Wentz Weekly Insights
Stronger Economic Data Reprices Expectations, But Will the Strong Data Continue?

U.S. stocks fell last week as investors reprice economic risks and the chance the Fed pushes rates higher than previously thought. At the start of the year, investors were betting the Fed was close to the end of its rate hike cycle and re-pricing the chance of a recession after weaker economic data and inflation falling more than expected. There was an increasing view the Fed would avoid pushing the economy into a hard landing scenario, where it tightens financial conditions so much that it kills inflationary pressures but destroys demand with it where the economy falls into a recession, and avoid a soft landing as well, a scenario where rates rise just enough to cool inflation without causing a recession. Rather, there was an increasing view there would be a so called no landing scenario – where inflation slowly moves down but stays higher than target while the economy keeps growing.
But after a steady flow of stronger economic data, investors are betting the Fed will take interest rates higher than what it expected at the start of the year, and furthermore, betting the Fed will take rates higher than what the Fed itself was projecting in its December meeting. This has reset expectations, with recession talk back into the conversation.
This was after we saw further evidence last week that inflationary pressure remain high after the Fed’s preferred measure of inflation, the personal consumption expenditure (PCE) price index, showed another higher than expected increase in January. The PCE price index rose 0.6% in January and is up 5.4% from a year earlier, although down from its highs last year, is still almost triple the Fed’s target levels. Even more, the “Super core” PCE index, which is what the Fed said it is looking at more closely as it strips out volatile categories like food and energy, but also other things like shelter costs (home prices/rents) which economists and strategists have said is misrepresented in inflation indexes, rose more than expected again in the month. The index for “super core” prices was up 0.6% in the month and up 4.6% over the past 12 months. While this is down from the high of 5.0% last year, it was higher than expected and still over double the Fed’s target.
The higher inflation and investors’ concerns of higher rates pushed bond prices lower as yields on Treasury securities moved higher. The yield on the 1-year Treasury bill rose over 5% for the first time since 2007 while the note most sensitive to the Federal Reserve’s policy rate, the 2-year note, is not far behind, closing the week at 4.80%. The 10-year yield rose 17 basis points last week to 3.94%.
While one month of strong data like January does not make a trend, we believe data will continue to be unusually choppy. We believe the market will continue this pattern of seeing strong economic data as bad news and weakening economic data as good news. Either way you look at it, a recession seems inevitable at this point. With money supply contracting outright for the first time since 2006, consumers being more pressured and working through savings with delinquencies rising, student loan payments set to resume, higher interest rates for longer, higher rates impacting the economy in ‘long and variable lags’, and a steeply inverted yield curve, all signs point to a recession and lower earnings for companies.
In a slowing economy and declining earnings environment, we prefer to be overweight value and income producing securities. Bonds are now paying an attractive yield and provide a safer alternative to equities, while money markets are paying close to 5% and could be looked at as an appropriate place to park cash until there is more certainty on the outlook.
Week in Review:
U.S. stocks were lower in trading on Tuesday to start the holiday shortened week after morning earnings reports included Home Depot and Walmart that both had decent fourth quarter results, but lower guidance. In addition, Walmart management team gave a cautious view on the consumer and environment, saying consumers are very pressured and are pulling back spending, particularly on discretionary items. This led stocks lower for the day, at the same time Treasury yields continued to move higher with the 2-year now yielding the most since 2007. The S&P 500 closed below 4,000 again for the first time in a month after declining 2.00% on the day where internals were very weak (the ratio of declining to advancing stocks was 7.5 to 1). Data in the morning showed the housing market remains in a slump with sales on existing homes falling for the 12th consecutive month to the lowest monthly sales pace since 2010.
Comments on Tuesday from James Bullard of the St Louis Fed noted the economy is stronger than the Fed initially thought and the markets have been overpricing the risk of a recession, while supporting three more rate increases (versus the Fed projections of two more). It was a choppy trading session for stocks Wednesday, trading lower for most of the day with the release of the FOMC meeting minutes from February 1 pushing stocks to session lows. The minutes stated a few Fed officials favored raising rates 50 basis points, some raising concerns of recent easing in financial conditions, but all agreed ongoing increases are necessary. Stocks fell 0.26% while the NASDAQ and Russell 2000 ending slightly positive.
There were not many headlines on Thursday. Jobless claims were relatively unchanged in the latest week while economic growth (GDP) was revised lower in the fourth quarter due to a downward revision in consumer spending. A positive forecast from Nvidia had chip stocks moving higher, while e-commerce names were lower after disappointing results from Wayfair. The broader market opened higher, moved lower by mid-day, but were able to reverse course and move higher by the close with the S&P 500 finishing up 0.53%.
Stocks moved much lower Friday before the market opened after the personal income and outlays report for January showed strong consumer spending growth and the PCE price index, which has been the Fed’s preferred measure of inflation, much higher than expected. Markets remained focus on the strong data, moving lower but finishing off the lows of the day with the S&P 500 down 1.05%.
Treasury yields continued to track higher while U.S. stocks finished lower for the fourth consecutive week after a strong January. Oil markets have been more quiet, with recent risks to the upside over global economic strength, China’s reopening, and Russia cutting production, resulting in oil remaining near the upper $70s per barrel and relatively unchanged for the week. Bond prices fell with the yield on the 2-year note and 10-year note rising 13 and 17 basis points to 4.80% and 3.94%, respectively, while the major U.S. stock indices finished as follows: S&P 500 -2.67%, Russell 2000 -2.87%, Dow -2.99%, and NASDAQ -3.33%.

