The Fed Chair’s Comments May be the Most Critical Market Event of the Week
It’s a quiet week for economic data. If the market takes a direction this week, it may have to take its lead from something other than statistics that indicate economic strength or weakness. This could be a Fed governor speaking, or a central bank outside of the US altering its hawkish stance.
Monday 2/6
With no consequential economic releases, market direction may take its tone from earnings reports from a wide swath of industries.
Tuesday 2/7
11:00 AM ET, New York Federal Reserve inflation expectations.
3:00 PM ET, Consumer Credit, or more definitively, the installment credit outstanding by consumers is expected to have increased by $25 billion in December versus November’s $27.9 billion increase. There is such a long delay reporting this number that it seldom has a market impact.
Fed Chair Jerome Powell will be speaking at the Economic Club of Washington.
Wednesday 2/8
10:00 AM ET, Wholesale Inventories revision for December is in line with the first estimate of 1%. Wholesale sales and inventory data can provide investors a chance to look below the surface of the consumer economy. Activity at the wholesale level can then be a precursor of consumer trends.
Thursday 2/9
8:30 AM ET, Jobless Claims, including Initial Claims and Continuing Claims, have been a big focus of the market as unemployment is running at a historically low pace. The consensus is for growth in Jobless levels to 190,000 versus 183,000 the prior week. Overall low claims would seem to be good news for the economy. The problem now is that it is except that it is worrisome for a Fed that views current inflationary pressures, including wage pressures unacceptably high.
Friday 2/10
• 10:00 AM ET, The University of Michigan’s Consumer Survey Center questions households each month on their assessment of current conditions and expectations of future conditions. Consumer sentiment is not expected to show much improvement, at a consensus 65.0 in the first reading for February versus 64.9 in January.
What Else
The FOMC meeting that ended on February 1 was the last before Chair Powell delivers the semiannual monetary policy testimony in late February or early March (not yet set). Any remarks by Fed officials in the February 6 week should be viewed in that context. Powell and associates will not want to confuse any upcoming message given at the semiannual Monetary Policy Report to Congress. Whatever is said is likely to foreshadow what will be in the report when he speaks before the Senate Banking Committee and the House Financial Services Committee.
The Percentage Volume of Retail Transactions Has Surpassed 2020’s Level
Retail investors were a strong market force in 2021, and after a hiatus through much of 2022, they may be setting the tone in 2023. As a whole, the investors that fall into this category are watching signs that the US Federal Reserve and other central banks may be near the end of their rate hikes. This, coupled with last year’s sell-off, was taken as a sign to selectively jump back into positions. The positions they have been putting on have been moving the needle in the “risk-on” category; this has sent many of last year’s losers up double digits.
Data from JP Morgan demonstrate retail transactions have recently surpassed the market volume peak reached in the Fall of 2020. The more volume as a percentage of trades, the more influence over price movements any investment group has.
JPMorgan Data Shows Retail’s Market Percentage Has Quickly Grown
Retail Investors as % of Investors (JPM)
What Prices Have They Impacted?
During the last week in January, retail market orders as a percent of market value reached 23%, according to JPMorgan. Comparatively, it got to 22% a few times when GameStop (GME) was confounding institutional money while surging in valuation. As with the increase in retail volume during 2020, the renewed interest in committing to trades can have an outsized impact on sector movements and those of favorite stocks.
During the pandemic lockdown period, many self-directed investors chose to follow groups such as r/WallStreetBets on Reddit and forums on other chatrooms and platforms. One strategy that worked was directed at hedge fund short positions. It involved massive buying of stocks that were heavily shorted. The goal was to force the shorts to cover, which would produce buying and a higher stock price. This was effective enough to have caused significant problems with both institutional investors and the brokerage community settling the trades.
As January came to a close Many of the same risk trades, have gotten attention. AMC Theatres (AMC) is up 70% YTD. Cathie Wood’s ARKK fund, which invests in speculative disruptive companies, has risen nearly 46%. Also in the fund category is an ETF that invests in so-called meme stocks (MEME), this is up 41%.
Bitcoin (BTC.X), which had been presumed on its deathbed toward the end of last year, is up over 42% as it continues to track technology.
Will They Again Score?
“Mark my words, it’s going to end in tears,” was a popular line amongst market pundits back in 2020-2021. The Great Unwashed, the Meme Stock Investors, the market participants Jim Kramer called Robin Hoodies don’t have a long track record. But the track record they do have is worth noting.
According to JP Morgan, as of the first week in February, Tesla (TSLA) was the most sold stock by retail investors. Others that have been sold include those categorized as green and infrastructure stocks tied to EVs and 5G broadband.
The most purchased were Amazon (AMZN) and APPLE (AAPL). The hashtag #MOASS, or Mother of All Short Squeezes, has been trending most days on Twitter. The stock tied to the posts is AMC (AMC, APE), as there has been ongoing news surrounding this classic meme stock. One meme stock that has not attracted that much attention is Bed Bath and Beyond (BBBY). The company, which is trading at $3.20 after having been at $22.80 less than a year ago, is on life support, and closing dozens of stores amongst talk of bankruptcy. For those that were able to withstand the retail short-squeeze in BBBY, they may be able to cash in.
Take Away
If the “risk-on” trend among retail investors continues, discretionary institutional money has learned to pay attention. Self-directed investors should also pay attention to new activity, and any rotation from one cooling sector to one that is heating up.
