Equity markets wrapped up a volatile quarter with a volatile week as each major market index posted strong gains to end the week. The S&P 500 Index led the markets higher last week, notching a +3.48% gain, followed by the NASDAQ with a +3.37% gain, and finally, the Dow Jones Industrial Average returning +3.22% for the week ending March 31, 2023. These gains, coupled with gains thus far in 2023, pushed all three indexes into positive territory for the year’s first quarter (see year-to-date returns below). The weakness in markets spurned by the short-lived regional bank crisis was offset by investor beliefs that the Fed is finally winding down its aggressive interest rate hiking cycle, and the Fed will announce a long-awaited pause or pivot in interest movements at the May 2023 FOMC (Federal Open Markets Committee) Meeting. Interest rate expectations moved the 10-year US Treasury bond lower by 10 basis points, ending the week at 3.47%. Recall, as recently as October 2022, the 10-year US Treasury was trading at 4.24%, fully 77 basis points higher than today, see Chart 1 below.

US Economy

As mentioned above, US Treasury bonds have moved sharply lower in yield since the recent peak in rates in October 2022. Chart 1 below by Valley National Financial Advisors and Y Charts showing the current 10-year US Treasury bond yield and the current Fed Funds Target Rate). The chart shows the dramatic rise in the Fed Funds Rate (the interest rate at which depository institutions trade balances to each other overnight) as the FOMC has moved interest rates higher to combat inflation. While initially moving higher, long-term rates have tapered off and dropped, indicating that the markets are pricing to this current interest rate cycle. The equity markets are efficiently reading this Fed pivot and reacting accordingly – in the current case, by rallying in 2023.

While the markets appear to have moved beyond the recent regional banking crisis, we do not want to ignore other issues showing weakness in 2023 which could again put pressure on banks. Many companies in the U.S. and globally have begun to require a full-time return to work rather than work from home. Office vacancy rates remain elevated compared with pre-pandemic levels; see Chart 2 below from the National Association of Realtors. Like commercial loans, most commercial real estate loans are held by regional banks, and until office vacancy rates recede, pressure will remain on this banking sector. Furthermore, local economies rely on regional bank activities for growth and expansion.

Policy and Politics

Clearly, all is not well in Washington, and a media firestorm is about to unfold with former US President Trump being indicted. Some may argue that a distracted Washington is good for the markets and the economy as lawmakers are too busy making noise to impart new restrictive or harmful laws; lawmakers can stay out of the way and let the economy do its own thing. A returning calm in the markets can be seen from the VIX (The Volatility Index), which measures the implied expected volatility of the US Stock Market. See Chart 3 below from Valley National Financial Advisors and Y Charts showing the VIX. After a recent spike in the VIX due to the failures of Silicon Valley Bank and Signature Bank, the VIX has fallen back to recent pre-bank crisis levels.

What to Watch

• Monday, April 3^rd
  • U.S. Retail Gas Price at 4:30PM (Prior: $3.533/gal.)

• Tuesday, April 4^th
  • U.S. Job Openings: Total Nonfarm at 10:00AM (Prior: 10.82M)

• Wednesday, April 5^th
  • ADP Employment Change at 8:15AM (Prior: 242,000)
  • ADP Median Pay YoY (Year Over Year) at 8:15AM (Prior: 7.20%)

• Thursday, April 6^th
  • U.S. Initial Claims for Unemployment Insurance at 8:30AM (Prior: 198,000)
  • 30-Year Mortgage Rate at 12:00PM (Prior: 6.32%)

• Friday, April 7^th
  • U.S. Labor Participation Rate at 8:30AM (Prior: 62.50%)
  • U.S. Nonfarm Payrolls MoM at 8:30AM (Prior: 311.00K)
  • U.S. Unemployment Rate at 8:30AM (Prior: 3.60%)

World famous British Economist John Maynard Keynes said in 1930, “Markets can remain irrational longer than you can remain solvent.” This was a sly way of saying that timing the markets is a fool’s errand. We at VNFA, and others, say that it is “time in the markets rather than timing the markets” that creates true generational wealth. There is always a lot to digest when watching the financial markets. Bulls and Bears exist on both sides of a trade. We remain cautiously optimistic about market returns for 2023 and believe the Fed can moderate inflation without tanking the economy. Opportunities exist for investors, but volatility, while quiet today, could return in short order. Speak with your financial professionals at Valley National Financial Advisors for assistance.

Equity markets this past week seem to be moving on from the tumult caused by some regional banks earlier this month. The Dow Jones increased 1.18%, the S&P up 1.39%, and the NASDAQ 1.66%. Fixed income markets have also continued to rally this past week, with 2-year and 10-year yields moving lower by 16 and 9 basis points, respectively, indicating a continued flight to quality amid concerns over regional banks. Additionally, the Federal Reserve decided unanimously to raise rates by 25 basis points last week, keeping on track with the prior hike in February and slowing from the 50-basis point hike in December. In general, we believe the Fed is in a tough position between balancing actions in response to regional bank failures, targeting price stability, and quelling inflation. Congress will also discuss activity surrounding the banking sector and how to prevent such failures in the future. At the time of this writing, First Citizen Bancshares, Inc., a Raleigh, NC bank holding company, agreed to acquire Silicon Valley Bank, including $56 billion in deposits and $72 billion in loans.

