11 Apr Capital 19 Catch-Up
Weekly Index Movement
Aussie All Ords -0.2%
The tech-heavy Nasdaq 100 (QQQ) has been quite volatile this year. In fact, this is the 12th consecutive weak in which at least three trading days saw the Nasdaq 100 book an absolute move over 1%.
Unfortunately for bulls, QQQ gained 2%+ on Monday but proceeded to fall 2%+ on back-to-back trading days on Tuesday and Wednesday.
We have these different indices to tell us what is going on inside the market. The Nasdaq is a tech-heavy index and hence sensitive to interest rate changes.
By comparison, the Dow Jones Industrials is all about traditional companies like retail, energy and finance. That only fell -0.3% last week. These companies are less sensitive to interest rate changes.
Clearly, interest rates are upsetting the market and it comes from two fronts.
First is the course of interest rate rises from the Fed
On Wednesday the Federal Reserve released the minutes from the FOMC’s March policy meeting.
The minutes contained few revelations, but there were some notable details on the FOMC’s assessment of the economy and plans for policy.
- “Many” FOMC members said they wanted to go 50 bps in March but “a number” noted they elected a 25 bps hike due to uncertainties related to Russia’s invasion of Ukraine.
- “Many” participants said “one or more 50 bps increases in the target range could be appropriate at future meetings” which in our view is a clear signal that barring a major change to the outlook over the next month the FOMC will hike by 50 bps in at their May meeting.
- The FOMC is deeply concerned about inflation, with “many” participants reporting that business contacts are passing through “substantial increases in wages and input prices…without any significant decrease in demand”.
- While “a few” FOMC members focused on short-term inflation expectations “at historically high levels”, “several other” participants argued longer-term measures of inflation expectations “remain well anchored”.
- With labor markets “extremely tight” and an assessment that “demand for labor continued to substantially exceed available supply”, the FOMC emphasized that inflation is their focus: “All participants indicated their strong commitment and determination to take the measures necessary to restore price stability.”
- The more interesting new information was related to the FOMC’s outlook for the balance sheet, which the FOMC expects to start running off “at a coming meeting, with a faster pace of decline in securities holdings” than the last balance sheet runoff.
Takeaway – the Fed is going to ramp up interest rates very fast. Expect 50bps in May with a good chance of another 50bps in June. The Nasdaq will continue to struggle in this environment.
Under such conditions, it does beg the question of why stock prices are so resilient (at least within the industrial space)
The answer is, because, so far, there is no sign of these interest rate rises hurting earnings expectations
Aggregate next 12 month earnings for the S&P 500 have continued to climb all year regardless of whether equity prices are rising or falling. With earnings season around the corner, we will get a lot of clarity on this point.
We expect to see a divergence in announcements this season where profitable companies will exceed expectations, earnings growth will outpace interest rate increases and stock prices will rise.
Then there will be companies (probably the smaller ones) that show slowing growth in earnings and the market will quickly sell them down.
You want to make sure you are in the right companies so now is to the time to do a portfolio review.
This is the second problem interest rates are causing for stock markets.
We have been reading a lot of comments about interest rate markets signaling a coming recession.
This is something we touched on in our last quarterly webinar and is something we will take a closer look at in our next webinar.
The shortened version is this, in the past when the 2yr interest rate becomes higher than the 10yr interest rate, then a recession follows. It has been a fairly accurate indicator in the past as a recession has always come after this rate differential has inverted.
….and it inverted again last week.
The problem is, this indicator can, and often is, very early with the recession call. For example, a recession could come 2 years after the rates invert. An inversion does not mean a recession is about to start anytime soon.
There is also nothing particularly special about the 2/10. You could, for example, look at the 5/30. Or the 2/5.
We have two comments to make on this.
The first is, when you look in detail at the 2/10 and their predictive power of recessions, you will see that most of the time you get an initial inversion, then rates normalise and later there is a second inversion.
This second inversion is a much better predictor of a looking recession.
We are still at the first inversion point right now so we have plenty of time before we need to think about upcoming recessions.
The second point is, as we mentioned, you could take the 5/30 or the 10/30. We put a matrix together of all the possible inversions and found this helps better predict troubling times ahead for stocks.
Take a look at this chart.
The dark blue bars measure the percent of different yield curves that are inverted. The light blue line is the S&P500.
You can see that stocks only have trouble when you get up near the 100% of yield curves inverted.
Right now only about 10% of curves are inverted and that hasn’t caused stocks any trouble in the past.
Takeway – ignore the fear-mongering of recession. It isn’t coming any time soon. We will tell you when it is time to be fearful and now is not it.
The Coming Week
We will have a holiday-shortened week due to the Easter break. On Tuesday we will get CPI data. This inflation measure came in at +7.9% last month and is widely predicted to peak with this reading. Expectations are for +8.5%. Expect volatility around this announcement.
In addition, we have the start of earnings season. The big banks will kick us off on Wednesday.
This could set the tone for the rest of the season, so we did a bit of an analysis into what to expect from these banks.
You can read that analysis here
That’s it for this week folks.
Remember – we are here to talk to if you have any questions or want to discuss the markets, so please call us anytime.
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.