.17%. For the week yields overall moved higher with the 10-year Treasury yield moving from 2.00% to start the week to 2.25% at the high after the Fed meeting, and finishing at 2.15%, while major US equity indices finished with their best week since November 2020 with weekly returns as follows: NASDAQ +8.18%, S&P 500 +6.16%, Dow +5.50%, Russell 2000 +4.20%.
Recent Economic Data
- The level of inflation at the producers’ level was 0.8% in February, a little lower than the 1.0% increase expected, according to the producer price index. Compared to a year ago those prices are up 10.0%, the highest since data began in 2009. The core index, which strips out food and gas prices, rose 0.7% in the month and is 8.4% higher from a year ago, both higher than expected. Prices for final demand goods rose 2.4% in the month, the largest increase in the data series which goes back to 2009, with 40% of that increase due to a 14.8% increase in gas prices.
- After a very strong 4.9% increase in January (revised up from a 3.8% increase in the initial estimate), retail sales rose 0.3% in February, in line with expectations. A 5.3% monthly increase in gasoline sales drove most of the gains, while motor vehicle sales were up 0.8%. Excluding these two major spending categories, February sales were down 0.4%, but are still up 15.8% from a year ago. Sales on health/personal care was down 1.8%, furniture sales were down 1.0%, sales of electronics down 0.6%, while e-commerce sales were down 3.7%. Growth was seen in building materials and gardening equipment, up 0.9%, while apparel saw a 1.1% increase and sporting goods saw a 1.7% increase. Restaurants and bars continue to see a post-covid recovery, sales up 2.5% in the month and 33% higher from last year. After accounting for the 0.7% increase in consumer prices, real retail sales, which adjust for inflation, were down 0.5%. The large upward revision for January made comparisons much more difficult and make up for a softer February. It will be key to see how higher gasoline prices affect the pace of sales going forward.
- Construction of new homes grew 6.8% in February to an annualized pace of 1.769 million, a 22.3% increase from February 2021, and at the highest pace since 2007. The number of permits filed to start construction of a new home fell slightly from the highest levels since 2007 in January, to an annualized pace of 1.859 million in February for the third consecutive month above a 1.800 million pace. The jump could be a result of a bounce after harsh weather in January. Demand remains strong but the lack of workers continues to hold back new construction. The backlog of projects that have been authorized but not yet started is currently at the highest levels since data began in 1999.
- Existing home sales in February dropped a more than expected 7.2% to an annualized sales rate of 6.02 million units. Compared to a year ago existing home sales were down 2.4%. Supply of homes worsened in the month with just 870,000 units on the market, a 15.5% drop from a year ago, equivalent to 1.7 month supply at the current sales pace. The lack of inventory and strong demand is driving prices higher with the median existing home price up 15% from a year ago to $357,300. Because of higher prices and higher rates, home buyers are paying an average of 28% more for a home they could have bought 12 months ago. It is important to keep in mind sales in this report are based on closings, so for contracts that were signed in December and January that counted in this report were closed when rates were averaging 3.25% to 3.68%, but have since risen to 4.25%.
- There were 214,000 jobless claims in the week ending March 12, down 15k from the prior week, with the four-week average at 223,000. Continuing claims were 1.419 million, down 71k for the lowest level of insured unemployment since 1970. The four-week average was 1.463 million, also the lowest since 1970.
- It was reported that Hudson’s Bay and private equity firm Sycamore Partners plan to submit takeover bids for Kohl’s that could be around $9 billion. Kohl’s made a deadline of Wednesday for potential bidders and had previously said it believes its shares are worth at least $70/share. The offers coming in are reported to be in the upper $60s/share range. It was last month that Kohl’s rejected a $64/share takeover bid.
- FedEx reported quarterly results with earnings just below expectations as higher transportation costs, wages, and expansion related costs cut into margins, but revenues were well above estimates, growing 10% from a year ago. It increased its adjusted EPS guidance for the full year to $19.10/share at the midpoint, up $.40/share at the midpoint from prior guidance.
