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  • Writer's pictureJeran Van Alfen, CFP®

Monday Market Review: March 6, 2023

Weekly Summary Economic data for the week was mixed again, with ISM services remaining solidly expansionary, while ISM manufacturing continued to contract (although it improved from the prior month). Durable goods orders also fell, while pending home sales surprised on the upside.

Equities rose last week with mixed, but not terrible, economic data and earnings keeping sentiment elevated. Bonds also gained a bit as interest rates stabilized after a recent inflation-based spike. Commodities rose due to higher crude oil and natural gas prices.

What to know about the markets:

U.S. stocks rebounded last week after their worst showing in a few months, with sentiment surrounding inflation and earnings settling down a bit, and technical conditions remaining bullish. By sector, materials, energy, and industrials led the way with gains over 3%, while defensive utilities and consumer staples suffered minor declines. Real estate rose over a percent, with little change in long-term interest rates.

Several members of the Fed again called for continued higher rates in light of strong recent inflation numbers, while another remained a bit more guarded and pointed to a potential pause in hikes by summer. These comments aren’t necessarily out of nowhere, but often serve as a scripted ‘market test’ before future policy activity. Current Fed funds probabilities for the late March meeting remain at 0.25%, but chances of a 0.50% hike have risen to 30%. Expectations for Fed funds continue to run hot, with both the level of rate and duration of tight policy pushing the curve higher in recent weeks. (For example, the highest probability outcome for the December 2023 Fed funds midpoint has moved from 4.625% at year-end to 5.375% by Friday.)

Earnings for Q4 are close to wrapping up, with over 90% of S&P 500 companies having reported (per FactSet). The year-over-year decline remains around -5%, with expectations for a similar pace in Q1. Q2 and Q3 remain a bit of a mixed bag, as full-year 2023 estimates remain close to 0% growth, with slowdown risks high (whether or not a recession happens alongside). The forward P/E for the index remains around 17.5x, a bit lower than the 5-year average, but right around the 10-year average.

Foreign stocks fared well last week, with a weaker dollar, but also more positive economic news out of Europe. This was despite inflation pressure remaining high, and ECB rhetoric hinting toward another 0.50% hike at the upcoming mid-March meeting. Emerging markets performed similarly to developed, with gains in China and Mexico driven by continued reopening sentiment. The once-per-5-year Chinese National People’s Congress is set to meet this coming week, and has often resulted in positive domestic policy announcements. Economic and even housing data from China has also strengthened further into expansion, as expected upon the post-Covid reopening, albeit at a faster speed. Generally, the expected growth bump from the reopening has lifted spirits across the emerging markets complex.

Bonds generally gained last week as interest rates stabilized from prior weeks, with negative February returns the result of yields re-rising. High yield corporate and floating rate bank loans fared best, with positive returns following along with positive equity sentiment. Foreign bonds also earned positive returns, due to a decline in the dollar.

There remains significant investor interest in the short-to-intermediate part of the treasury yield curve, where rates benefit from the curve inversion, and lie just under 5% for the 3-mo. to 2-yr. area (with the latter touching a 15-year high last week). While higher rates always seem beneficial at first glance, they’re not without other risks. While default is not considered one of them for U.S. debt (debt ceiling jokes aside), reinvestment risk is a primary one, as is duration risk, which of course accounts for chances of good bond returns should long-term rates fall back. This is the key feature of the diversification benefit offered by bonds in a portfolio. Cash or short-term bonds can provide some decent yields for the time being, which has helped emergency funds, but ultrashort bonds can actually have a stronger correlation to equities at times than do intermediate bonds, as measured over the past few decades.

Commodities rose a few percent on net last week, with gains in energy and metals offsetting a decline in ag. Crude oil rose over 4% just under $80/barrel. After falling from the low $90’s last November, crude has bounced around within a fairly tight trading range of $70-80, with an apparent more consistent and offsetting supply/demand balance. However, natural gas prices remained volatile, up nearly 20% last week alone with a colder-than-expected March weather forecast for a good part of the U.S.

Our Weekly Economic Notes:

Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.

(-) Durable goods orders for January fell by -4.5%, just below the -4.0% expected, and reversed a gain of similar magnitude the prior month, even with a downward revision. As this was driven by a sizeable drop in non-defense aircraft (a lumpy sector), removing transports from the headline transformed it into a 0.7% gain. This was a half-percent above expectations, driven by higher orders in machinery, defense aircraft, and electronics. Similarly, core capital goods orders and shipments rose 0.8% and 1.1%, respectively. This pace reversed a string of declines in latter 2022, bringing year-over-year durable goods order growth to 3%.