Global Economy

As mentioned, the Federal Reserve raised rates by a quarter-percentage point last week on March 22nd, marking the ninth time in a row that they have hiked. This brings the Fed Funds range between 4.75% and 5.00%. Members of the Fed’s rate-setting committee have made it clear that they believe higher rates will be necessary to quell inflation. Policymakers are anticipating another 25-basis point hike by the end of the year. This hike comes after calls for a pause due to the collapse of both Silicon Valley Bank and Signature Bank earlier this month. However, Treasury Secretary Yellen has implied that these pressures have eased, and large withdrawals have “stabilized.” Chart 1 below of the Federal Funds Rate since 1994 shows that current rates are still a way off from their peak of 6.50% in mid-2000.

The House and Senate committees that oversee banking are holding back-to-back hearings this week to examine regulatory lapses that contributed to the failing of Silicon Valley Bank and Signature Bank. Those testifying at the hearing include Federal Deposit Insurance Corporation Chairman Martin Gruenberg, Federal Reserve Vice Chair for Supervision Michael Barr, and the Treasury Undersecretary for Domestic Finance Nellie Lang. These hearings aim to try to understand what caused the two banks to fail, as well as contain further damage to the economy and reinforce confidence in the banking system. However, there will also be a discussion about whether tighter banking sector regulations are necessary. Keep in mind that, at the time of its failure, 94% of Silicon Valley Bank’s deposits sat above the FDIC’s $250,000 limit, which will likely become a point of scrutiny in these hearings.

What to Watch

• Monday, March 27^th
  • U.S. Retail Gas Price at 4:30PM (Prior: $3.534/gal.)

• Tuesday, March 28^th
  • Case-Shiller Composite 20 Home Price Index YoY at 9:00AM (Prior: 4.66%)
  • Case-Shiller Home Price Index: National at 9:00AM (Prior: 297.08)

• Wednesday, March 29^th
  • U.S. Pending Home Sales MoM at 10:00AM (Prior: 8.13%)
  • U.S. Pending Home Sales YoY at 10:00AM (Prior: -24.10%)

• Thursday, March 30^th
  • U.S. Gross Domestic Purchases Price Index QoQ at 8:30AM (Prior: 3.60%)
  • U.S. Initial Claims for Unemployment Insurance at 8:30AM (Prior: 191,000)
  • U.S. Real GDP (Gross Domestic Product) QoQ at 8:30AM (Prior: 2.70%)
  • US Total Vehicle Sales at 10:30AM (Prior: 16.20M)
  • 30-Year Mortgage Rate at 12:00PM (Prior: 6.42%)

• Friday, March 31^st
  • U.S. Core PCE (Personal Consumption Expenditures) Price Index MoM at 8:30AM (Prior: 0.60%)
  • U.S. Core PCE Price Index YoY at 8:30AM (Prior: 4.71%)
  • U.S. PCE Price Index YoY at 8:30AM (Prior: 5.38%)
  • U.S. Personal Income MoM at 8:30AM (Prior: 0.58%)
  • U.S. Personal Spending MoM at 8:30AM (Prior: 1.76%)
  • U.S. Index of Consumer Sentiment at 10:00AM (Prior: 63.40)
  • U.S. Crude Oil Production at 3:30PM (Prior: 375.14M bbl.)

The fallout from Silicon Valley Bank and Signature Bank’s failures is under control as the Federal Reserve and Congress act to understand and contain it. The Fed is committed to raising rates as it sees necessary to continue fighting inflation despite banking issues, but we believe that they are nearing the end of their hikes before a pause to digest data. The outcome of the upcoming congressional hearings is top of mind—will Congress reenact some of the changes made to Dodd-Frank in 2018? Despite all of this, we still believe in staying the course when it comes to investing. Trying to time the market means you must be correct at two points: first when you exit the market, and second when you attempt to reenter the market. Please reach out to your financial professional at Valley National Financial Advisors.

Equity markets posted mixed results last week as issues surrounding U.S. Regional Banks continued to roil investors. Further, Swiss banking giant Credit Suisse, beleaguered for decades, finally found a merger partner in fellow Swiss Bank UBS. While seemingly good news on the surface, investors took this news as more of a “canary in a coal mine” signal that further unwelcome news could follow in the banking sector. As a result, there was a large flight to quality trade as investors scooped up U.S. Treasury Bonds. By week’s end, the bellwether 10-year U.S. Treasury Bond had moved lower by 16 basis points to close the week at 3.39%. Just three short weeks ago, the rate on the 10-year U.S. Treasury was 4.06%. Last week, the Dow Jones Industrial Average returned -0.15%, the S&P 500 Index moved higher by +1.43%, and finally, the NASDAQ rallied higher by +4.41%. 

