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The most important charts and themes in markets and investing…
1) Is This the End?
As expected, the Fed hiked rates for the 10th time, pushing the Fed Funds Rate up to 5.00-5.25%. This is now the highest rate we’ve seen since September 2007.
It took 10 rate hikes and 500 bps in cumulative increases, but the Effective Fed Funds Rate (5.08%) is finally above the rate of inflation in the US (4.93%).
Since 2010, this has been a rarity, with ultra-easy monetary policy persisting nearly the entire time.
The question investors are asking: is this the end?
Meaning…
a) Was that the last rate hike?
b) Is the easy money era over?
On the first question, the market is currently saying that the recent hike was indeed the last, with an expected pause at the June/July FOMC meetings followed by rate cuts starting in September.
This would be a relatively quick shift to easing after only 4 months at a peak cycle rate. Here’s how long it took in the last 3 cycles for the Fed to move from its final hike to a rate cut:
- Dec 2018 (last hike to 2.25-2.5%) – Jul 2019 (first cut to 2.20-2.25%): 7 months.
- Jun 2006 (last hike to 5.25%) – Sep 2007 (first cut to 4.75%): 15 months.
- May 2000 (last hike to 6.5%) – Jan 2001 (first cut to 6.0%): 8 months.
As for the easy money era, it will likely be dependent not only the path of inflation/employment from here but also the Fed’s willingness to move back to a more normal monetary policy framework. The bias towards easing is a powerful one, though, and until the Fed states otherwise market participants will likely assume it’s only a matter of time before helicopter money returns.
2) Inflation at a 2-Year Low
The latest CPI report came in slightly better-than-expected, with overall inflation falling to 4.9%. That was the 10th consecutive decline in the YoY rate of inflation and the lowest level since April 2021.
US CPI has moved down from a peak of 9.1% last June to 4.9% in April.
What’s driving that decline? Lower rates of inflation in Fuel Oil, Gasoline, Used Cars, Gas Utilities, Medical Care, Apparel, New Cars, Food at Home, & Electricity.
Rates of inflation in Transportation, Food Away From Home, and Shelter have increased since last June but declines in the other major components have outweighed these increases.
Core CPI (which excludes food/energy) moved down slightly to 5.5%, but remains elevated due in large part to sustained housing inflation. However, this may be about to change.
After 25 consecutive increases, YoY Shelter CPI moved down from 8.2% in March (highest since 1982) to 8.1% in April. If the Shelter inflation rate has finally peaked, this will have a huge impact on overall CPI as Shelter represents more than a third of the index.
Why was Shelter CPI still moving higher while actual rent inflation has been moving lower for some time? Shelter CPI is a lagging indicator that wildly understated true housing inflation in 2021 and the first half of 2022. Shelter CPI has been playing catch up but still only shows a 16.9% increase since the start of 2020 versus a 21.9% increase in actual Rents and a 38% increase in Home Prices (nationally).
3) More Room to Pause
The Fed is set to meet again on June 14, and by then they will likely have further room to pause. The May CPI report is being released on June 13, and that report is expected to show a significant decline in the inflation rate, with the Cleveland Fed model currently forecasting a move down to 4.1%.
Why big drop?
Base effects. The high inflation number from last May (+0.9%) will drop off and in its place will likely be a much lower number. For the June CPI report, we should see an even bigger move down as the spike from last June 2022 (+1.2%) falls off.
The Fed will thus have ample room to pause, and that’s indeed what the market is pricing in with a near 100% probability of no change.
4) A Return to Prosperity
US wage growth has failed to keep pace with rising consumer prices for a record 25 consecutive months.
Wages have lagged most expense categories over the last two years.
This has been a loss of prosperity for the American worker and the primary reason why the Fed was so aggressive in hiking rates. It’s also the primary reason why consumer confidence has remained low in survey after survey, and why small business confidence is at its lowest level in a decade.
But with the next CPI report, we could see a move back into positive territory, assuming wage increases hold firm at 4.4% and inflation falls as expected down to 4.1%. That will be welcoming news for many and hopefully a sign that we are back on the path to prosperity.
5) Back to Work
Speaking of prosperity, the U.S. US Unemployment Rate moved down to 3.4% in April, the lowest level since 1969.