Recent Economic Data

  • Existing home sales declined for the 12th consecutive month in January, falling 0.7% to a seasonally adjusted annualized pace of 4.00 million. This is the slowest pace of existing home sales since October 2010. Compared to January 2022, sales are down 37% from the 6.34 million annualized pace. The NAR chief economist said lower priced regions experienced modest growth in sales while more expensive regions experienced declining sales. The median sales price was $359,000, the increase in prices slowing to just 1.3% from a year earlier. Inventory has steadily improved, up 2% in the month and 15.3% from a year ago with 980,000 units on the market making up 2.9 month supply at the current sales pace. It is however, taking longer to sell homes – the average property was on the market for 33 days, up from 26 days in December and up from 19 days a year ago.
  • Sales of newly constructed homes rose more than expected in January, rising 7.2% above December’s sales pace but 19.4% below the pace from January a year ago, according to the U.S. Census Bureau. A seasonally adjusted annualized rate of 670,000 new homes were sold in the month, helped by interest rates that fell further in January and the median home price that was down 8.2% in the month (and relatively unchanged from a year earlier). Inventory of new homes was at 439,000, down about 3% from December with supply that would last about 7.4 months at January’s sales pace, worsening from 9.6 month and 11.4 months in December and November, respectively. Also, the supply of completed homes has increased quickly over the past couple months with builders finishing more homes as cancellation rates increase with affordability declining.
  • The second revision of GDP for the fourth quarter 2022, based on more complete source data than the first estimate, showed growth was slower than the first estimate, rising at an annualized pace of 2.7% versus 2.9% in the first estimate. The update reflects a downward revision to consumer spending (likely from a weaker December than what was initially thought) and partially offset by an upward revision to nonresidential fixed investment. The worse news was GDP inflation was revised higher to a 3.9% annual rate in the fourth quarter, up from 3.5% in the prior estimate, while prices are 6.3% higher than the fourth quarter a year earlier.
  • The number of unemployment claims for the week ended February 18 was 192,000, a decrease of 3k from the prior week and below 200k for the sixth consecutive week. The four-week average was 191,250, relatively unchanged from the week prior. The number of continuing claims declined 37k to 1.654 million with the four-week average relatively unchanged at 1.669 million.
  • The Bureau of Economic Analysis report on personal income and outlays showed income rose less than expected, consumers spent more than expected, while the Fed’s preferred measure of inflation was higher than expected in January – additional data that confirmed January was an unusually and unexpectedly strong month.
  • Personal income rose 0.6% whereas economists were expecting a 1.0% increase. Importantly, wages and salaries rose a solid 0.9% and are 6.6% higher than a year ago. This is still significantly above trend but now is just keeping with the pace of inflation. Social security payments, which make of 6% of Americans’ income rose 9.0% as cost of living adjustments kicked in for 2023.
  • Consumer spending increased 1.8% (versus the 1.2% increase expected), matching the strong retail sales report, with spending up 9.4% from a year ago. Not all the spending growth is due to inflation, subtracting the pace of inflation real spending was up around 3% over the past year. Spending on goods picked up, rising 2.8% in the month but up just 4.7% from last year. Spending on services remains strong, rising 1.3% in the month and now 11.1% higher than a year earlier.
  • Income and spending levels caused the personal savings rate to increase slightly, from 4.5% last month to 4.7% in January. This is above the all-time low of 2.7% set in June, but still below the 20-year average (excluding the past three covid years) of 6.0%.
  • And most importantly, the PCE price index (which has been the Fed’s preferred measure of inflation), increased 0.6% in January and was up 5.4% from a year ago, both higher than expected. Core prices were higher than expected as well, the January increase was 0.6%, versus 0.4% expected, while the increase over the past 12 months was 4.7%, above 4.3% expected, and returning to the highest annual rate since October.
  • The FOMC meeting minutes show a few Fed officials would support raising rates 50 basis points instead of the 25 bps increase that took effect, with those officials noting a larger increase would bring the target range closer to levels that would be “sufficiently restrictive.” All agreed on further increases in rates, but there was a bigger focus from some officials over the fact financial conditions have eased over the past several months, cautioning that an unwarranted easing could complicate their efforts. The uncertainty on the outlook was high, but a variety of factors could lead to price pressures that are more persistent than anticipated.