It will take some time for 2022’s interest rate tightening to be completely felt in the economy, but the direction is correct – lower inflation. The Federal Open Market Committee meets this week. Several Wall Street analysts are calling for a pause in further rate hikes, given the recent inflation reports and the continued economic uncertainty surrounding the banking sector. While Fed Fund Futures are still pricing in a +0.25% rate hike this week, we at VNFA certainly believe a pause is more appropriate.

Policy and Politics 

Several factions in the U.S. House and the U.S. Senate call for the Federal Deposit Insurance Corporation to guarantee all deposits at U.S. Depository Institutions (banks, savings and loan associations, and credit unions) rather than only to the current limit of $250,000. A change in the FDIC limit would require an act of Congress, which is possible should a crisis in confidence in the banking sector continue.

 What to Watch 

• Monday, March 20^th  
• U.S. Retail Gas Price at 4:30PM (Prior: $3.568/gal.).

• Tuesday, March 21^st  
• U.S. Existing Home Sales at 10:00AM (Prior: 4.00M).
• U.S. Job Openings: Total Nonfarm at 10:00AM (Prior: 10.82M).

• Wednesday, March 22^nd  
• Target Federal Funds Rate Upper Limit at 2:30PM (Prior: 4.75%).

• Thursday, March 23^rd  
• U.S. New Single-Family Houses Sold at 10:00AM (Prior: 670.00K).
• 30-Year Mortgage Rate at 12:00PM (Prior: 6.60%).

Wall Street insiders, executives, regulators, and lawmakers have managed to quell the current banking problem, which thus far has been limited to very few banks specifically catering to the technology and crypto world. Banks remain very well capitalized, especially compared to the 2008-08 Global Financial Crisis, see Chart 2 below from the FDIC & Bloomberg. Contagion is a tricky beast, and the markets need to see just the right amount of government and private intervention before taking a directional turn. We remain cautiously optimistic about the equity and fixed-income markets for 2023. Watch for cues from Chairman Powell this week on whether we get a pivot in policy this year. 

Despite last week’s dramatic sell-off across all equity market sectors, the –4.55% drop in the S&P 500 Index fails to tell the week’s full story. The Dow Jones Industrial Average was down –4.44%, and the NASDAQ fell –4.71%, in concert with the broader S&P 500 Index. The stock market’s decline directly implied strong jobs data released Friday and very hawkish comments made by Fed Chairman Jay Powell earlier in the week during his congressional testimony. By the end of the week, Silicon Valley Bank, a bank catering to tech start-ups, was on the brink of failure due to losses on bond reserve holdings, customer withdrawals, and shrinking liquidity. The FDIC seized Silicon Valley Bank, and by late Sunday evening, a new Fed liquidity facility was created and announced that depositors at Silicon Valley Bank would be made whole. We will discuss each of these events below. Meanwhile, in a massive flight-to-quality move, the 10-year US Treasury fell 28 basis points to close the week at 3.70%. 

US Economy 

Fed Chairman Jay Powell testified to congress for two days, first to the U.S. House of Representatives and secondly to the U.S. Senate. Chair Powell was adamant about his objectives to quell still hot-running inflation at these hearings. This message was factored into the markets and moved expectations on further Fed interest rate hikes to moves in the +0.50 – 0.75% at the March 21-22 meeting next week. As expected, markets reacted negatively to even higher than previously expected interest rates as higher rates increase funding costs, slow the economy, and increase the overall cost of expansion for corporations. This turn of events was a solid negative for markets, but the unwelcome news continued.

• As mentioned above, last week Silicon Valley Bank, the so-called one-stop shop for technology start-ups in the U.S., failed as losses on its bond holdings created a liquidity crisis as depositors lined up to withdraw funds created an old-fashioned “run-on-the-bank.” Following this collapse, another tech-central bank, Signature Bank, also failed. These bank failures, while small by bank standards, prompted the Fed, the FDIC, and bank regulators to:
  • Seize Silicon Valley Bank and Signature Bank
  • Label Silicon Valley Bank and Signature Bank as new “Systemic Institutions.”
  • Guarantee depositors’ access to their accounts, even those over the $250,000 FDIC limit.
  • Create a new Bank Term Funding Program, which will provide liquidity to U.S. depository institutions by allowing them to pledge U.S. Treasury securities to the facility as collateral at PAR value. (This move by the government negates current book losses on U.S. Treasury holdings of banks and provides needed liquidity.)
  • This special Bank Funding program smooths/negates the duration risk that bank bond portfolios had as their holdings have lost money due to the rise of interest rates over the past year (remember, as interest rates rise, bond prices fall).