(0) The ISM manufacturing survey for February ticked up by 0.3 of a point to 47.7, just below expectations for a larger rise—however, the index remained in contraction. Closely-watched new orders up over 4 points was a key contributor, although it remained in contraction as well. On the other hand, production and employment declined a bit, further into contraction. Prices paid rose by 7 points back into expansion, aided by perhaps operational supply/demand inventory dynamics noted in the official report. Regardless, the below-50 reading continues to be indicative of economic slowing, and higher recession risk looking ahead, in keeping with tendencies over the past 70 or so years. However, we know that economic data and stock market returns don’t tend to align. In fact, since the dataset started in 1948, ISM readings under 50 (whether they’re falling further or are in reversal higher) have tended to result in strong stock market performance for the coming year at roughly two times the long-term average.

(+) The ISM services/non-manufacturing survey for February barely edged down by -0.1 of a point to 55.1, better than estimates of a larger drop to 54.5. This obviously remains in expansionary territory, as all but 5 of the 18 industry groups showed growth. Under the hood, items were mixed, with new orders up several points (to above 60, the strongest place in over a year), as well as gains in employment back to expansion. On the other hand, business activity fell by -4 points but remained solidly in expansion, as did prices paid, while supplier deliveries fell back from neutral to contraction. This continues to reflect the post-pandemic reality of consumers moving away from goods toward services—which still have yet to recover to pre-Covid levels in some industries. Higher activity and a need for workers in services have also kept inflation in those areas running hotter.

(-) Construction spending fell -0.1% in January, in contrast to an expected 0.2% increase, in addition to net revisions higher for recent prior months. Jan. data was driven by near-1% gain in private non-residential spending and a minor rise in public residential. Private residential and public non-residential each fell, all resulting in an overall mixed bag. These are reported in nominal terms, though, with inflation playing a key cost role—real spending growth is far less, falling largely to negative.

(+) Pending home sales rose 8.1% in January, well above the 1.0% expected. The year-over-year rate remained quite depressed at -22%, but this report bodes well for the next several months of potential existing home sales reports. Every U.S. region experienced a solid gain in the high single digits or better, and, in the case of the West, at 10%. January saw a dip in mortgage rates from highs for a time, which has since reversed somewhat, and may weigh on forward-looking reports.

(0) Initial jobless claims for the Feb. 25 ending week fell by -2k to 190k, below the expected rise to 195k. Continuing claims for the Feb. 18 week fell back by -5k to 1.655 mil., well below the 1.669 mil. expected. The largest rise was seen in CA, while KY and TX experienced the greatest declines. Winter weather may have played a bit of a role here, but seasonal adjustment comparisons with the pandemic period continue to affect measurements, and may take time to fully normalize.

There continues to be debate about the future of the Bank of Japan’s YCC (yield curve control) policy, with the changing of the bank’s leadership and pressures from high global inflation. What is YCC? Essentially, like quantitative easing in the U.S., it involves active involvement from the central bank in buying/selling government bonds to keep the Japanese 10-year bond yield within a particular range. Current policy calls for targeting short rates at -0.1% (!) and 10-year government bonds at 0%, +/- a range of 0.5%, with a long-term goal of achieving consistent 2% long-term inflation. Japan has been the last major central bank to remain stimulative, due to more complicated dynamics, such as weak internal demographics (the population isn’t growing, and immigration is limited, putting a damper on potential economic output). Ironically, the greater central bank worry has been deflation, with the YCC policy intended to generate ‘some’ positive inflation. Some has been created post-pandemic, but isn’t expected to remain as ‘sticky’ as in the rest of the world. Along with new bank leadership in coming weeks, pressure exists to expand the current policy band to more like 0% +/- 1.0%, and/or change the focus from 10-year to 5-year bonds instead. This is made easier by the fact that most government debt is held by the BOJ itself (about half of all outstanding) or private citizens, allowing greater ease of movement than if the market had more of a global audience, as U.S. treasuries do. Debate continues about whether this policy will or won’t work, or if the stringent rules just box the BOJ into a corner. As an open economy, something has to give among the three key moving parts: monetary policy, capital flows, and exchange rates. In this case, more stringent monetary policy has caused the yen to fluctuate more dramatically as the ‘safety valve’ of the trifecta, along with evolving market expectations.

An important potential side effect of rates eventually normalizing in Japan is the narrowing of the ‘carry trade’. This takes place as investors borrow in low-rate currencies (like Japan) and invest in higher-rate currencies (like the U.S. or emerging markets), with the spread differential representing profit. (However, some currency hedging activities can either enhance or erode some of that, based on variable cost, making the effort much more complicated and risky than it sounds.) Closure of these country-to-country yield gaps take away some of the cross-border opportunities. Currencies have tended to strengthen when interest rates rise, which could benefit the yen—all else equal, but conditions are never equal in a vacuum.

Have a good week!

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Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.

Sources: Ryan M. Long, CFA; Director of Investments; FocusPoint Solutions, Inc.

FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, First Trust, Goldman Sachs, Invesco, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, PIMCO, Standard & Poor’s,, The Conference Board, Thomson Reuters, T. Rowe Price, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.

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