Company News

  • Earnings reports from Home Depot and Walmart last Tuesday morning caused stocks to open the week lower after cautious guidance for 2023. Home Depot results for last quarter were mixed but said it expects 2023 growth to be flat compared with 2022 and earnings to decline mid-single digits over higher costs including the company saying it will spend an extra $1 billion to increase compensation for its frontline workers. Walmart beat expectations for last quarter, noting gains in its U.S. grocery market, with a lower forecast for 2023 than analysts’ estimates. But the worst came from management commentary. The company said consumers are very pressured and are pulling back spending as consumer balance sheets are “running thinner and savings rates are declining.”
  • The CEO of McCormick, the maker of spices, seasonings, and condiments, said major retailers like Walmart and Kroger are giving pushback on the latest round of price hikes on products from sauces to spices/seasonings as the retailers are more concerned about margins and the consumer’s ability to bear more price increase.
  • After several disappointing quarters and losing market share to competitors like AMD, Intel said last week it will cut its quarterly dividend by 66% to $0.125 per share, for a yield of 2.0% as of Friday’s close. The company said the reduced dividend “reflects the board’s deliberate approach to capital allocation.”
  • Boeing said it halted deliveries of its 787 Dreamliner planes to perform more tests of a fuselage component after a review of certification records discovered an analysis error by a supplier. The production pause will take place while it completes the required analysis and documentation.