In addition to following the news on Channelchek, investors can watch the Investor Movement Index (IMX) reported on the last weekend of each month by TDAmeritrade. For additional insight, it is always fun to check in on what the message boards are buzzing about and sorting through the serious and the nonsensical on Reddit and Twitter.
Global Dynamics Have Helped Silver’s Impressive Price Increase
In mid-October, silver performance began outpacing gold, and it has stayed more or less on track since. During this 3.5-month period, silver had better than a 25% gain in value. What’s behind its current strength, and can it continue to outperform not only the mineral it is most closely associated with but the overall stock market as well? Much of the price rise is likely in response to perceived growing demand in much the same way as petroleum prices have risen each time China is rumored to be opening up after their pandemic response, but there is more to the story.
Silver would have more of a tailwind than gold in a growing global economy as it’s an industrial metal with growing utility in manufacturing. Gold is used for primarily for jewelry and a diversifying store of wealth. So this enhances its performance as it gets its value from scarcity like gold, is a precious metal that investors speculate in, and is becoming more in demand to build photovoltaic cells, electronics, and medicines. The appeal of silver can be used as an indicator that investors see the global economy growing stronger, with more demand for industrial metals. While much of the focus surrounding a full opening of China has centered on renewed demand for petroleum, the impact should reach much farther.
Other industrial metals have also gained as Chinese pandemic restrictions have eased. China is the worlds largest consumer of metals, copper and iron-ore futures on Comex each climbed by nearly 11% in January.
In addition to its functional utility, the price increase has also come at a time when uncertainty and in some cases turmoil around the globe has caused investors to seek shelter in precious metals.
There is more causing the strength as well. There is substantially more demand now than before the coronavirus shutdowns because in many parts of the world there is a push toward alternative and clean-energy production. This includes more products with more electrical connectors, the ability to produce power from solar, and other technology that is more in demand now than ever.
Over the same three-month-plus period as above, both gold and silver gained while the ICE U.S. Dollar index, a benchmark for the international value of the dollar, lost over 8%. The Fed slowing its interest rate hikes has had a depressive impact on dollar strength. It now simply takes more dollars to buy the same amount of silver.
Take Away
There are a number of factors why silver has been outperforming gold, the stock market, and the US dollar. These include its reputation as a store of value, parts of the world gearing up for what is expected to be an energy renaissance, the opening of the largest metals consuming country, and a weakening dollar.
Different investing environments call for adjustments to portfolios. What’s in your equity portfolio mix? Whether you’re an index investor, stock picker, or a 60/40 with a regular rebalance investor, stocks of different companies, different sectors, and different sizes are not the same. The characteristics of each slice of your portfolio can swing performance from negative to positive. For example, the Dow Industrials have returned less than 2.50% this year, while the large-cap Nasdaq 100 and the small-cap Russell 2000 have exceeded the Dow’s performance by well over 10%.
Performance
The reason for the tech large-cap resurgence may be a reaction to last year’s sell-off, a declining dollar, some surprise strength in earnings, or any combination of things. Can the large-cap rally be trusted? Time will tell. Small-caps are also doing well; they had been running behind the other indexes in terms of performance based on price/earnings averages and overall return. The two have different forces driving the performance of each; for this reason, investors looking to diversify could find comfort in allocating to large and smaller stocks if they haven’t already. The 60% of a 60/40 mix should be mixed and varied if the investor is truly interested in diversification. Recent performance shows small-cap stocks have outperformed over the last six months with the Dow Industrials in second place and measured year-to-date with the Dow barely getting off the starting line – the small-cap index however has taken off.
The Russell 2000 index turned around in late summer last year after it hit its low. The large-caps didn’t bottom until early winter, a little over a month ago. This discrepancy in timing shows they trade on different factors and often have very different investors. One example is large-cap stocks are in the news each day and easily driven by hype, while small-cap stocks that are out of the spotlight are driven by other factors, including growth prospects, sharp pencil analysis, and even raw speculation.
The optimism that kicked off 2023, includes the Fed nearing the end of its aggressive tightening, a healthy labor market, and an economy that is still flush with capital looking for a home. Add in a weakening dollar, as US interest rates have remained stagnant, and last year’s weak markets may continue to unwind their negativity as higher highs are reached.
A Word on Diversification
An investor in a fund that tracks the S&P 500 may feel they have the diversification of 500 multi-industry stocks. They do have exposure to 500 stocks, however the top 10 of the 500 represents more than 25% of the performance of the index – and most of these would qualify as tech stocks. For this reason diversifying away and into investments that are less correlated to tech may be prudent. Small-cap stocks, especially considering the past six months, would seem to be the best offset to this concentration risk.
If an investor is astute enough to understand market dynamics, digest research on industries and companies within those industries, and know how to recognize high-quality objective research, the investor may do better hand selecting a variety of stocks rather than being an index investor or even a single index investor.
This experience doesn’t happen automatically, if you are already there, may I suggest signing up for Channelchek’s daily emails to get introduced to, and stay on top of some interesting small companies (small and microcap)? And if you don’t believe that you are at that level yet, let Channelchek build on your knowledge with exclusive video content, insightful articles, and top-tier company research?
The year 2023 will be filled with opportunity. Let Channelchek help you explore. Complementary registration here.