The labor force participation rate among 25-54 year-olds (prime working age) has moved up to 83.3%, the highest rate we’ve seen since March 2008.
The overall participation rate remains below the pre-covid level (63.4%), however, as many older workers (55+) have left and not come back.
Jobs have now grown for 28 consecutive months.
Will this streak continue?
That seems likely with the number of job openings still exceeding the number of unemployed by 3.8 million.
6) An Upside Surprise
With 86% of companies reported, S&P 500 revenues (+7.5% YoY) and earnings (+6% YoY) have come in much better than expected.
With significant cost cutting and companies maintaining pricing power, profit margins expanded, moving up to 12%.
Here’s a look at the major tech companies that have reported thus far. Weak revenue growth across the board as compared to the last decade, but above the low expectations heading into the quarter.
Apple is perhaps the best example here with revenues and net income down 3% YoY but the stock continuing to move higher, up 33% year-to-date and now only 4% below its all-time high.
With slower growth and rapid price appreciation this year, valuations have jumped higher once again. The two largest companies in the US, Apple and Microsoft, are trading at 29x and 34x earnings. Is that too rich? That all depends on your expectation for future earnings.
7) Bond Market Gone Haywire
The bond market has officially gone haywire, with 1-month Treasury yield recently rising to 5.76%, its highest level on record.
Just a few weeks ago we saw the 1-month yield drop to 3.36% and the spread between the 3-month and 1-month hit a record high of 1.78%. Now it’s reversed 180 degrees and near a record low of -0.50%.
What’s going on here?
Fears over the debt ceiling seem to be the best explanation, with market participants moving from favoring the 1-month to avoiding it as we get closer to the so-called deadline. With a deficit of nearly $2 trillion, however, any notion of a debt “ceiling” is a complete farce. You can’t have a ceiling when you’re spending more money than you’re taking in.
They’ll raise the ceiling just like they always do. The one constant is more debt because the primary objective of most politicians is to keep their job, and they do that by promising to spend more money.
8) “Rising Rates are Good for Banks”
Be wary of anyone telling you a simple adage can be applied to financial markets that are highly complex.
Rising rates can be good for banks at times, but not when those banks are saddled with long duration assets that go down in value when rates rise.
That’s precisely what happened at Silicon Valley Bank and with the Fed Funds Rate up 500 bps over the last year, regional bank stocks have been cut in half.
The bank problems don’t seem to be going away.
PacWest ($PACW) is the most recently example, with its share price plummeting after reporting negative earnings and $5 billion in deposit outflows. Incredibly, they still had $8 billion in uninsured deposits at the end of the quarter. Why would anyone keep deposits there above the FDIC insurance limit and take the risk of losing money? I don’t know, but it doesn’t seem to make much sense given that they can easily move to short-term Treasuries, money market funds, or a too-big-to-fail bank.
9) Winners and Losers
The shareholders SVB Financial have lost nearly everything ($SIVBQ) while the shareholders of the bank that purchased the bulk of SVB’s assets at huge discount (First Citizens, $FCNCA) have received a windfall.
In their recent earnings report, First Citizens reported an eye-popping gain of $9.82 billion from the acquisition.
10) Racing Higher
Higher interest rates don’t seem to be curbing demand for luxury goods.
The waiting list for a new Ferrari now extends into 2025. Their Daytona SP3 model, of which Ferrari only plans on making 599 units, has a starting price of $2.25 million and was sold out before its unveiling. The stock ($RACE) is at an all-time high, up 38% this year.
11) Eggs and Free Markets
Free markets will solve most problems if you let them, and as I said earlier this year, the rising prices of eggs did not warrant government interference.
Very quickly we’re seeing egg prices decline, now down 32% from their peak.
These retail price declines should continue in the coming weeks with wholesale egg prices crashing, now down over 80% from their January high.
12) The Sentiment Gift That Keeps on Giving
It was a close one, but the only indicator with a perfect track record lives on. The S&P 500 total return was 1.5% over the last year following the May 5, 2022 “markets in turmoil” special report.
And that’s it for this week. Have a great rest of the week!
-Charlie
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full disclosures here.