• Certainly, these actions by the Fed and FDIC have stabilized the current issue impacting the banking sectors. These bank failures, again small by bank standards (Silicon Valley Bank assets were ~$200 billion compared to JP Morgan Chase assets ~ $2.6 trillion), point to a crack in the technology start-up funding world. Technology start-ups and start-up companies provide new jobs across all markets; funding these ideas is critical to their success until a replacement to funding institutions like Silicon Valley Bank are found, whether venture capital, private equity, or large banks like JP Morgan or Wells Fargo. This nascent industry will face headwinds. 

Policy and Politics 

There will be a lot of naysaying and gnashing of teeth this week in Washington as regulators, Fed officials, and Law Makers clash and cross-blame each other for 1) allowing banks to fail at all and 2) permitting yet another bailout by the Fed of another financial institution.

What to Watch 

• U.S. Core Consumer Price Index YoY for February 2023, released 3/14/2023, (prior 5.55%).
• U.S. Inflation Rate for February 2023, released 3/14/2023, (prior 6.41%).
• U.S. Core Producer Price Index YoY for February 2023, released 3/15/2023, (prior 5.37%).
• U.S. Building Permits for February 2023, released 3/16/2023, (prior 1.339M). 
• U.S. Index of Consumer Sentiment for March 2023, released 3/17/23 (prior 67.00).

A massive batch of economic data is on deck for this week. Early in the week, important inflation information will be released, which will help gauge whether the Fed is impacting hard-hitting inflation that continues to hurt businesses and consumers. Mid-week building permits will add information about the housing industry and whether a spring bounce is on deck. Lastly, we will see how consumers feel as U.S. Sentiment for March 2023 is released.

In a conversation with our Founder and Chairman, Tom Riddle, over the weekend, we called on his previous experience as a bank examiner working for the U.S. Treasury Department. Tom recalled his methods for judging a bank’s health, “One does not only look at a bank’s balance sheet. A far more accurate reading is to evaluate a bank’s growth, or decline, of its net interest income.” “By this measure, banks we invest with at Valley National Financial Advisors are not those with declining or poor net interest income. However, Silicon Valley Bank would have been on such a list.” Tom continued, “banks with poor net interest income growth exhibit very unusual balance sheet characteristics such that they are lending money and offering deposit rates at levels that are higher than their investment returns.” Tom closed with, “It is a stressful time for banks that have ventured away from traditional banking.”

• Looking beyond the Silicon Valley Bank meltdown, we have a busy week ahead with economic data, regulators, and lawmakers all helping to navigate the markets. The Fed may use this issue to slow or halt further interest rates, but inflation will need to continue to cool for this to happen. Meanwhile, corporate America is experiencing an unexpected earnings tailwind from cost cutting, supply chain stabilization, a declining dollar, and increased demand from China. Don’t hesitate to contact your financial advisor at Valley National Financial Advisors for help or guidance.

Despite U.S. Treasury Bond yields moving higher, equities notched a solid gain last week as all major indexes ended the week higher, with the Dow Jones Industrial Average rallying +1.75%, the S&P 500 Index moving up +1.90%, and the NASDAQ increasing by 2.58%. The 10-year U.S. Treasury Bond, after briefly touching 4.00% mid-week, closed the week at 3.97%. Oddly, even with higher bond yields, the VIX (Volatility Index, the CBOE Measurement of Expected Volatility) moved lower (18.49) and is down from its October high (33.63) (Chart 3). Further, Fed Fund Futures point to higher short-term rates and a higher terminal rate for Fed Funds rate around 5.25% (Chart 1). Lastly, corporate EPS (Earnings Per Share) releases for the 4th Q 2022 are over, and most were moderately higher even after many analysts projected lower EPS. After the 1st Q 2023 closes, markets will get fresh evidence of economic activity.  

US Economy 

Most inflation indicators are moving lower, and markets continue to point to higher short-term interest rates and a higher terminal rate for the Fed Funds Rate. Chart 1 below by the Federal Reserve of St. Louis shows the current Fed Funds Effective Rate of 4.75%. The average of Fed Fund Futures is now predicting a terminal rate of 5.25 – 5.50% by December 2023. Considering how far and fast we have moved in interest rates—from ZERO last year to 4.75% one year later—why are markets reacting so negatively to, at most, +0.75% higher from here?

It has been and continues to be our opinion at VNFA that the U.S. Economy remains healthy and will be able to easily digest up to three additional +0.25% rate hikes over the next three FOCM meetings, ending the year near 5.25 – 5.50%. Notwithstanding the 1980s inflationary period, multiple GDP (Gross Domestic Product) expansions occurred when interest rates were high, but the economy continued to grow. 

 As mentioned above, bond yields continue to increase, especially in the short end of the yield curve (3 months to 2 years). Chart 2 below from Bloomberg shows generic bond yields, which continue to hit multi-year highs offering investors risk-free rates of return significantly higher than in previous years. The opportunity cost for staying out of equities and keeping safe on the sidelines by investing in short bonds (2-year yields ~5.00%) is much lower than in previous years when short rates were zero. However, we at VNFA want our investors to consider whether equity returns over the next two years will be higher than 5.00%. Given the information in front of us: bank health, labor markets, corporate earnings, and consumer spending, we believe investors still need equities in their portfolios to take advantage of future compounding returns. 

