Nolte Notes 9.20.21

September 20, 2021

It is way early to be getting ready for Halloween, but I’m hearing “I’ve got a spell on you” running around in my head when looking at the market action of the past few weeks. From monetary policy to fiscal policy, the continued rise in Covid cases and economic slowing as a result, the markets are struggling to figure out what to do next. This past week was the (now) much-anticipated consumer price index that came in below expectations. The higher product prices and lower consumer prices mean that corporate margins will likely be under some pressure in the coming quarters. Even as concerns over rising inflation show up near the top of consumer worry list, interest rates have remained very stable around current levels. This week we’ll hear from the Fed directly as they likely make their “ho-hum” announcement that their target for interest rates will not be changing. What will be more interesting is how Chair Powell discusses their plan to reduce the amount of bonds they are buying, which will also start the clock on when the Fed is likely to raise interest rates. Maybe less the spell and more the sound of silence.

We are smack in the middle of what has historically been the worst 12 weeks for the financial markets, yet the SP500 is slightly higher over the past six weeks. The economic data, as has been highlighted over the past month or so, has been coming in “worse than expected” and many attribute the weakness to the rise in the Delta variant. When checking out TSA daily “activity”, there is a noticeable decline in travel since early August vs. a “normal” 2019 that remained stable through the summer months. Consumer surveys are highlighting worries about rising inflation. Certainly, businesses are feeling the pinch. Many cannot get the stuff they need to sell to the end consumer or finish their products for sale. The reduced supply of goods is one of the key factors behind the higher inflation reports. Chair Powell will likely address some of those “transient” pieces at his press conference. However, supply chains do not look to be getting repaired soon and outages of various products will likely be a feature as we get closer to the holiday season.

The bond market is also under “the spell”, as it has moved very little over the past few weeks. The difference between short and long-term rates is also stuck. Worries about inflation, economic slowing, or robust growth do not show up in the bond market just yet. The bond model used to project interest rates over the short-term also indicates lower yields ahead with only commodity and utility prices showing up negative in the five-factor model. How much of the inflation fears are grounded in the transitory discussion or will be a long-term issue will not be known for at least the next six months, if not longer. By that time, we should have a better sense of what “transitory” really means.

The last few weeks of the third quarter should determine whether the broader market can regain its mojo. This quarter has been led by technology and surprisingly, utility companies, with the difference between large-cap growth and value, exceeding 5 percentage points. The “why” is likely due to the rising virus counts and overall weaker economic data that investors believe will be around for a while. If the economy struggles, technology has become the safe play. Valuations remain extremely high, however by themselves do not “make” the market decline. Once things get going on the downside, though, they are likely to end somewhere around “fair” value. Based upon today’s earnings, that would mean a 20-30% decline. That is not a “call” that the markets will do that over the next few weeks or even months, but something to watch for whenever the markets begin to unravel.

The short-term direction of the markets may be lower, but the Fed meeting this week should provide investors plenty to chew on as we start the fourth quarter soon. Bond should provide direction, so we will be watching their reaction to the press conference later this week.

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.

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Nolte Notes 9.6.21

September 6, 2021

In what may be considered “Delta Dawn”, the current variation of Covid is beginning to show up in the economic data. Friday’s huge miss on employment (250k vs est of 750k) caused barely a ripple in the financial markets. After much head scratching, investor’s figured that the Fed would continue to keep rates lower for longer as well as postponing their tapering of bond buying. Bad news is good news when it comes to the financial markets today. The surprises continue to occur on the downside, from employment to the various assessments of economic activity. Employment in the “customer facing” portions of the economy were essentially flat from the prior month. Manufacturing added jobs and the employment rate fell again, getting close to 5%, as the total workforce is contracting with more retiring all together. This week will be light on economic data, save for the produce price report on Friday. The next focus for the markets is inflation, as worries are beginning to surface that growth is slowing with inflation not being as transitory as the Fed expects.

The markets continue to grind higher, making 50+ new all-time highs this year and pushing the valuation levels of the market to all-time highs as well. Why? Investors are back to the belief that there is no alternative to stocks. Bond yields are very low, money market rates are essentially zero and the Fed continues to support “risk taking” by keeping rates low. How long can it last? Longer than many currently believe. Yes, a correction of 3-5% is long overdue, however a larger decline is not yet on the horizon. At some point the markets will have enough of the debt creation and decline, but so far, the signs of a larger decline are not evident. The market internals remain less than stellar, with stocks making new all-time highs still lower than their peak in June. The number of stocks above their long-term average price has been falling since March, another indication that investors are focused on the largest of the large US stocks. The markets have shifted back toward growth and away from the “re opening” trades, fearing that Covid will continue to make any economic recovery very uneven. If inflationary pressures continue to build and economic activity slows further, investors may indeed decide that the Fed will have no alternative but to raise rates. That could drop the curtain on the advance, but that may be months away.