Jerome Powell and FOMC Will “continue to monitor the implications of incoming information”
The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from the previous target of 4.25% – 4.50% to the new target of 4.50% – 4.75%. This was announced at the conclusion of the Committee’s first scheduled meeting of 2023. The monetary policy shift in bank lending rates was as expected by economists and the markets as the overwhelming consensus was for a 25 bp move. It has been less than 12 months since the Fed began this tightening cycle, overnight rates since the beginning of last year have increased from near 0.00% to the current target of up to 4.75%.
One recent market focus has been that inflation has been, by most measures, trending lower each month. While lower increases may suggest that inflation is successfully being wrung out of the system, Powell and the other FOMC members have a 2% target for inflation which guides their policy. The current level is more than two times as high. The art of being the nation’s top bankers and economists trying to provide a soft landing for the still strong economy, is difficult. The result of the actions taken by the Fed can only be seen in the rearview mirror, months after the action.
Synopsis of Fed Decisions
The Board of Governors of the Federal Reserve System voted unanimously to approve a 1/4 percentage point increase in the primary credit rate to 4.75 percent, effective February 2, 2023. In a related decision, the Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on reserve balances to 4.65 percent, effective February 2, 2023.
Text from Federal Reserve’s Statement February 1, 2023
Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated.
Russia’s war against Ukraine is causing tremendous human and economic hardship and is contributing to elevated global uncertainty. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Take-Away
Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. The risk of inflation also weighs on the markets. Additionally, investors find that alternative investments that pay a known yield may, at some point, be preferred to equities. For these reasons, higher interest rates are of concern to the stock market investor. However, an unhealthy, highly inflationary economy also comes at a cost to the economy, businesses, and households.
The statement suggests the Fed continues to remain data dependent, but expects further increases will follow. The statement did not provide strong guidance as to what to expect following future meetings.
Chairman Powell’s 2:30 PM ET press conference can be viewed here.
January’s Stock Market Performance Bodes Well for the Rest of 2023
The stock market has put in a solid January in terms of overall performance. Following month after negative month last year, this is a welcome relief for those with money in the market which is beginning to look welcoming to those that have been on the sidelines. While the Fed is still looming with perhaps another 50-75 basis points in rate hikes left to implement over the coming months, the market has been resilient and has already made up for some of last year’s lost ground.
For the month (with an hour left before market close on January 31), the Nasdaq 100 is up over 10.8% for the month. Over 10% would be a good year historically, of course averaging in last year, it is still solidly underperforming market averages. The small-cap Russell 2000 index is also above 10%. Small-caps have underperformed larger cap stocks over several years and are seen to have more attractive valuations now than large caps as well as other fundamental strengths. These include a higher domestic US customer base in the face of a strong dollar, fewer borrowings that would be more costly with the increased rate environment, and an overall expectation that the major indexes will revert to their mean performance spreads which the small-cap indexes have been lagging. The S&P 500, the most quoted stock index is up over 6% in January, and the Dow 30 Industrials are up almost 2.4%.
Rate Increases
The stock and bond markets hope for a solid sign that the FOMCs rate increases will cease. The reduced fear of an ongoing tightening cycle will calm the nervousness that comes from knowing that higher rates hurt the consumer, increases unemployment, reduces spending and therefore hurts earnings which are most closely tied to stock valuations.
January Historically
January rallies, on their own, statistically have been a good omen for the 11 months ahead. When the S&P 500 posts a gain for the first month of the year, it goes on to rise another 8.6%, on average for the rest of the year according to statistics dating back to 1929. In more than 75% of these January rally years, the markets further gained during the year.
Other statistics indicate a bright year to come for the market as well. Using the S&P 500, it rallied for the final five trading days of last year and the first two of 2023, it gained for first five trading days of the new year, and rallied through January. When all three of these have occurred in the past, after a bear market (20%+ decline), the index’s average gain for the rest of the year is 13.9%. In fact it posted positive returns in almost all of the 17 post-bear market years that were ushered in with similar gains.
Follow Through
Beyond history, there is a reason for the follow-through years. January rallies are signs of confidence, they indicate that self-directed investors and professional money managers are buying stocks at the lower prices. It suggests they have a strong enough belief that conditions that caused the bear market have or will soon reverse.
And this is quite possibly where the markets are at today. The lower valuations seem attractive, this is especially true of the overly beaten down Nasdaq 100 stocks and the small-caps that had been trailing in returns since before the pandemic.
Federal Reserve Chair Powell is looking to make money more expensive in order to slow an economy that is still exhibiting inflationary pressures. He is not, however, looking to crush the stock market. Fed governors seem to be concerned that the bond market prices haven’t declined to match their tightening efforts, but a healthy stock market helps the Fed by giving it latitude to act. Powell will take the podium post FOMC meetings eight times this year.
Each time his intention will be to usher in a long term healthy economy, with reasonable growth, low inflation, and jobs levels that are in line with consumer confidence.
Image: President Biden reads newspaper before a phone call with Kevin McCarthy, Aug. 23, 2021 (The White House)
Could the Debt Ceiling Challenges be Ironed Out Before the Eleventh Hour?