Markets continue to be volatile, which is expected and common during the Fed tightening interest rates because of the implied uncertainty. However, the VIX (Volatility Index, the CBOE Measurement of Expected Volatility) moves lower. Chart 3 below from the Valley National Financial Advisors and Y Charts shows the VIX Index. The VIX decreases when there is less demand for put options (options bought by investors predicting lower equity prices). The VIX moves inversely to equity prices. 

Global Economic Politics 

• The Russia/Ukraine war continues to muddle on without much hope for a cessation. Thankfully, a modest winter has helped EU countries avoid an economic disaster that could have happened given natural gas shortages due to the war. Sanctions on Russia have been de minimis as other countries such as China, and India has increased trade, replacing former western trading partners. 

• While finally coming out of zero-Covid lockdown, China has set the lowest GDP growth target in decades. Much can be said about China’s economic ambitions. Still, their new growth target of “only” 5% is telling, in that China may finally acknowledge the many issues, demographic among the most important, facing the country in the future.  

What to Watch 

• U.S. Job Openings: Total Nonfarm, for January ‘23, released 3/6/23, prior 11.01M.
• U.S.  Initial Claims for Unemployment Insurance week of 3/4/23, released 3/9/2023, prior 190K. 
• U.S. Nonfarm Payrolls MoM (Month Over Month) for February ‘23, released 3/10/23, prior 517K.
• U.S. Unemployment Rate for February 2023, released 3/10/23, prior 3.4%.

Equity markets and bond yields both ended higher last week. The Fed is on a course to reduce inflation to 2.00% while keeping full employment and a growing economy. This scenario would be considered an exceptionally soft landing and a tough one for Chairman Powell to “stick.” Every piece of the puzzle is known – higher rates, employment, economic growth. Short-term bond yields at 5.00% are incredibly enticing to investors still wounded from last year’s market wipe-out. However, wealth is gathered over exceptionally extended periods and is generational. Missing a few big days in the markets can make an enormous difference in portfolio returns, and market timing usually is a fool’s game. Stick to your investment plan and always look at the big picture rather than the minutia of daily market swings.

Equity markets performed poorly last week in anticipation of the release of the Federal Reserve minutes. The Dow ended lower -2.61%, the S&P down -2.94%, and the NASDAQ finished the week down -3.89%. News of an approximately 16% decrease in US Real GDP QoQ (down to 2.70% from 3.20%) and a significant increase in U.S. Core PCE MoM (up 0.60% from 0.40% previously) contributed to the weak performance of the market. Additionally, consumer debt rose to a record $16.9T, and OECD is becoming slightly more optimistic about its global outlook. 

Global Economy 

Consumer debt reached a record $16.9 trillion (with a T), up approximately $1.3T from the year prior. Much of this debt is held in mortgage loans, roughly $11.9T worth, despite the recent decline in originations which fell to $498 billion, less than half of 4Q21’s number and a drop of $135B from 3Q22. With this increase in debt comes an increase in delinquencies, rising to 0.57% for mortgages (more than double the year prior), 2.2% for the auto loan debt, and 4% for credit card debt. The below chart from the Federal Reserve Bank of New York shows the evolution of the Total Debt Balance over the last 20 years.

Chart 1: Total Debt Balance 

The OECD Secretary-General has mentioned a “slightly brighter” economic outlook for 2023 than previously thought while also acknowledging that inflation risks continue to remain elevated. The reasoning for this change in perspective is due to falling energy and food prices that are far below their peaks throughout the European Union. Additionally, the OECD made sure to highlight that China’s continual reopening is “overwhelmingly positive” for the global economy and its attempts at mitigating inflation. “Over the medium to longer term, this is very much a positive in terms of making sure that the supply chains function more efficiently and more effectively, making sure that demand in China and indeed trade more generally resumes in a more positive pattern,” he said during the World Economic Forum in Davos, Switzerland last month. The below chart from the IMF, published in January 2023, does a fantastic job of breaking down the global outlook by both Advanced and Developing economies.

Chart 2: Overview of World Economic Outlook Projections 

What to Watch 

• Monday, February 27^th 
  • U.S. Pending Home Sales YoY at 10:00AM (Prior: -33.76%) 
  • U.S. Retail Gas Price at 4:30PM (Prior: $3.494/gal.) 
• Tuesday, February 28^th 
  • Case-Shiller Composite 20 Home Price Index YoY at 9:00AM (Prior: 6.78%) 
  • Case-Shiller Home Price Index: National at 9:00AM (Prior: 298.11) 
  • U.S. Crude Oil Production at 3:30PM (Prior: 371.24M bbl.) 
• Wednesday, March 1^st 
  • U.S. Recession Probability at 11:00AM (Prior: 57.13%)
• Thursday, March 2^nd 
  • 30 Year Mortgage Rate at 12:00PM (Prior: 6.50%) 

Despite recent weak performance in the markets, global outlooks are beginning to become less negative. Note this does not necessarily mean a “stronger” economy. However, recession probability is on the decline (albeit slowly), and inflation is gradually but surely tempering, with interest rate increases being pushed to quicken the pace of adjustment. As mentioned, one of our more significant concerns here at VNFA is the current level of consumer debt. With inflation at its elevated level and the end of a “free money” environment, we expect consumers to pull back on their spending. Still, the opposite seems to be occurring, and delinquencies are rising. We still believe the economy is better than many others seem to believe, but we are willing to acknowledge areas of concern that may affect our outlook as we advance. 

