Wentz Weekly: Stocks Continue Decline As U.K. Unexpectedly Buys Bonds

Wentz Weekly Insights
Stocks Continue Decline As U.K. Unexpectedly Buys Bonds

The big story of the past week was the wild ride in bond yields and the equity market as stocks made new 52-week lows, with the S&P 500 closing Friday down 25.6% from its all-time high set in January. Bond yields saw sharp moves higher to start the week, repricing after the Fed’s hawkish meeting the week prior and from additional Fed speak that reiterated more rate hikes are needed. Then they saw the largest drop in years on Wednesday after the Bank of England made a surprise announcement it would temporarily start buying bonds to support prices and bring down longer-dated yields.

There was widespread concern about market functioning after thousands of pension funds were faced with demands for additional cash to meet margin calls after a collapse in U.K. government bond prices, known as gilts, according to the Financial Times. To bring back market stability and support these bond prices, the Bank of England (BoE) said it would temporary purchase long-dated bonds in any amount necessary to achieve stability. The BoE was on a path to start selling gilts starting this week in its continued effort to cool inflation. That has been postponed to October 31, with interest rate increases still on the table.

The move had a massive effect on global markets with the British pound strengthening after falling to its lowest level on record versus the dollar, while bond prices recovered as yields moved lower with U.S. Treasury yields seeing the sharpest daily drop in years. Stocks got a boost as well due to the drop in yields and increasing probability the Fed will not be able to raise rates as much as feared. There was also the spillover effect with thoughts global central banks would have to do the same to ensure financial stability and avoid a liquidity crunch.

This led to the question can the Fed continue its aggressive tightening path, raising interest rates and continuing to reduce its balance sheet, without causing financial instability. The latest Fed speak suggests that is the case with policymakers consistent in their message the Fed wants to get rates to the mid-4% range. Market’s expectation of future rates moved lower through the week however, pricing in a terminal rate of 4.45% versus 4.75% where it started the week.

The one-day bounce in stocks was short lived though after solid economic data that was released Thursday and Friday brought market’s attention back to the Federal Reserve having to continue its rate hikes. Weekly unemployment claims fell below 200,000 again, indicating the labor market remains very tight with no signs of easing yet, while the BEA’s personal income and outlays report Friday showed consumer spending was stronger than expected, wages rose more than expected, and inflation was higher than expected in September. The issue is inflation data is starting to show price pressures are building in the “core” category which includes items that tend to be “stickier” like shelter, which also makes up the largest chunk of the index.

If there is a silver lining, it is that cyclical names are no longer the worst performers – over the past several days it has been defensive sectors like utilities and staples. In addition, there are more stocks making new 52-week lows and only 5% above 50-day moving averages. While we are not calling a bottom, this is typically a sign of a bottoming process.

Week in Review:

Markets opened last week Monday continuing to focus on global central bank policy and the sharp rise in the U.S. dollar, especially compared to the British pound and the Japanese yen, with the pound falling to an all-time low versus the dollar. This has led some to call for emergency rate increases by the Bank of England. It was another day of sharp declines with 4.99 to 1 declining to advancing stocks with the S&P 500 closing down 1.03%.

Tuesday was another day of a rising dollar and rising bond yields. Stocks got off to a rare solid start after an optimistic tone on being able to engineer a soft landing from a Fed official but began to turn lower in afternoon trading and moved past the lows of the year to make a new closing low. Foreign exchange was again the biggest headline as the dollar continued to rise with China stepping up efforts to support its yuan after its recent depreciation, while Japan reiterated concerns about the yen’s sharp decline and India intervening to support its rupee. Data in the morning included solid core durable goods orders and a 40% jump in new home sales from a six-year low. U.S. stocks hit a new low of the year after falling 0.21% for the day with Treasury yields and the dollar continuing the move higher.