The market-moving potential of key meetings in Washington on Wednesday, February 1st, includes more than the FOMC decision on monetary policy. Up the road from the Federal Reserve building, also scheduled for the first of the month, will be another important meeting for the markets. House of Representatives Speaker Kevin McCarthy will be headed to the Oval Office for a discussion to resolve other risks to the US economy, risks that could quickly spin out of control. High on the list is the national debt limit. Without a plan, the inability for the government to borrow above the current debt ceiling, could impact trust in the credit rating of US debt. This would move bond prices lower as rates would naturally rise at even the smallest prospect of a US default.
Why It’s Critical to Markets
A debt limit increase would allow the government to finance existing obligations. These obligations have, as in the past, expanded beyond the borrowing cap imposed on the US Treasury. An inability to roll existing maturing debt or afford additional interest rate costs would cause a default. The reverberations of this can not be understated as US Treasuries, like US currency, is the backbone of the worlds financial system.
An actual default could precipitate a mega financial crisis, threatening jobs, asset values, and trust.
The US reached its technical borrowing limit of $31.4 trillion in January. US Treasury Secretary Yellen enacted planned accounting moves that will allow the federal government to pay its bills until sometime in June by postponing some obligations. Before then, a solution must be devised by lawmakers that would then be signed by the President in order for the government to take on new debt and fund its responsibilities.
The Meeting Agenda
President Biden and House of Representatives Speaker Kevin McCarthy will meet at the White House to find common negotiating ground to avert a default. They currently seem far apart on a potential solution as the President’s party wishes to raise the debt ceiling quickly and resume business as usual in DC, while many in the House Speaker’s party are looking for concessions and spending cuts before they agree to raise the borrowing limit.
Republican lawmakers don’t currently support a measure that would let the country pay its debts unless there is agreement on various spending cuts going forward. The White House, which must sign or veto anything passed in Congress, has said raising the debt limit is critical and non-negotiable, citing the risk to the US economy from a default.
Both Biden and McCarthy will want to come away from this meeting with something their constituents and the onlooking financial markets can be comfortable with, and at the same time provides assurance to the world that is also looking on.
Congress has always passed an increase in the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or change the definition of the debt limit. Congressional leaders in both parties have believed in the end that it is best. However, the negotiations tend to go to the eleventh hour with escalating showmanship on all sides.
The eleventh hour comes sometime in June. Skeptics of any success of this face-to-face talk have a long history on which to hang their skepticism. However, McCarthy being new to his role and Biden having an aggressive spending agenda may help to shape a quicker outcome than in the past.
On Sunday, January 9th, McCarthy said that Republicans would not allow a US default that cuts into Social Security and Medicare, this would be “off the table” in any debt ceiling negotiations.
“The President will ask Speaker McCarthy if he intends to meet his Constitutional obligation to prevent a national default, as every other House and Senate leader in US history has done,” a White House spokesperson said.
The statements following, both by the White House and the Speakers camp, may cause a sigh of relief or elevate the level of panic.
Politics Involved
House Speaker McCarthy, in order to be elected speaker, agreed to rules that made it easier for his party to oust him over policy disagreements. He said he’d focus on discretionary spending, which has increased dramatically in the past two years with infrastructure and semiconductor legislation and a green-energy bill supported by Democrats.
“I think everything, when you look at discretionary, is sitting there,” McCarthy said. “We shouldn’t just print more money, we should balance our budget. So I want to look at every single department. Where can we become more efficient, more effective and more accountable?”
Biden, who is contemplating seeking re-election in 2024, has been sharply critical of McCarthy’s Republican caucus. He characterized them as “fiscally demented” earlier this month, threatened to veto their legislation and accused them of trying to balloon the deficit, favoring billionaires, raising middle-class taxes and threatening benefit programs.
Take Away
In the past, debt ceiling news typically made the top headline when the negotiations are truly in the eleventh hour. The meeting on Wednesday between two politicians that have a lot to gain from a successful outcome may avert a late Spring crisis and provide calm in what is already a cloudy economic environment. An agreement would be positive for the markets – lack of agreement will likely be taken as business as usual.
The Fed May Try to Talk Rates Up While Increasing Overnight Levels by a Lower Amount
There will be plenty for the market to digest this week. While all ears will be on what Fed Chairman Powell says following Wednesday’s FOMC policy announcement, investors will get to also digest a barage of earnings reports. The quarterly reports, from various sectors, may set the tone for their industries. These include reporting on Monday by Advanced Micro (AMD), Amgen (AMGN), Caterpillar (CAT), Exxon Mobil (XOM), McDonald’s (MCD), Pfizer (PFE), and United Parcel (UPS). On Tuesday Meta Platforms (META) will be one of the most talked about, then on Wednesday the market gets a barrage from tech and pharmaceutical companies as Alphabet (GOOGL), Amazon.com (AMZN), Apple (AAPL), Bristol-Myers (BMY), Eli Lilly (LLY), Honeywell (HON), Merck (MRK), and Qualcomm (QCOM) are all scheduled to report operating performance.
Monday 1/30
With no consequential economic releases, market direction may take its tone from earnings reports from a wide swath of industries (see tickers above).
Tuesday 1/31
The first of 2023’s eight scheduled two-day FOMC meetings begins.
8:30 AM ET, Employment Cost Index is expected to have risen 1.1% for the fourth quarter. For the last five quarters, large gains of 1 percent and more have been keeping wage inflation a concern.