Equity market returns were mixed last week ahead of the President’s Day Holiday weekend, with the NASDAQ posting a modest gain of +0.59%. The S&P 500 Index moved lower by –0.28%, and the Dow Jones Industrial Average lost –0.28%. Mixed signals from the economy continue to foil investors and Wall Street Economists. Last week, we saw continued decreases in inflation indicators as measured by the U.S. Consumer Price Index and the U.S. Core Consumer Price Index. This tells the story the Fed is looking for: a slowing economy and inflation. However, behind that data release, the U.S. Retail Sales report (remember, ~70% of the U.S. Economy is consumer driven) came in higher-than-expected, hinting that the economy is still running at full steam. Overnight, economists moved over to our ongoing thesis here at VNFA, that a recession in 2023 is less likely.

US Economy 

As mentioned above, last week showed us that the U.S. Economy continues to hum along nicely, with solid retail sales data proving that the consumer is not backing down and continues spending. Chart 1 below from the Federal Reserve Bank of St. Louis shows U.S. Retail Sales. Advanced Retail Sales (Trade & Services) increased by 3.0% in January 2023 versus a decline the prior month of –1.1%. This unexpected increase in consumer activity shows that not only is the U.S. Consumer remaining resilient, but they are also not concerned very much about the future economy to curtail their spending.

Chart 2 below from Valley National Financial Advisors and Y Charts shows U.S. Consumer Price Index and U.S. Core Consumer Price Index. As can be seen in Chart 1, inflation continues to cool as it had been doing since the 9% peak rate in June 2022. However, the pace of the slowing is what concerns the Fed. Fed Chairman Jay Powell would like to see inflation hit its target rate of 2%, as we all would, but it is taking longer, and more rate hikes will be needed. Futures markets are now pricing in a 50% chance of a June rate hike of +0.25%, which would be on top of +0.25% rate hikes at the March and May 2023 FOMC (Federal Open Market Committee) meetings. While concerning to us that further rate hikes are needed, we also believe that the economy continues to be strong enough to sustain higher interest rates and still grow at a modest pace, and the markets all seem to agree.

Policy and Politics 

The Great China “Re-opening” of 2023 gives foreign markets reasons to hope that a pent-up, Covid-lockdown, Chinese consumer is about to unleash their spending on the global economy and fuel a solid rebound in economic activity. The Russia / Ukraine War rages on with neither side capitulating. U.S. President Biden’s surprise visit to Ukraine on February 20 pointed to symbolic support from the U.S., and a $500 million check from the U.S. offered real support. As spring comes into focus, the war could hurt global food supplies (Ukraine) and fertilizer (Russia). Lastly, instability in South America with regional democratic powerhouses such as Argentina always offers us a little worry and uncertainty.

What to Watch 

• Tuesday, February 21^st  
  • Existing Home Sales at 10:00 AM (Prior: 4.02M) 
  • Existing Home Sales MoM (Month Over Month) at 10:00 AM (Prior: -1.47%) 
  • Retail Gas Price at 4:30 PM (Prior: $3.502/gal.) 
• Thursday, February 23^rd  
  • Real GDP (Gross Domestic Product) QoQ at 8:30 AM (Prior: 2.90%) 
  • Total Vehicle Sales at 10:30 AM (Prior: 16.20M) 
  • 30 Year Mortgage Rate at 12:00 PM (Prior: 6.32%) 
• Friday, February 24^th  
  • Core PCE Price Index YoY at 8:30 AM (Prior: 4.42%) 
  • PCE Price Index YoY at 8:30 AM (Prior: 5.02%) 
  • Personal Income MoM at 8:30 AM (Prior: 0.22%) 
  • Personal Spending MoM at 8:30 AM (Prior: -0.23%) 
  • Index of Consumer Sentiment at 10:00 AM (Prior: 66.40) 

The Federal Reserve and Chairman Powell are on a mission to combat inflation with a target of 2%. Chart 2 above shows the progress the Fed has made thus far. A slowing pace in this regard simply puts more rate hikes on the horizon. Solid labor growth, falling unemployment, increasing consumer activity, and corporate “belt-tightening” show us that the U.S. economy remains healthy and will power through the current rate-hiking cycle. Further, a brief look at the equity and bond markets year-to-date shows that they are living up to their function as wonderful future economic indicators. Chart 3 below from Valley National Financial Advisors shows all three major equity market indicators and the iShares Core U.S. AGG Bond ETF. Year-to-date, each indicator is modestly higher, with the tech-heavy NASDAQ topping them all at +12.6%.