Overnight Tuesday into Wednesday a Bloomberg report said Apple is reversing plans to increase iPhone production after weaker demand, pushing markets lower over additional demand concerns. Then several hours later, after a sharp decline in the British pound, a sharp rise in bond yields, and concerns over collateral calls, the Bank of England bailed out markets by announcing it would begin buying an unlimited amount of long-dated government bonds to support market functioning. Global bond yields moved lower, with U.S. treasury yields seeing the sharpest drop in years as bond prices rallied and stocks bouncing from overnight lows to open in positive territory and rallying through the day. Stocks finished near the highs of the day with the S&P 500 up 1.97% and small caps outperforming with the Russell 2000 gaining 3.17%.

Stocks failed to follow through on Wednesday’s strong gains and moved lower at the open Thursday with data in the morning showing a drop in jobless claims, reflecting the still very tight labor market. There were additional concerns in Europe after British PM Truss defended her economic plan, against calls from global organizations to reconsider tax cuts. Global yields moved higher, taking back Wednesday’s declines, with stocks moving lower. Oil moved higher over reports OPEC is planning to announce production cuts at next weeks meeting. The S&P 500 ended the day down 2.11% for its lowest close since November 2020.

A couple earnings reports overnight including Nike that saw lower margins due to higher freight/logistics costs and more markdowns to clear inventory, and Micron that saw less demand from suppliers had stocks on a cautious stance heading into Friday’s trading. In addition, data from the morning showed consumer spending and income measures were higher than expected in August as well as the Fed’s preferred measure of inflation. The core personal consumption expenditure price index rose 0.6% in the month, almost double expectations. Stocks set a new 52-week low with the S&P 500 closing down another 1.51%.

It was another wild week in the markets with heightened volatility continuing in the fixed income markets. Treasury yields moved higher in the beginning of the week before falling Wednesday after central bank action in the UK with a slight steepening of the curve. Oil was relatively unchanged for the week with rumors OPEC will consider cutting production at its monthly meeting. Stocks fell to new 52-week lows to end the week with all the major indices finishing the week down again and as follows: Russell 2000 -0.89%, NASDAQ -2.69%, S&P 500 -2.91%, Dow -2.92%.

Recent Economic Data

• According to the S&P CoreLogic Case-Shiller Home Price Index, average U.S. home prices rose at a 15.8% annual gain in July, down from 18.1% in June for the largest deceleration in annual home prices in a one month period ever, and down from the peak annual increase, and record high, of 20.6% in April. For the month, the index fell 0.2% versus the expectation for a 0.3% increase. The theme was still strong, but decelerating price gains. Tampa region continues to grow the fastest with home prices up an average of 31.8% from a year ago, followed by Miami (+31.7), and Dallas (+24.7%), with Minneapolis (+9.0%), Washington (+9.4%), and Detroit (+11.4%) continuing to be at the bottom of the list. Cleveland remains in the middle with a 12.4% y/y gain.

• New orders for manufactured durable goods, which are a proxy for business investment and an input to GDP, decreased 0.2% in August, about half the decline expected, but declined for the second consecutive month. More importantly, core capital goods, which remove volatile categories and are more core to the economy, rose a solid 1.3% which is almost double the expectation. Shipments rose another 0.7% and are higher for 15 of the past 16 months, while unfilled orders rose for the 24^th consecutive month.

• Sales of newly built homes saw a huge surprise and a large bounce in August, rising to 685,000 homes on a seasonally adjusted annualized basis, almost 40% more than expected, and significantly above July’s six-year low of 532,000 for a 28.8% monthly increase and the highest since March. The pace of new home sales was relatively unchanged from a year ago. The median price of a new home fell 6% in the month to $436,800, but still about 2% above two months ago and about 1.5% above where prices started the year. Supply continues to improve with 20% more newly built homes available than the start of the year with a supply of 467,000 which is equal to 8.5 month supply.

• The consumer confidence index was 108.0 for the September survey, better than expected and up from 103.6 in August, and moving to a five-month high thanks to falling gas prices. The index of the current situation was 149.6, up from 145.3 last month while the index on feelings about the next six months rose to 80.3 up from 75.8 for the highest since January.