8:30 AM ET, After jumping 7 points in December, the consumer confidence index is expected to firm only 0.7 of a point to 109.0 in January. The pattern in consumer attitudes and spending is often the largest influence on stock and bond markets. For stocks, strong economic growth translates to healthy corporate profits and possibly higher stock prices as a result.
Wednesday 2/1
7:00 AM ET, the Mortgage Bankers’ Association (MBA) compiles various mortgage loan indexes. The purchase applications index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction. The composite index is expected to come in at 27.9%, while the Purchase applications are expected to show a reading of 24.7%. The data provides a gauge of not only the demand for housing, but economic momentum.
9:45 AM ET, Construction Spending, for December is expected to slip 0.1 percent after moving 0.2 percent higher in November. Spending has been flat in recent months as gains in non-residential construction have been offset by declines on the residential side.
10:00 AM ET, Job Openings and Labor Turnover Survey (JOLTS), which have been steady to lower, are expected to fall to 10.2 million in December versus 10.458 million in November.
2:00 PM ET, FOMC meeting concludes with statement of policy shift. The Fed is expected to reduce its rate hike magnitude to 25 basis points. A 0.25% increase would raise the overnight Fed Funds rate range up to 4.50% – 4.75%.
2:30 PM ET, Fed Chair Powell’s press briefing. The purpose of the briefing is to provide additional context to the FOMC’s policy decisions and to allow for questions-and-answers with the press. There has been concern that the market has been pushing rates down out in terms beyond two years to maturity. This could be a undermining the Fed’s stated objective by tightening. If this is true, the briefing may be filled with language that tries to convince the bond markets, that the Fed is determined to slow the economy by pushing rates up.
Thursday 2/2
7:30 AM ET, the Challenger Job Cut report counts and categorizes announcements of corporate layoffs based on mass layoff data from state departments of labor. The job-cut report doesn’t distinguish between layoffs scheduled for the short-term or the long term, or whether job cuts are handled through attrition or actual dismissals. Also, the job-cut report does not include jobs eliminated in small batches over a longer time period. Unlike most economic data, this series is not adjusted for seasonal variation.
8:30 AM ET, Nonfarm Productivity is expected to rise to a 2.4 percent annualized rate in the fourth quarter versus growth of 0.8 percent in the third quarter. Unit labor costs, which rose 2.4 percent in the third quarter, are expected to rise to a 1.5 percent rate in the fourth quarter.
10:00 AM ET, Factory Orders are expected to rise 2.2 percent in December following November’s steep 1.8 percent drop. The expected increase comes in the wake of a surge in aircraft orders.
Friday 2/3
• 8:30 AM ET, Nonfarm Payroll is expected to have grown 185,000 in January versus 223,000 in December which was the eighth straight month and tenth of the last eleven that payroll growth exceeded the average economists expectation. Average hourly earnings in January are expected to rise 0.3 percent on the month for a year-over-year rate of 4.4 percent.
What Else
The tone of the chatter that is expected to come from Fed officials is one of continued hawkishness. The Fed’s preferred inflation measure (PCE) was at 4.4% for all of 2022, and has been trending downward. This is more than double the stated target of 2%. The question they are now facing is, whether they should soon pause tightening and observe the impact of previous moves. Or if the solid employment numbers and strong bank reserve positions leave room for continuing the war on inflation through aggressive overnight rate hikes. Powell’s press conference after the 2 pm announcement on Wednesday should reveal quite a bit.
Will ESG Investing be Able to Recycle Itself in 2023?
Investment trends run in cycles. As a new trend is recognized, it attracts new money, which drives up prices, until there isn’t as much additional money left to keep the trend going strong. At some point, investors may feel there is a more profitable use for their capital, and the old trend then falls out of favor. Over the decades, sustainable and social investing have had several up cycles, followed by a hiatus and then a new incarnation. Where is ESG investing in its cycle in 2023?
Background
Environmental, social, and governance (ESG) holds as an underlying promise that companies and those that invest in them can do well by doing good. Just a couple of years back, investors trillions of dollars into ESG strategies. This had the effect of causing many businesses to alter their business model in ways that would conform to an unofficial ESG designation(s).
Investment companies aimed to fill the demand by creating new ESG funds, at the same time the business of creating ESG profile rankings also grew. Professionally managed assets with ESG mandates surged to an astronomical $46 trillion globally in 2021. According to Deloitte’s Center for Financial Services, assets, ESG funds represented nearly 40% of all assets under management.
The first couple of years this decade were riddled with black swan events, investment assets swelled on many fronts. Investors in ESG have recently stepped back and moved the most money out of U.S. sustainable funds in more than five years (4Q). The fund industry experienced nearly $6.2 billion pulled from professionally managed funds catering to environmental, social, and governance strategies. As compared to the trillions in the funds, this is not overly significant. What is significant is the reversal of what had been a strong trend of inflows.
Sustainable funds overall netted more than $3 billion in positive flows for all of 2022 – traditional U.S. funds experienced more than $370 billion in withdrawals during the year. A lower percentage but still significant as it was the first calendar year of net outflows since Morningstar began tracking data in 1983.
According to a new report from Morningstar, flows of money into U.S. sustainable mutual funds and ETFs has declined since its record high in the first quarter of 2021. The withdrawal of money comes as many companies are improving their ESG scores. The decline in 4Q 2022 came as a myriad of factors soured investors on many market sectors.