- Senator Joe Manchin (D-WV) said he will not vote to confirm Sara Bloom Raskin for Federal Reserve Vice Chair of Supervision. Assuming all Republicans vote against, a no vote from Manchin means Raskin would not have enough votes for confirmation. Raskin was expected to use the position to make a push at the Fed for climate change policies.
- The Bank of England raise its benchmark interest rate another 25 basis points to 0.75%, as expected. There was speculation the central bank would do a 50 bps increase, as voted by several members.
- China saw 1,800 new Covid cases last Sunday, the highest since the pandemic began March 2020. As a result the country put Shenzhen and its roughly 18 million residents on lockdown for about one week. the city is a key manufacturing hub and home to global semiconductor manufacturers including Apple’s iPhone supplier Foxconn. Because of the surge in cases and accompanied lockdowns, oil prices were down as China is a major oil importer and a drop in demand is expected from the lockdowns.
- After a 10% drop in Hong Kong’s Hang Seng Index and 7.5% drop in the Shanghai Composite Index the first two days of the week, both bounced back Wednesday with a 9.1% and 3.5% gain respectively. The drop the beginning of the week was driven mostly by the concerns over covid lockdowns, potential delisting of Chinese securities from US exchanges, and reports of China’s potential involvement in supplying Russia in the Ukraine war. The reversal Wednesday came after reports the Chinese government is working on a plan with US regulators to address audit requirements of Chinese companies and reports the government is looking at ways to stabilize its markets, ensure liquidity, and support growth by taking measures to boost the economy.
- Per the WSJ, Chinese President Xi Jinping vowed to reduce the impact of Covid controlled measures on the economy and people’s lives for the first time. The country has used extreme measures to control the spread of the virus, but is indicating it will use less draconian measures to lessen he economic impact.
Did You Know…?
One Year Later:
The Freddie Mac mortgage survey showed the average mortgage rate for a prime 30-year loan was 4.16% last week, a jump from 3.85% the week prior. Keep in mind mortgage rates move in correlation to the 10-year Treasury yield which moved from 1.80% to 2.15% over the same period. The average 30-year rate fell to a low of 2.65% in January 2021 and started 2022 at 3.11%. Because of higher home prices (due to limited supply) and higher interest rates, a $1,000 mortgage payment a year ago would cost $1,280 today for a 28% increase in just one year.
Update on Tax Forms
As tax time is upon us, please be aware of this important note:
- Clients with retirement accounts (traditional IRA, Roth IRAs, etc.) will be receiving TWO 2021 Retirement Tax Packages (this includes Forms 1099-R and/or 5498). Raymond James made a back-office change where Raymond James Trust Company of New Hampshire (RJTCNH) is the new custodian of IRAs (you and your accounts are unaffected by this change). This change became effective September 7, 2021 and as a result accounts that had reportable activity before and after the Raymond James custodianship change will be receiving TWO tax packages. Please take note the second package is not a duplicate of the first. All forms must be used when completing the 2021 tax return.
- The first package contains reportable activity occurring from January 1, 2021 – September 3, 2021, under the RJA custodianship
- The second package will contain reportable activity occurring from September 7, 2021 – December 31, 2021, under the RJTCNH custodianship.
For more information on when you will be receiving your tax documents, please refer to this email.
The Week Ahead
The calendar lightens up in the week ahead. It remains a more quiet time of the quarter for earnings reports however there are still several notable companies reporting this week including from Nike on Monday, Carnival and Adobe on Tuesday, General Mills on Wednesday, and Darden Restaurants and Nio on Thursday. Elsewhere on the corporate calendar are many investor and analyst day events including from Nvidia, Moderna, and Lululemon where updates on pipelines and product lines could be announced along with guidance updates. The economic calendar is more quiet this week with key economic reports like new home sales on Wednesday, durable goods orders and weekly jobless claims on Thursday, and the University of Michigan’s consumer sentiment survey on Friday. In addition, there will be a lot of Fed speak this week with several Fed members making remarks on the economy and Fed policy. The war on Ukraine will continue to dominate many news headlines with President Biden planning to travel to Brussels for a two-day meeting with NATO and European leaders focusing on the response to Russia’s invasion.