• The number of unemployment claims filed the week ended September 24 fell 16k to 193,000 for the lowest level since spring and closer to its 50-year lows. The four-week average fell to 207,000. Continuing claims were 1.347 million, falling 29k from the week prior, also back near the lows from spring and close to 50-year lows, with the four-week average down to 1.381 million. The number of unemployment claims filed still suggests a very tight labor market.

• Second quarter economic growth was -0.6% in the final GDP estimate, unchanged from the second estimate published last month. There was a slight upward revision to consumer spending which was offset by a slight downward revision to exports.

• The University of Michigan’s consumer sentiment survey was 58.6 in September’s final reading versus expected 59.5, but still up from the record low of 50.0 in June. Expectations index was 58.0 versus 60 expected (47.3 was low in July). One-year ahead inflation 4.7%, more than expected (high was 5.4% in July), five-year ahead inflation expectations of 2.7%, in line with estimates (high was 3.1% in June).

• Personal income and outlays:
• Personal income in August increased 0.3%, in line with expectations and follows a 0.3% increase from July. Compared to a year ago, personal incomes are 5.7% higher. However, the more important wages and salaries component rose 0.3% and is 9.5% higher than a year ago. On a real basis, or inflation adjusted, real wages/salaries are 1.3% higher (adjusting for the 8.2% y/y inflation).
• Consumer spending was up a solid 0.4% in the month, double expectations, and follows a downward revised 0.2% decline in July. On a year-over-year basis, spending is up 9.8%. A trend that started a little over a year ago continues where consumers are spending more on services versus goods. Goods spending fell 0.5% in August while spending on services rose 0.8%. Compared to a year ago goods spending was up 8.7% while services spending was up 10.3%.
• The savings rate, what is left over from income after personal outlays and taxes, remains near the lowest levels since the mid-2000s, at 3.5% in August, matching July’s rate and the second lowest since the 2000s behind June’s 3.0% savings rate. To give a better comparison, the savings rate averaged 7.3% in the 2010’s.
• The personal consumption expenditure price index – the PCE price index which has historically been the Fed’s preferred measure of inflation – rose 0.3% in the month, is up 6.2% from a year ago (versus 6.1% expected, but falling from 6.4% in July), while the core index rose a strong 0.6% in August and accelerated from a year ago at +4.9%, up from 4.7% in July.

Company News

• Amazon said it will hold a second Prime Day on October 11 and 12.

• Apple said it will manufacture its newest iPhone 14 in India as it continues its attempt to move production out of China.

• Separately, a Bloomberg report noted Apple is pulling back its plans on increasing production of its new iPhone 14 after initial sales and demand was weaker than expected. Apple told suppliers to back off their efforts to boost assembly of the iPhone 14 models by up to 6 million units. Right before Apple’s launch event to announce its new products several weeks ago, it boosted production in anticipation of strong demand, but that never materialized, according to the reports, and it will now focus on its original 90 million forecast.

• Casino stock like Wynn and Las Vegas Sands moved higher last week after Macau announced plans to resume e-visa issuance and allow groups from Mainland China by the end of October for the first time since the pandemic started. A large part of Macau’s casinos generate revenue from Mainland China visitors.

• DocuSign said it will cut its workforce by roughly 9% and take on a $35 million charge in a restructuring effort that would be completed by the end of fiscal year 2023.

• Apparel company VF Corp, parent company to brands such as North face, Van’s, Timberland, and Supreme, reported quarterly results that were below expectations due to a weaker than anticipated back to school sales performance, leading it to lower full year guidance. It also said increasing inventories led to a more promotional environment.

• Nike stock took a hit after reporting mixed quarterly results with a 44% increase in inventories causing the company to take strategic pricing actions including markdowns, which put downward pressure on margins. Its results were also affected by higher freight/logistic costs, weaker sales in China, a large foreign exchange impact, all impacting margins by a much more than expected 220 bps to 44.3% versus the expectation for 45.4%. Nike mentioned it expects the margin pressures to be transitory, but many analysts have been cutting earnings forecasts and price targets.