Other News

  • Tensions with China are heating up again as the U.S. believes China is deepening its relationship with Russia and as the U.S. said it will send more troops to Taiwan to bolster its military training program. The WSJ reported the U.S. is increasing the number of troops in Taiwan to bolster its training program for its military amid a rising threat from China. The plan calls for an addition 100 to 200 troops which will include Marines and special-operations forces. Also, there appears to be increasing evidence of China deepening its ties with Russia, with WSJ reporting the White House is considering releasing intelligence it says shows China is weighing supplying weapons to support Russia in its war in Ukraine. The article says China hasn’t made a final decision yet, and its previous stance has been cautious on its support of Russia through financial assistance and oil purchases, but the stance appears to be shifting, according to the latest intelligence.
  • The Conference Board said it expects the U.S. economy to fall into a recession and it may already be in one currently. They added that the leading economic indicators show if we have a recession, it’s probably starting around now, although it is “probably going to be short and shallow.”
  • Federal Reserve latest:
  • The FOMC February meeting minutes were released last week. See the recap under the economic data commentary above.
  • St Louis Fed president Bullard said the markets have been overpricing the risk of a recession in the second half of 2023, the economy is stronger than the Fed had initially thought, and his target range for the Fed Funds rate is now 5.375% (equals 3 more increases). Last time he gave a number, in November, he mentioned he was targeting 5.125%.
  • New Fed Governor Jefferson said high inflation may come down slowly and that worker shortages is an important part of the inflation picture and wage pressure remains high with recent data showing wages have started to decelerate, but only somewhat. Bringing service inflation under control, which is the focus right now and where most inflation pressure is coming from, will depend more on a better balance between labor supply and demand.

Did You Know…?

2022 Retirement Analysis

Fidelity, a workplace benefits provider including retirement plans like 401k’s, said its 2022 Retirement Analysis report showed retirement account balances grew in the fourth quarter, but were still down 20.5% from the end of 2022 compared to the end of 2021. The average 401k balance was $103,900, the average 403b balance was $92,683, while the average IRA balance was $104,000. Despite Americans spending down their savings and inflation eating away purchasing power, the savings rate in retirement plans remains solid. The total savings rate in the fourth quarter was 13.7%, which includes both employer and employee contributions, holding steady through 2022. Pre-retiree Baby Boomers save the most out of all age groups (between Boomers, Gen X, Millennials, and Gen Z), averaging a 16.5% savings rate, while Gen Z savings rate was 10.2%. Furthermore, about one-third of retirement savers increased their savings rate last year by an average increase of 2.6%. Also important, outstanding 401k loan balances continue to trend downward with 401k loans matching the lowest percentage on record with the percentage of savers with a loan at 16.7%, down from 17% a year ago and down from 21% five years earlier. However, it appears retirement savers have been less likely to rebalance their retirement accounts. In 2022, just 9% made a change to their asset allocation, down from 11.7% in 2020.

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Updates on 2022 Tax Documents

Please note tax documents will not start mailing until January 31. Most retirement accounts will see 1099-R and form 5498 mailed on January 31. Retail accounts will see 1099 and related documents mailed by February 15. Certain accounts with more complex securities may have 1099’s mailed as late as March 15. Please see this email for more details. If there are any questions on tax documents, please reach out to us at 330-650-2700.

The Week Ahead

This week’s earnings calendar will remain centered on retailers and several other tech companies. Notable reports will come from Zoom Video on Monday, Target, JM Smucker, HP, AutoZone on Tuesday, Lowe’s, Dollar Tree, Kohl’s, Salesforce, Snowflake on Wednesday, and Best Buy, Costco, Kroger, and Broadcom on Thursday. On the corporate calendar there will also be several company events, including from Tesla, Chevron, and Goldman Sachs. The economic calendar is busy this week and notable data releases include durable goods orders and pending home sales on Monday, Case-Shiller home price index and consumer confidence on Tuesday, the PMI, ISM manufacturing survey indexes and construction spending on Wednesday, weekly unemployment claims and worker productivity and costs on Thursday and wrapping the week with the ISM services survey index on Friday. There are no notable events on the Fed calendar, but there will be several public appearances by policymakers. Also on the calendar is the Supreme Court hearing two cases on Biden’s student loan forgiveness plan that could determine if his plan is legal or not.