Neither Teetering nor Tottering
I look like I’m stable; Like nothing can move me; I look like I’m steady, Like nothing will shake me; But really I teeter; To every work I flinch; But really I totter; To every change I break. Vishal Dutia, Teeter Totter
After making its 2022 lows on October 14th the S&P 500 provided investors a very nice recovery of nearly 16% from that date through February 14th. Marrying a much sunnier stock market to the economic and financial news was sufficient to provide investors the glimmerings of an early onset of Spring. A Fed near to done raising interest rates. Inflation cresting and on its way to lower levels. The economy showing a bit of a spark and our starting to hear talk of “soft landings”. Then came the release of the January payroll number on February 3rd with a figure of 517,000 shocking a market expecting a 188,000 number. The market became a bit more nervous seeing an onrushing hawkish Fed through its rear-view mirror wondering if it wasn’t about to crash the party. Then on February 14th came the release of the January Consumer Price Index number which, while in line with expectations, wasn’t good enough. The same day news of the highest rate of increase in personal spending in two years was sufficient to raise already elevated fears of a Fed, perplexed by the economy’s failure to submit to its will by revealing evidence of its deceleration, and so the S&P sacrificed 4% in the second half of a no longer quite so sunny February.
So, at this point let’s step back, look at the cards we’re holding, discuss how to best play the hand we’ve been dealt and see about the setting of expectations for what the rest of the year may be offering us. Demonstrating some measure of self- restraint, we’ll focus upon just three specific elements. That should provide us the luxury of covering each in sufficient detail that we should be able to walk away from this discussion in possession of some measure of clarity and light.
First, as has been mentioned in prior commentaries, the pandemic caused the inflation and it’s receding further back into time will be the cause of its decline. It was the pandemic that led to the “locking down” of the economy, its subsequent reopening, and the $2.3 trillion dollars the federal government paid many of us to stay home. That is $30,000 for a family of four. The economic consequences of closing down a $25 trillion economy are profound and even three years later those effects still linger. That is a piece of this particular puzzle often missing in the analyses of those who make it their business to study the subject and it contributes to the offering of prescriptions for a problem whose solution is likely not what they or the Federal Reserve are seeking to prescribe. Giving people lots of money while not providing its recipients the means of spending that money on the goods and services they would normally have sought to purchase created effects that have largely subsided but the current rate of inflation is a consequence that, while declining, is one of the effects that still linger.
Second, we come to the realization that the current vibrancy of our national economy is having a limited effect on the current level of inflation. Remember. It’s not the economy that is causing the inflation. It was the pandemic. The awareness of this removes the rationale for what the Federal Reserve is doing. As discussed in the first paragraph, the direction of the stock market was very clearly altered by the strength of the economic data which means the stock market is currently a believer of the following set of beliefs. The vibrancy of the economy is a significant contributor to the current level of inflation. Thus, the economy needs to slow down materially for the rate of inflation to decline. The Federal Reserve has been very aggressive in raising interest rates. The increases to date have failed to slow down the rate of economic activity making it necessary for it to raise interest rates for longer and to higher levels. Those rate increases will quite possibly push the economy into a recession leading to a decline in the level of corporate profits and the stock market. This is most likely not true, but most believe it is.
Our third point is that the price of something is what establishes the balance between supply and demand. When demand increases faster than supply the price of that something will increase. Financial markets are forward looking and react in the present to what they expect to experience in the future. The stock market made a low this past October and has since, even after February’s modest decline, recovered approximately half of its prior 22% decline. The current economic data showing an economy stronger than many expected is good news but does not match the very negative sentiment of investors towards the economy and the stock market resulting in the demand for stocks being currently low and thus their prices. As investors become increasingly aware that inflation has peaked and is declining and the economy will continue to be stronger than expected then the demand for stocks will increase and you, dear investor, will own an asset whose price will likely rise.
60 equity 40 fixed income and cash investors who celebrated the first month of 2023 with returns of 4.7% surrendered a bit less than half of those gains in February experiencing portfolio declines of 2.1% leaving a year to date return of 2.6%. The guiltiest party was the 3% decline in the equity markets with large cap value and foreign markets declining a bit more than that and small cap and large cap growth a bit less. The fixed income portion didn’t help though hurting less with losses of near 1% as rising interest rates made bonds worth a bit less than at the end of the prior month. The first half of the month actually added to January’s gains, so it was the market’s just over 4% decline in the month’s second half in which the damage was done.
Mark H. Tekamp; March 5, 2023