Other News

• Yields on U.K. government bonds, also known as gilts, were on their pace for the sharpest monthly increase in at least six decades, rising from 2.81% in the beginning of September to 4.54% last week before the Bank of England intervened and announced it would temporarily buy government bonds to support prices and market stability. The issue arose after thousands of pension funds faced demands for additional cash from investment managers to meet margin calls after a collapse in government bond prices, as reported by the Financial Times. The move lower in bond prices accelerated after incoming PM Liz Truss and her party announced a major tax package aimed at cutting taxes and providing economic support. This immediately caused bond prices and its currency to move sharply lower. Bank of England was on a trajectory to start selling its government bonds this week, but quickly reversed those plans after seeing instability in financial conditions and these collateral calls in pension funds. The central bank said if the conditions were to continue it would lead to material risks to UK financial stability (which could spill over into global economies) and unwarranted tightening of financial conditions which could reduce the flow of credit to the real economy. The BoE still plans to reduce its gilt holdings, which was planned to start today (Monday the 3^rd) but will be delayed until October 31 and still plans for rate increases.

• The International Monetary Fund (IMF) is asking UK to rethink tax cuts as that would just add to already high inflation. This was a rare move in asking a G7 nation to reconsider fiscal policy.

• It was a busy week of Fed speak, much of which reiterated the aggressive and hawkish stance by the Fed, with several highlights below:
• Cleveland’s Fed President Mester said the federal funds rate is still not high enough to be considered restrictive, suggesting many more rate hikes are ahead. She said when navigating uncertain economic conditions, some research has shown policymakers should be more cautious, or lean on doing less with policy versus more, then went on to say that the more recent research suggests that is not so true because some studies show acting more aggressively prevents the worst-case scenario. Regarding inflation she wants to be certain it is going down and not assume because of one or two improved months of data because wrongly assuming inflation is well-anchored is more costly than no assuming. She went on to say she believes the Fed will not stop raising rates if inflation is still elevated even if the economy falls into a recession. She said she sees inflation more persistent than what the latest Fed projections suggest, making her more hawkish. She is a voting member on the FOMC this year.
• Chicago’s Fed President Evans said he was getting nervous about lack of wait time between rate hikes and is optimistic the peak rate the Fed is projecting will be restrictive enough to bring inflation back to its goal. He said the median peak rate is 4%-4.25% (another 100 bps of increases).
• Atlanta’s Fed President Bostic said “we’ve still got a ways to go to control inflation” and the Fed is “only now getting to a point” where policy is slightly constrictive.
• Chairman Powell spoke at a conference but it was focused on cryptocurrency, saying it is important regulation is in place to use in the retail financial system. The Fed does not expect to make a decision on a central bank digital currency any time soon and will require backing from Congress.
• St Louis’ Fed President Bullard said inflation is a serious problem in the U.S. and the levels of inflation are similar to what was seen in the late 1970s and 1980s and the Fed needs to be careful not to replay the scenario that played out over that period. He added that policy has moved into a restrictive territory.
• San Francisco’s Fed President Mary Daly said a deep recession is not warranted to slow inflation, but a “downshift in economic activity” and rising unemployment is what is needed. She said this will not be easy though as a myriad of risks are narrowing the path for a smooth landing. She believes getting the rate to 4.5%-5.0% and holding it there through the end of 2023 will get inflation in check.
• Fed Vice Chair Lael Brainard said policy/rates will need to be restrictive for some time for policymakers to have confidence inflation is moving down and the Fed is “committed to avoiding pulling back prematurely.” Reiterated Fed will be data dependent.

• Reports from Axios are saying Treasury Secretary Janet Yellen, as well as the National Economic Council Director Brian Deese, are likely to leave their positions early next year after the Midterm elections over disagreements with the Biden Administration. Yellen disagreed with faulting corporations for increasing inflation as well as forgiving student loan debt.

• In a parliamentary address, Putin announced the official annexation of the four Southeastern Ukrainian regions of Donetsk, Luhansk, Zaporizhzhia, and Kherson on Friday morning following sham referendums that were held the days prior. This is leading to concerns that Russia has raised the nuclear threat option as it gives Russia a reason to, in its own words, defend its territorial integrity and lays the groundwork to place the blame on Ukraine.

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