Political Winds Changing
But stock market sentiment may only be part of the story. There are louder and louder voices that are questioning the purity of this newer incarnation of social investing. They ask if it provide for what is good and best overall? There is even some confusion by investors that remember the older versions of social and environmental investing that specifically excluded things like nuclear power. Today many ESG scores view carbonless nuclear generation as clean.
Where there is money, there is also politics. This is part of what originally helped the trend pick up steam. Now opposing political voices are causing some second looks at the overall benefits. The most recent examples include the person who moved the electric vehicle (EV) movement out so far into the spotlight that the car company he founded is the most valuable in the world (market cap). Elon Musk made one of his negative ESG comments as a tweet responding to self-described “Hero of the Environment” and author, Michael Shellenberger.
Image: Twitter (@elonmusk)
Less political, but perhaps more important, Federal Reserve Chair Jerome Powell made his official position clear during a conference titled Central Bank Independence and the Mandate—Evolving Views. Standing before an international audience in Stockholm, Sweden, Powell said, “we resist the temptation to broaden our scope to address other important social issues of the day. Taking on new goals, however worthy, without a clear statutory mandate would undermine the case for our independence.”
Sustainable funds lagged behind the broader market in performance. Remember, there was an increasing supply of names that were attaining ESG status. Also their lack of exposure to the top-performing oil and gas sector and its 66% gain during the year hurt performance.
The drag in the last quarter of 2022 was even more pronounced as it was the first period in more than three years that U.S. sustainable funds had a lower organic growth rate than the total U.S. fund market. During the fourth quarter, sustainable funds shrank by 2.2% compared with an 0.8% shrinkage in the overall U.S. landscape.
Morningstar’s sustainable fund universe encompasses mutual funds and ETFs “that, by prospectus or other regulatory filings, claim to focus on sustainability; impact; or environmental, social, and governance factors.”
Take Away
Last year while the overall markets were gloomier, ESG investors slowed and then reversed their piling into ESG funds. These funds had attracted 40% of fund assets, so it is no surprise they paused. However last quarter was the first decline since 1983. Part of the issue is the normal cyclicality of investment trends. Make no mistake; sustainable investing is not dying, but it suffers from a lack of clarity as to how companies are scored, and who is doing the scoring.
Investors that wish to keep the entire universe of opportunities open to their portfolios can still invest in stocks that suit their appetite for many factors, including environmental, social, or corporate governance. A little digging through analyst research reports ought to provide enough information to steer one clear of companies individuals would rather not be part of, and those they feel especially good about owning.
Discovering Why Trading is Halted on One of Your Stocks
Fair and orderly trading is an admirable goal of any system of exchange. As part of this ideal, exchanges, the SEC, and brokers can temporarily halt trading in stocks. The impact of news, or tripped circuit breakers designed to decelerate snowballing reactions (both human and programmed reactions), are the most common reasons to halt trading. There have also been events when a computer glitch, either feeding into an exchange or into the exchange’s systems, has triggered a pause or a halt. A total of 77 stocks were reportedly halted after the opening on the NYSE (January 24). They were all labeled “LULD,” this code is used to indicate it was a volatility trading pause. But officials at the NYSE say they’re still looking into it.
Reasons to Halt Trading
Companies listed on a U.S. stock exchange are responsible for notifying the listing exchange about any announcements or corporate developments that might affect trading in its stock. These often include:
Changes related to the financial health of the company
Changes in key management individuals
Major corporate transactions like restructurings or mergers
Significant positive or negative information about its products
Legal or regulatory developments that affect the company’s ability to conduct business
A circuit breaker has been reached due to volatility
Stock Halt Codes
Each day the exchanges list stocks as they are paused or halted and include a code to indicate the reason. The codes help market participants understand for how long it may be halted and for what general reason. It’s a good idea to be familiar with the codes shown below.
LUDP or LULD: Volatility trading pause (high volatility risk for investors).
T1: News pending (halted to give investors of all varieties ample time to evaluate).
H10: This is not enacted by the exchange but instead by the SEC (could be any number of regulatory reasons).
Image: Two of the many stocks halted on January 24, 2023 (NYSE Website)
The reason for the recent multiple stock pauses was available immediately on the NYSE website. Many of the stocks showed they were opening down substantially; the exchange says they are looking into this further.
There are also times when a circuit breaker stops trading across the market exchange. This is not the reason for the multiple pauses experienced in January, but also worth mentioning. There are three levels of halt based on size of the markets (S&P 500) move.
Level 1: 15-minute halt due to a 7% decrease from the S&P 500’s previous close
Level 2: 15-minute halt due to a 13% decrease from the S&P 500’s previous close
Level 3: Day-long halt due to a 20% decrease from the S&P 500’s previous close
Take Away
When the market opens and it is not business as usual, a lot of frustration can be saved by knowing market rules and finding resources to get a fast answer. While other traders wait for their favorite news service to report on it, going directly to the NYSE website to, in this case, get a listing of affected stocks and why, can put you ahead of those that are waiting for CNBC or another news outlet. Nasdaq also will post paused or halted stocks and use the same codes as above to indicate why.
In 2022, central banks purchased the largest amount of gold in recent history. According to the World Gold Council, central bank purchases of gold have reached a level not seen since 1967. The world’s central banks bought 673 metric tons in one month, and in the third quarter, the figure reached 400 metric tons. This is interesting because the flow from central banks since 2020 has been eminently net sales.
