Nolte Notes 4.4.22

Download the PDF here.

April 4, 2022

The first quarter was a tale of two periods. The first two months, when the markets fell over 10% and then late February when stocks rallied back to within 5% of their all-time highs. With everything that has been tossed at this market, it is a wonder that stocks have done so well. Higher inflation, the invasion of Ukraine, a Fed hiking rates and some discussion of Covid have all cycled through the headlines during the quarter. The employment report on Friday was indicative of the shift in the economic landscape. Last year spending focused upon “stuff”, as consumers remained in some semblance of “stay at home”. Today, with most all mask mandates gone, people are looking to get out and about. The shift in spending has moved to “experiences” as people realize that life is indeed short. Employment gains were in hospitality, restaurants, and retail. The amount of time people are unemployed has fallen to just under eight weeks, a low not seen (outside of the pandemic) since 2000. There remains plenty of folks on the sidelines, judging from the very low participation rate. What comes next? Could be anything from a ripping rally or a decline to retest those February lows.

The economic data over the quarter has been overshadowed by the geo-political environment and the market reaction to all the news. The quarter ended with two-year yields above ten-year treasury yields for the first time since 2018. What happens next, within the equity markets, could be a rally. Historically, stocks do trade lower, but have finished higher over the ensuing year save for the year following the 2000 inversion. The volatility within the market was among the top 15 quarters since 1945. Here too, history would argue that stocks should be bought following these bouts of volatility, as they have generally finished higher a year later. Even after a big rise in interest rates, stocks finished higher a year later. Monetary policy is not yet tight, and rates have barely moved from the zero level and remain very low from a historical perspective. Will Fed Chair Powell be more focused on fighting inflation, or will he keep an eye on the financial markets reaction to higher rates? The answer could provide the road map for equities in the months ahead.

The bond market suffered worse losses than the stock market. Unusual to be sure, and the worst quarter for bonds in over 40 years. The Fed has signaled they will continue to raise rates through the year and want to see rates above 2% (now 0.50%) on short-term bonds. The long-term implications will be interesting if rates are able to get to those levels and stay there for a while. Interest payments on the huge amount of debt will begin to squeeze out other forms of spending. The “inversion” of the yield curve discussed above does start the clock on a recession countdown. The timing of any recession is less than certain, as it could be anytime over the next three years. The bond market is already expecting a recession AND a Fed that will begin cutting rates by 2024. If the market is to be believed, interest rates will not get too high and ultimately will reverse lower over time.

The “two-part” market, falling, then rising during the quarter, was also reflective of overall sector performance. Growth was under pressure from late in 2021 until the market bottom in February. From there, it led the market higher during March. This was in the face of higher rates, which are supposed to hurt the technology sector. A flatter yield curve is supposed to hurt financials, as banks usually make money on the difference between short and long-term rates. Financial were among the better performing sectors in the quarter. Energy, of course, led the way as prices rose dramatically. Can it continue or will consumers shift spending away from gas? Historically, higher energy prices do not last long as additional supply comes onto the markets at high prices. The other “odd” sector were utilities. As interest rates rise, utilities tend to perform poorly as investors flip over to the safety of bonds to get income. Typical relationships over the past quarter did not seem to hold given the economic backdrop.

Historically, stocks can continue their March rally into the remainder of the year, even as the economic headwinds build. Higher rates and rich valuations could temper those gains, so expect more back and forth in the markets in the months ahead.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

2:30

Nolte Notes 3.14.22

Download the PDF here.

March 14, 2022

“The Bitch Is Back” was a top song in 1974 by Elton John. Why bring it back now? That bitch could be inflation, that is back and has politicians grabbing for the “WIN” (Whip Inflation Now) buttons. Buttons that President Ford used to acknowledge the high rates of inflation. Today the administration is pointing toward Russia as the cause of the inflationary problems that are staring everyone in the face. The seeds for inflation today were planted a couple of years ago, by cutting rates to zero and flooding the financial market and economy with money. Core inflation rates were at multi-decade highs beginning in April of ’21 and have been rising ever since. Russia has only exacerbated an already rough situation that the Fed is finally beginning to acknowledge. Their meeting this week will finally start the process of “normalizing” interest rates. Given the current rate of inflation, that level could be much higher than many are expecting. Complicating the situation, the economy is already showing signs of slowing. Additionally the Fed has never hiked rates with a yield curve this flat since the bad old days of Paul Volker, when he slayed inflation with rates well north of 10%. Yep, the bitch is back, and it will be difficult to get rid of this time.

Much of the economic data took a back seat to the news from Ukraine and the geopolitical news surrounding the war. Consumer prices came in just shy of 8% and may go higher still as the impact from higher commodity prices works its way into the economy. Not surprisingly, consumer sentiment fell last month as prices began to spike. Slowly there is a shift in psychology from “when will I get this delivered” to “how much am I going to pay for it”? Within the inflation data too has been a slight shift toward the services and away from goods. Used car prices dipped ever so slightly, while airfare and live entertainment are showing signs of rising as mandates are being generally lifted. Wednesday will be a big day, as the Fed will announce a hike in rates and the news conference following by Chair Powell will likely set expectations for future increases. Along-side the economic news and Fed announcement will be the ongoing war in Ukraine. For as long as that continues, commodity prices will likely continue to rise, albeit at a bit slower pace than the parabolic rise of the past month.

The bond index has fallen nearly 5% so far this year as interest rates rise. Even last week, as stocks fell, bond prices also fell. Is there safety anymore in bonds? Are they still an alternative to stocks? Yes, and yes are the short answers. Individual bonds have a certain maturity when face value will get paid out, so in those cases, the losses are temporary. For bond mutual funds and ETFs that do not have maturities, their losses continue to pale compared to stocks. Short-term bonds and those that are “inflation protected” have done well in this environment. The rougher part of the market has been those tied to corporate and high yield bonds which act more like stocks than bonds. Bonds are still a good stock market offset, if not always providing positive returns.

The themes of this year continue to play out. Technology related issues have struggled as investors shift toward more “value” parts of the market. Surprisingly too, small US stocks have performed well, likely due to their being sheltered from international trade issues. Companies that are providing improving cash flows, dividends and are valued near their long-term valuation ranges are also doing well. Of course, basic materials and commodities continue to rise at a crazy pace, as the energy sector within the SP500 has already jumped 35+% this year. Given the significant rise in a short time, it may be a good opportunity to begin taking some of those gains off the table. By selling some of the winning positions, it will provide some cash to take advantage of other parts of the market that have been beaten down to the point of providing good long-term value. Unfortunately, the geopolitical news will continue to dominate sentiment on Wall Street for the foreseeable future.

There are still some good hiding places to be invested while the storms of war and higher interest rates blow over. Some extra cash is not a bad thing, however selling everything and waiting until a “better time” may keep investors from recognizing the beginning of the next inevitable leg higher for stocks.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

2:30