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The most important charts and themes in markets and investing…
1) Just Like Nobody Predicted
The S&P 500 is off to its best start to a year since 1997, up over 15%.
Did the experts see this coming? Not exactly. Entering the year, Wall Street strategists were actually forecasting a down year for stocks, a rarity for this perennially bullish group of predictors.
If you polled them today, though, I’m guessing they would have a very different response.
Why? Because sentiment is driven by price. And with the S&P 500 rallying 27% from its October low, optimism once again is in the air. This is the highest level for the index since April 2022, leaving it only 8% below its January 2022 peak.
The largest sector in the S&P 500, Technology (28% weighting), is already there.
The Tech sector ($XLK ETF) hit a new all-time high this week, surpassing its December 2021 peak (note: total return including dividends). During the sharp sell-off in 2022, there were many comparisons to the March 2000 dot-com bubble peak which was not surpassed for nearly 17 years. But this time around it took less than 16 months for the Tech sector to recover, with a much smaller drawdown along the way (-34% vs. -82% after the 2000 peak).
The optimism surrounding big tech and AI continues to boost broader market sentiment. Individual investors (AAII poll) haven’t been this bullish since November 2021, with Bulls now outnumbering Bears by over 22%.
2) A Pause at Last
Another reason for the improved sentiment: a shift in monetary policy from the Federal Reserve.
After 10 consecutive meetings with rate hikes, the Fed finally decided to pause, holding the Fed Funds Rate at a range of 5.00-5.25%.
Some called the decision a “hawkish pause,” however, as the Fed increased their median projection for the year-end Fed Funds Rate to 5.6%. That would imply two more rate hikes at some point this year.
The market is currently expecting just one more hike, and for that hike to take place in July (74% probability).
But these odds can change in a hurry, as can the Fed’s projections. On that point, here’s a look at the evolution of the Fed’s predictions for the Fed Funds Rate at the end of 2023…
A few takeaways:
- The Fed has consistently underestimated inflation and its persistence.
- The Fed has been consistently behind the curve (reactive instead of proactive when it comes to fighting inflation).
- The Fed has not been very good at forecasting, including their own policy actions.
3) Down Goes Inflation
The primary reason why the Fed felt comfortable pausing: the continued downward trend in inflation.
The May CPI report was released a day before the FOMC meeting, showing a decline in the overall inflation rate to 4.0%. This was the 11th consecutive decline in the YoY rate and lowest level since March 2021. Core inflation (ex-Food/Energy) moved down to 5.3%, the lowest since November 2021.
CPI has now moved from a peak of 9.1% last June to 4.0%.
What’s driving that decline?
Lower rates of inflation in Fuel Oil, Gasoline, Gas Utilities, Used Cars, 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 far outweighed these increases.
After 25 consecutive increases, YoY Shelter CPI has now moved down for 2 straight months, from 8.2% in March (highest since 1982) to 8.0% in May. We should see this number continue to move lower which will have a huge impact on overall CPI as Shelter represents more than a third of the index.
Elsewhere on the inflation front, we saw a similar trend to CPI:
- US Producer Prices (PPI) increased 1.1% over the last year, the 11th consecutive decline in the YoY rate-of-change and the lowest print since December 2020. PPI peaked at 11.7% in March 2022.
- US Import Prices fell 5.9% over the last year, the largest YoY decline since May 2020. US Export Prices fell 10.1% over the last year, the largest YoY decline on record with data going back to 1985.
- Truflation’s real-time US inflation gauge has moved down to 2.4% from a peak of 12% last June.
4) Back on the Path to Prosperity
US wages outpaced inflation on a YoY basis in May by 0.2%, ending the ignominious streak of 25 consecutive months of negative real wage growth. We’re now back on the path to prosperity, a great sign for the American worker.
This positive trend should continue for at least another month, with the inflation rate expected to fall to 3.2% in June.
The reason: the June 2022 spike in prices (+1.2%) will drop off, and in its place will be a much lower number. After that, the path of inflation will become harder to predict, as the YoY comparisons become much less extreme.
5) Tightest Monetary Policy Since 2007
The Fed Funds Rate is now over 1% higher than the US inflation rate. The last time monetary policy was this tight with a Fed Funds Rate above 0% was back in October 2007.
If the markets are correct, we could see this tight policy (Fed Funds Rate > CPI) persist for the remainder of the year, with no rate cuts now expected until January 2024.
This shift in expectations has provided a boost to yields, with the 1-Year Year Treasury Bill rising to 5.27%, its highest yield since July 2006. A year ago it was at 3.15% and two years ago it was at 0.05%.
6) Consumer Pullback Continues
While tighter monetary policy may be helping to curb inflation, it is also curbing demand.
After adjusting for inflation, US retail sales fell 3.3% over the last year, the 7th consecutive YoY decline. That’s the longest down streak since 2009. Nominal sales increased 0.7% YoY vs. a historical average of 4.8%.
A recent CNBC survey found that 92% of Americans are pulling back on spending, with clothing and other nonessential categories (entertainment, home decor, appliances) being hit the hardest.
While its still early, Retailers seem to be preparing for a slower holiday season, with 43% of respondents to a recent survey saying they are ordering less than the last year (vs. 21% saying they are ordering more).
7) Hello $32 Trillion
While consumers may be pulling back, the US government is most certainly not. National Debt hit $32 trillion for the first time, $10 trillion higher than where it stood 4 years ago (45% increase).
Why is the National Debt moving higher?
The US government continues to spend much money than they’re taking in. The budget deficit has now widened to $2.1 trillion, its highest since February 2021.
When interest rates were at historic lows, many dismissed rising debt and increasing deficits, saying the interest expense on that debt was immaterial. But with the spike in rates over the last year, that’s becoming a harder argument to make.
Interest Payments by the US Government rose to 3.5% of GDP in Q1 2023, up from 2.4% in Q1 2022. That’s the largest annual increase on record. This % is projected to continue to rise over the next decade with interest payments becoming a much larger share of the Federal budget.
8) Valuation Matters
When Japan’s Nikkei 225 Index peaked back in December 1989 it marked the top of one of the most epic bubbles in history.
Japan’s CAPE ratio was a sky-high 77, making the US dot-com bubble peak in March 2000 look tame by comparison (CAPE ratio of 47).
More than 33 years later, after an 82% drawdown, the Nikkei is still below its bubble peak. But it’s getting closer, ending week at its highest level since March 1990 (note: price index, not total return).
The two lessons for investors here:
a) Valuation always matters, you just don’t know when.
b) Diversification is most needed when it seems like you don’t need it at all.
9) A Teenage Dream
It’s going to be a great summer for teenagers looking for job. Wages for 15-19 year-olds are approaching $15.00/hour on average, an astounding 41% increase from January 2020 levels.
And with average gas prices down to $3.58/gallon from last year’s peak of over $5.00/gallon, that money will go a lot further.
10) Some Interesting Stats
a) The top 5 stocks in the S&P 500 now make up 24% of the index, the highest concentration since at least 1990.
b) Venture capital funding in Q1 was 60% lower than peak 2021 levels.
c) In 2023, investments in solar are expected to surpass oil production for the first time.
d) Netflix is seeing a record number of new subscribers after cracking down on password sharing.
e) 6,100 US bank branches were closed between 2019 and 2022, the highest number of closures over a three-year period in history.
And that’s it for this week. Have a great Sunday and Happy Father’s Day!
-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.