Why are global central banks adding gold to their reserves? There may be different factors.
Most central banks’ largest percentage of reserves are US dollars, which usually come in the form of US Treasury bonds. It would make sense for some of the central banks, especially China, to decide to depend less on the dollar.
China’s high foreign exchange reserves are a key source of stability for the People’s Bank of China. But the high amount of US dollars ($3.1 trillion) may have been a key stabilizing factor in 2022, but it could be too much if the next ten years bring a wave of money devaluation that has never happened before.
Central banks have been talking about the idea of issuing a digital currency, which would completely change the way money works today. By issuing a digital currency directly into a citizen’s account at the central bank, the financial institution would have all access to savers’ information and, more importantly, would be able to accelerate the transmission mechanism of monetary policy by eliminating the channels that prevent higher inflation from happening: the banking channel and the backstop of credit demand. What has kept inflation from going up much more is that the way monetary policy is passed on is always slowed down by the demand for credit in the banking system. This has obviously led to a huge rise in the prices of financial assets and still caused prices to go through the roof when the growth in the money supply was used to pay for government spending and subsidies.
If central banks start issuing digital currencies, the level of purchasing power destruction of currencies seen in the past fifty years will be exceedingly small compared with what can occur with unbridled central bank control.
In such an environment, gold’s status as a reserve of value would be unequalled.
There are more reasons why a central bank might buy gold.
Central banks need gold because they may be preparing for an unprecedented period of monetary devastation.
The Financial Times claims that central banks are already suffering significant losses as a result of the falling value of the bonds they hold on their balance sheets. By the end of the second quarter of 2022, the Federal Reserve had lost $720 billion while the Bank of England had lost £200 billion. The European Central Bank is currently having its finances reviewed, and it is predicted that it will also incur significant losses. The European Central Bank, the US Federal Reserve, the Bank of England, the Swiss National Bank, and the Australian central bank all “now face possible losses of more than $1 trillion altogether, as once-profitable bonds morph into liabilities,” according to Reuters.
If a central bank experiences a loss, it can fill the gap by using any available reserves from prior years or by requesting help from other central banks. Similar to a commercial bank, it may experience significant difficulties; nevertheless, a central bank has the option of turning to governments as a last resort. This implies that the hole will be paid for by taxpayers, and the costs are astronomical.
The wave of monetary destruction that could result from a new record in global debt, enormous losses in the central bank’s assets, and the issuance of digital currencies finds only one true safe haven with centuries of proven status as a reserve of value: Gold. This is because central banks are aware that governments are not cutting deficit spending.
These numbers highlight the enormous issue brought on by the recent overuse of quantitative easing. Because they were unaware of the reality of issuer solvency, central banks switched from purchasing low-risk assets at attractive prices to purchasing any sovereign bond at any price.
Why do central banks increase their gold purchases just as losses appear on their balance sheets? To increase their reserve level, lessen losses, and foresee how newly created digital currencies may affect inflation. Since buying European or North American sovereign bonds doesn’t lower the risk of losing money if inflation stays high, it is very likely that the only real option if to buy more gold.
The central banks of industrialized nations will make an effort to shrink their balance sheets in order to fight inflation, but they will also discover that the assets they own are continuing to depreciate in value. A central bank that is losing money cannot immediately expand its balance sheet or buy more sovereign bonds. A liquidity trap has been set. Quantitative easing and low interest rates are necessary for higher asset values, but further liquidity and financial restraint may prolong inflationary pressures, which would then increase pressure on asset prices.
The idea that printing money wouldn’t lead to inflation served as the foundation for the monetary mirage. The evidence to the contrary now demonstrates that central banks are faced with a serious challenge: they are unable to sustain multiple expansion and asset price inflation, lower consumer prices, and fund government deficit spending at the same time.
So, why do they buy gold? Because a new paradigm in policy will unavoidably emerge as a result of the disastrous economic and monetary effects of years of excessive easing, and neither our real earnings nor our deposit savings benefit from that. When given the choice between “sound money” and “financial repression,” governments have forced central banks to choose “financial repression.”
The only reason central banks buy gold is to protect their balance sheets from their own monetary destruction programs; they have no choice but to do so.
About the Author:
Daniel Lacalle, Ph.D., economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and Life in the Financial Markets (2014).
Daniel is a professor of global economy at IE Business School in Madrid.
With a Light Week Ahead for Economic Reports, Investors Eye Big-Tech Earnings
In contrast to recent weeks, which began quietly as investors waited on late-week releases (i.e.: inflation, Beige Book, Fed announcements, etc.) before getting involved, this week is relatively quiet for economic reports. With less to be concerned about undermining any new positions, early week activity, without a holiday, may help increase volume. The scarcity of economic numbers could also cause more attention to be paid to earnings reports. This coming week we’ll receive a slew of big tech companies reporting. Disappointment may cause tech, which is showing signs of life early in 2023, to fall behind again. Whereas surprises on the upside could help unwind some of last year’s dismal big tech performance. Small Cap stocks, for their part, are keeping pace with the Nasdaq 100 mega stocks.
Earnings of both small-caps and mega-caps this week may produce a clear front-running segment based on capitalization.