Equity markets moved slightly lower last week, with the Dow Jones Industrial Average down -0.17%, S&P 500 down -1.11%, and NASDAQ down -2.41%. On the other hand, mortgage rates have plateaued at approximately the 6% level, posting a slight average increase to 6.12% from 6.09%. Additionally, consumer sentiment increased slightly to 66.40, from 64.90—a 2.3% change from prior and up over 5% from this time last year. Pending the inflation numbers coming this week (currently 6.45%), the data could be painting the picture of an improving economy. As mentioned last week, this comes on the back of shockingly positive job numbers and the lowest unemployment rate in over 50 years. The Federal Reserve is sure to be weighing these data points heavily as it plans for the future of this tightening cycle. 

Global Economy 

China has begun its reopening process and is doing so at a much faster pace than anticipated, causing some analysts to forecast a 6.5% GDP growth rate for the country in 2023. There are three core pillars of China’s reopening and its impact on the rest of the world. First, there is likely to be an increase in domestic demand, causing an increase in core goods exports from China’s foreign trade partners. Secondly, China’s rescission of the zero-Covid policies that have been in effect for the last three years will allow for a significant increase in travel to and from the country. Finally, commodity demand and prices may rise, especially for oil, and help to lift other net exporters up during potentially rough economic times. 

Based on the recent Wall Street Journal survey of recession expectations, firm economists forecast a median recession probability of 65%. However, the range of predictions is incredibly vast, as seen in the chart below. The thesis for those forecasting a lower-than-median recession probability is that labor markets continue to show signs of strength, and GDP growth is expected to increase beginning in the spring. However, it is worth noting that the rebalancing of the labor market is far from complete, although it is, in fact, on its way there, as indicated by the pullback in wage growth. 

What to Watch 

• Monday, February 13^th 
  • U.S. Retail Gas Price at 4:30PM (Prior: $3.552/gallon) 
• Tuesday, February 14^th 
  • U.S. Consumer Price Index MoM at 8:30AM (Prior: -0.08%) 
  • U.S. Inflation Rate at 8:30AM (Prior: 6.45%) 
• Wednesday, February 15^th 
  • U.S. Job Openings: Total Nonfarm at 10:00AM (Prior: 11.01M) 
• Thursday, February 15^th 
  • U.S. Housing Starts MoM at 8:30AM (Prior: -1.36%) 
  • 30 Year Mortgage Rate at 12:00PM (Prior: 6.12%) 

Equity markets posted mixed results last week with the NASDAQ leading the pack at +3.3%, the S&P 500 Index taking up second place at +1.6% and the Dow Jones Industrial Average cleaning up the rear at –0.15%. The FOMC (Federal Open Markets Committee) raised rates on Wednesday by +0.25%, the lowest increase in several meetings and investors took that action as a dovish move by Fed Chairman Jay Powell, meaning the Fed’s aggressive rate hiking is ending. However, by week’s end a case of “Good News” is “Bad News” hit the markets with the Nonfarm payrolls number blasting all Wall Street Economists’ estimates and coming in at +517,000 new jobs vs. estimates at +260,000. Further, the national U.S. Unemployment Rate fell to 3.5%, the lowest in 53 years! These numbers may be telling Chairman Powell that, regardless of higher interest rates, the economy is still doing quite nicely even as inflation is cooling. 

Economy 

As mentioned above, the employment data continues to be strong, and unemployment continues to fall. Chart 1 below from Valley National Financial Advisors and Y Charts showing the U.S. Unemployment Rate 1940-2023.

We have a 53-year low in the unemployment rate. This is at a time when the tech sector (e.g., Microsoft, Google, Facebook) is shedding jobs each week, announcing layoffs for the very first time in many of these companies. Oddly, these layoffs are not showing up in the data, which is most likely because an engineer or coder is immediately re-employable, especially in an economy with 11 million job openings, Chart 2 below from Valley National Financial Advisors and Y Charts showing the U.S. Job Openings.

What is puzzling to us at VNFA is the conflicting behavior of the markets. Historically, low unemployment, coupled with many job openings and lumped together with healthy banks, corporations, and consumers, would be good news for the markets. Still, the markets are only focused on the Fed and its fight against inflation. As we showed last week, we have seen inflation impacted by higher rates with falling Personal Consumption Expenditures over the past three months. However, the Fed is also watching employment, which, as noted above, is still strong and growing, telling us the economy is not slowing down. A slowing economy slows inflation, which is the Fed’s objective again.