The bond market has reversed course a bit over the last few weeks as the difference between short and intermediate term treasuries is getting larger. The difference between high yield and treasuries is also contracting. Both conditions have been supportive of risk taking in the markets and has led to the recent rally in stocks. Until the markets believe that the Fed will be raising rates to combat inflation, the interest rate environment should support stocks. Worries about a larger decline in stocks are usually preceded by a flatter Treasury curve and widening spread between high yield and Treasuries, which is not the case today. The tipping point will likely occur when investors begin to worry more about the likelihood that inflation is not transitory. The Fed’s favorite indicators of inflation are all well above their 2% target and rising. So far, the markets are buying the transitory label on inflation.

The song remains the same in the equity markets, the largest US stocks are doing well, while the rest of the markets suffer. International stocks gained some traction with the decline in the US dollar. The dollar has been relatively strong as the US economy has performed better than many of their international competitors. Looking over the longer term, the dollar has been bouncing within a range since last July. A break lower could indicate better strength internationally, higher would mean a stronger US relative to others. A declining dollar would also mean that international holdings would fare well as those gains buy more of an ever-cheaper dollar. The international markets, especially emerging markets, are among the best long-term estimated returns. However, that is predicated upon a more normal functioning global economy.

The long-term key to the markets may lie in strength of inflation and investor’s fears that it is more than transitory. That is not likely to show up in the next inflation report or two, but persistence into yearend may concern investors.

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.

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Nolte Notes 8.30.21

August 30, 2021

Everybody’s working for the weekend, or until Friday when Fed Chair Powell started his talk on policy. The Jackson Hole confab has been known to be a spot where new policies are rolled out, from the Bernanke tapering to Powell’s inflation target changes last year. Investors were concerned that another bombshell could be dropped. However, what was said was music to investors ears. Tapering but not raising rates for a looonngg time was the tune. Subsequently, Fridays “everything rally” put stocks again at new all-time highs and the delivered promise of lower rates for even longer. This could keep stocks rising. The economic data remains ok, while inflationary pressure continue to build. This time, however, inflation is due to supply problems that adjusting rates won’t fix. This week’s employment report comes ahead of a long weekend ending the summer doldrums. What happens next is likely to be driven by inflation and Covid, which is well out of the Fed’s purview. The markets have held up well during one of the poorer months in the calendar, but the next two historically have been just as poor.

Even after Friday’s rally, the markets are looking a bit ragged. The largest stocks are once again taking the performance lead. That in turn has meant the bulk of stocks are not following the indices to all-time highs. The shine has come off the “reopening” trade. The enthusiasm for a full economic recovery is following the slowdown in air travel and lower energy prices. The economic backdrop remains challenging as many locations are going back to masking mandates. Those steps “backwards” are keeping many companies from going back “full-time” and giving consumers pause before heading to the mall or other activities. The combination of stimulus rollback in a few weeks and increasing fear or the virus may put another kink in the road to recovery. The markets are not reacting to the economic data as much as to the still very easy monetary policy. The reason the markets rallied so strongly Friday was a clear indication that investors are hyper focused on the direction of monetary policy. Stocks are likely to continue to get bid for as long as the fed remains accommodative.

Chair Powell’s comments got the bond market going too. Unfortunately, there are more questions than answers. How long will tapering take? At what point do rates rise after tapering finishes? How will the path of the virus impact policy? Just how transitory is inflation? Will slowing economic data keep the fed involved in the financial markets longer than expected? The yield spread remains well below spring levels when it was anticipated the economy would be roaring back. Yet it has not collapsed to a point that would start investors worrying about a completely different set of outcomes. Investors also piled back into high yield bonds, supporting the dregs within the bond market world. Another indication of investor’s desire to take on risk, no matter the asset class.

The rotation back toward the largest companies also means a move toward technology. The momentum has been waning for the various sectors within the SP500 since May, with technology getting back up to the “very overbought” territory. Fridays everything rally may start a new leg higher for some forgotten parts of the market. Small and international stocks were among the big winners on Friday after underperforming the broad market for the last few months. From strictly a valuation perspective, companies outside of the US are much cheaper than similar ones inside the US. Better returns from international markets require better growth there vs. here and a weaker dollar to translate those returns to the dollar. The biggest knock-on international stocks are the lack of technology stocks. Domestic weights are around 30% and less than 20% overseas. After a decade of US dominance in the performance race, there should be a rotation to overseas, but until tech takes a back seat, it will remain a US-centric performance race.

The market continues to churn higher but is showing some signs of internal weakness that could (maybe?) push stocks lower over the next few months. At this point, nothing more than a much-needed rest/reset for investors. That said, even the 2+% decline of two weeks ago was seen as a buying opportunity. At some point the “buy the dip” will not be working as well as it has over the past 16 months

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.

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