Denial….Ain’t Just a River in Egypt

Bull Stocks recorded their worst weekly performance for 2023 as investors finally took the time to digest last week’s blowout nonfarm payrolls report and as Fed Chairman Jerome Powell and other Fed speakers continued to make the case for maintaining a restrictive posture despite signs of slowing inflation and weakening demand. In remarks at The Economic Club of Washington, D.C. on Tuesday, Powell reiterated that “disinflation has begun but is going to take time.” He also mentioned the Fed could also be forced to hike more aggressively if labor markets remain strong and inflation moves higher. “The reality is we’re going to react to the data,” Powell said. Investors initially only heard the “disinflation has begun” message, quickly bidding up stocks.  The “higher for longer” portion of the message, however, seemed to sink in as the week progressed and additional Fed speakers reinforced Powell’s comments.  Economic news was light this week which meant Fedspeak received most of the attention.  December’s trade data surged higher, helped by a strong rise in passenger cars and automotive parts. Consumer sentiment also moved higher with The University of Michigan sentiment index increasing to 66.4. This is the index’s highest reading in a year, and it coincides with evidence of increasing consumer activity. After what had been a very strong start to the new year, this week bulls were forced to reassess if perhaps they might have gotten ahead of themselves, sending the S&P 500 down -1.11%.

Downing of Spy Balloon Might Help Pop China Trade Bubble

Easing supply chain constraints helped increase the flow of goods into the U.S. in December, pushing the trade deficit up 10.50% month-to-month to $67.4 billion in December. Imports rose 1.30% to $317.6 billion, while exports dropped -0.90% to $250.2 billion. Passenger cars, automotive parts, and cellphones helped drive much of the rise in imports as the supply chain crunch continued to show signs of easing.  A fresh supply of cars was welcomed by dealers who have struggled to maintain inventory amid high pandemic buyer demand. An important thing to watch over the coming month will be whether the previous dip in car demand was entirely a function of higher interest rate costs, or if it was also negatively influenced by the lack of desirable models and options available. As imports surged, the value of U.S. exports declined due to both cooling global goods demand and a decline in crude oil prices.  Even with Covid largely behind us, the pandemic set in motion a supply-chain reorganization, or “nearshoring”, that is now more pronounced in trade deficit data. In December, the U.S. recorded a higher trade deficit with key trading partners, Mexico, Canada, and India, while for 2022 in its entirety, the U.S. trade deficit grew strongly with Mexico, Canada, India, South Korea, and Vietnam. Between the pandemic and political tensions, the U.S. is increasingly expanding its trading partnerships away from China.  The fallout from the spy balloon, forthcoming sanctions, and domestic pressure on corporations are likely to amplify that trend.

Feeling Good Again

Inflation and a slower economy were not enough to weigh on the consumer’s mind in February. The University of Michigan sentiment index, a measure that tracks how consumers feel about the economy, rose to 66.4 in February from 64.9 in January. February’s reading was a one-year high and the third consecutive monthly increase. Despite signs of slowing economic activity and high profile layoffs, consumers are feeling pretty good about their financial situation. The subcomponent within the index that measures what consumers think about their particular financial situation climbed to 72.6, also a one-year high. Inflation still remains a hot topic with consumers expecting inflation to rise to 4.20% for the year. This is higher than the 4.00% level they estimated in January and well above the Fed’s 2.00% target level. Consumers, however, remain confident the central bank will ultimately prevail on taming inflation, with their long-run inflation expectations averaging at 2.90%.

Final Thoughts

A light week in economic news put the focus back on the Federal Reserve and whether the central bank will continue to maintain its restrictive monetary policy. Markets have been priced for perfection lately under the theory that slowing demand would cool growth and inflation, but not so much that employment would erode materially. This week the Fed continued to stress the “higher for longer” party-line, which along with signs that economic data is beginning to inflect positive, had traders reassessing whether their rate expectations are too optimistic. As we spoke about last week, the jobs and wage figures were far stronger than expected. This week we got a sentiment reading that supports the rebound in consumer demand seen elsewhere (used car prices, mortgage demand). Also, while S&P’s operating earnings are roughly 11% lower YOY, company margins are still holding strong at the 11.20% level. This is good news until you consider that consumer spending and the subsequent wealth effect could slow the progress on inflation, which is the very thing the Fed has been warning. The S&P 500 was off approximately -1.11% this week, which may have been its lowest weekly performance for the year, but which is hardly indicative of a paradigm shift. At best you might say the market may have awakened to the possibility of “higher for longer” but it still has yet to fully accept it.   

The Week Ahead

Due to the upcoming Presidents Day holiday, stock and bond markets will be closed on Monday, February 20th. Week in Review will not be published on Friday, February 17th. Our next edition returns on February 24th with the latest existing home sales, consumer spending, and producer price figures. We hope everyone enjoys the long holiday weekend.