There’s a Fed meeting next week. While the consensus seems to be for a 25 bp hike, Fed governors have been clear in recent addresses that the tightening cycle is not over. The PCE number late this week is considered the Fed’s favorite inflation gauge. There are no scheduled addresses by Fed regional presidents leading up to the two-day meeting that concludes on February 1.
Monday 1/23
8:30 AM ET The index of leading economic indicators, which has been in steep decline (dropped a full 1.0 percent in November), is expected to have fallen a further 0.7 percent in December. The index of leading economic indicators is a composite of 10 forward-looking components, including building permits, new factory orders, stock market performance, and unemployment claims. As such, estimates pre-report tend to be very close to the actual number. The report attempts to predict general economic conditions six months out.
Tuesday 1/24
9:45 AM ET, The Purchasing Managers Index (PMI) has been drifting down further into contraction – no relief is expected for January. Manufacturing is seen at 46.5 with services at 45.5.
Wednesday 1/25
7:00 AM ET, the Mortgage Bankers’ Association (MBA) compiles various mortgage loan indexes. The purchase applications index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction. The composite index is expected to come in at 27.9%, while the Purchase applications are expected to show a reading of 24.7%. The data provides a gauge of not only the demand for housing but economic momentum.
Thursday 1/26
8:30 AM ET, Forecasters see Durable Goods Orders rebounding 2.8 percent in December, which would more than reverse November’s steep 2.1 percent decline. Yet the gain is seen concentrated in aircraft as both ex-transportation and core capital goods orders are seen falling 0.2 percent.
8:30 AM ET, Gross Domestic Product, or GDP for the fourth quarter is expected to have slowed to a 2.7% annualized growth versus third-quarter growth of 3.2%. Positive growth would indicate that the economy is not in a recession.
8:30 AM ET, Jobless Claims are a weekly report. For the January 21 week, it is expected to come in at 202,000 versus a very low 190,000 in the prior week. The Fed focuses on jobs; the very strong numbers (low) suggest the Fed has room to tighten without being overly disruptive to job creation. Also, a tight labor market can be viewed as inflationary.
10:00 AM ET, New Home Sales in December are expected to revert to the downward trend at a 614,000 annualized rate versus November’s 640,000. Higher home sales reverberate throughout the economy in terms of spending and growth.
Friday 1/27
• 8:30 AM ET, Personal Income is expected to have increased a monthly 0.2 percent higher in December, with consumption expenditures expected to have decreased 0.1 percent. These would compare with respective November gains of 0.4 and 0.1 percent.
The PCE inflation readings for December, which are part of the PI numbers, are expected to show no change overall and up 0.3 percent for the core (versus respective gains of 0.1 and 0.2 percent) for annual rates of 5.0 and 4.4 percent (versus November’s 5.5 and 4.7 percent).
What Else
The Federal Reserve is very likely through most of its overnight Fed Funds tightening cycle. Japan, which had gone through decades of having a deflation problem, is now experiencing the highest inflation in 41 years. The Bank of Japan has not adopted the aggressively hawkish monetary policy that the US has. The US central bank, chaired by Jerome Powell, must be looking on and holding his stated opinion that he’d rather do too much tightening than too little.
Extraordinary Measures as Outlined by US Treasurer Janet Yellen
There’s no doubt, the US Secretary of the Treasury, Janet Yellen, has been working overtime to provide an austerity plan as the US debt ceiling has just been reached. In the absence of the legal ability to sell debt in excess of the current outstanding, going to the bond markets and issuing Treasury Bills/Notes/Bonds is off-limits to the US government. So what’s a Treasury Secretary to do? The government has bills and other liabilities that are coming due, and today’s higher interest rates create a larger discount and nets less for the Treasury when rolling over some securities. This can be very problematic if the US stops paying bills on time or if there is a risk of default on debt; the US dollar can tumble, interest rates can skyrocket, and faith in our economic engine can unravel. You can imagine what this has the potential to do to equity markets.
In a letter, Yellen wrote to Congress dated January 19, she outlines the Treasury Department’s contingency plan, while Congress is expected to develop its own more permanent financial solution.
In the letter, she says the Treasury will cease adding to the Civil Service Retirement and Disability Fund (CSRDF) for those values not currently required to pay beneficiaries. Under ongoing business practices the CSRDF invests in special-issue Treasury securities specifically for its use. These securities count against the debt limit.
Similarly, the Postal Accountability and Enhancement Act of 2006 provides that investments in the Postal Service Retiree Health Benefits Fund (PSRHBF) are made in the same manner as investments for the CSRDF. The treasury will suspend additional investments of amounts credited to the PSRHBF.
It is expected that the CSRDF and the PSRHBF will be made whole as part of the eventual solution.
She ends the letter by urging Congress to act swiftly as her measures will not provide a solution beyond late Spring.
Letter Dated January 19, 2023
Take Away
When the US bumps up against its debt limit it creates many problems. From a macro approach, if they raise the debt limit automatically may only serve to kick the spending can down the road. To have no upper limit long term can come back to hurt the US dollar and those that use it for purchases. Creating a strict upper limit serves to provide fiscal restraint but may stand in the way of economic stimulation. A government with its spending hands tied may find it problematic in times of war or other crises.
As the Secretary of the Treasury postpones payments or debt issuance, this has in the past not saved money, it has only delayed acquiring it through borrowing.
Depending on how intense the game of chicken becomes in the halls of Congress, the debt, equity, and Forex markets could become tumultuous.