Policy and Politics

The United States could certainly be a stand-alone, insular economy providing goods and services within the confines of our geographic region. Add in Canada, Mexico, and the North American region is a global powerhouse. However, it is neither practical nor realistic to think of economics and markets as regionally insolated. That said, there continue to be serious global pressures on markets. Not the least of which is China/U.S. trade policy, impacted as recently as last week when the U.S. shot down a Chinese “Spy Balloon” just off the coast of South Carolina. NO! This is not from a Jack Ryan spy novel; this happened. Further, the Russia/UK war is heating up rather than cooling down. Uncertainty prevails, and markets hate uncertainty, as we have repeatedly said.

What to Watch 

• U.S. Initial Claims for Unemployment Insurance, week of Feb 4, release 2/9/23 (prior +183,000).
• U.S. Index of Consumer Sentiment for Feb 2023, released 2/10/23 (prior 64.90).

Equity markets are up year-to-date, with the NASDAQ leading the way at +14.8%, the S&P 500 Index up +7.9%, and the Dow Jones Industrial Average at +2.4%. Bonds, as measured by the Bloomberg U.S. Aggregate Index, are up +3.0% year-to-date, and bonds are finally paying a yield. The 2-year U.S. Treasury Note is currently yielding 4.30%, and the benchmark 10-year U.S. Treasury yields 3.53%. Uncertainty continues, especially regarding international tensions and conflict, but the U.S. economy continues to hum along nicely despite the Fed’s attempt to slow the economy and fight inflation. Inflation is falling, and jobs are plentiful; that is what the markets see. Wealth is created over generations, not by inefficient trading on rumors and conjecture. Stay focused on your objectives and reach out to your advisors at Valley National for assistance.

Economists may be predicting a recession in 2023. Still, the markets are certainly telegraphing a different story as last week’s returns marked the 4th week in a row for positive returns across all three major market indexes, with the NASDAQ leading the way, notching an additional +4.3% for the week and sitting at +11.0% so far in 2023. On a year-to-date basis, the Dow Jones Industrial Average is up +2.5%, while the broader S&P 500 Index is up +6.0% thus far in 2023. The markets are focused on three converging events: the Fed wrapping up its aggressive rate hiking policy, inflation finally showing signs of coming down, and a labor market that, despite continued announcements of layoffs, shows no signs of cooling.

Global Economy 

As mentioned above, one item where Wall Street economists, strategists, and portfolio managers agree is that the Fed is near the end of its aggressive rate-hiking strategy. The Fed has raised rates by +425 basis points since their zero-interest rate policy was in effect due to the Pandemic. Chart 1 below from the Federal Reserve Bank of St. Louis shows the Effective Fed Funds Rate. 

The Fed’s current rate hiking strategy pattern has been one of the steepest and swiftest moves in the Fed’s history, and their goal of cooling the economy and thereby taming inflation is working. Last week, two inflation indicators that Federal Reserve policymakers widely watch and are considered their “favorite” measures of inflation were released, and both showed significant drops. U.S. PCE (Personal Consumption Expenditures) and U.S. Core PCE for December 2022 fell for the third month in a row, as shown in Chart 2 below from Valley National Financial Advisors and Y Charts. The Fed prefers the PCE indicators because this measure responds better to rapidly changing consumer preferences, includes an exhaustive list of typical consumer expenditures, and the Core measure excludes volatile food and energy prices. The drop in these indicators since their peak in July 2022 shows the Fed’s policies are impacting the economy and taming painful inflation numbers impacting consumers and industry. 

The last point mentioned above was about the strength of the labor market, even in the face of continued announcements of layoffs. Thus far, approximately 40,000 layoffs have been announced by technology companies such as Twitter, Amazon, Google, and Microsoft. We at TWC would never suggest that an engineer or coder from Microsoft is widely more employable than a starting-level service employee, but that seems to be the case as those tech layoffs are not yet showing up in the weekly claims for unemployment insurance, suggesting these coders and engineers found new jobs very quickly. The U.S. Unemployment Rate is at a 50-year low of 3.50%, Chart 3 below from Valley National Financial Advisors and Y Charts. We must go back to 1969 to see a lower level of U.S. Employment than today. Cautiously we watch the labor market, our concerns are that layoffs spread beyond the technology sector.

What to Watch 

• U.S. Job Openings: Total Nonfarm for December 2022, released 2/1/2023, prior 10.46 million. 
• U.S. Recession Probability for January 2024, released 2/1/2023, prior 47.31%.
• U.S. Initial Labor Force Participation Rate for January 2023, released 2/3/2023, prior 62.30%.
• U.S. Nonfarm Payrolls for January 2023, released 2/3/2023, prior 223,000. 
• U.S. Unemployment Rate for January 2023, released 2/3/2023, prior 3.50%.

We are big believers in the “efficient markets hypothesis,” a theory in financial economics that states that asset prices reflect all available information. Simply put: the markets are smarter than investors. Most Wall Street professionals continue to call for a recession in 2023, albeit a shallow or minimally painful and short-lived recession. After digesting current economic conditions and market reactions, some are walking back their predictions for 2023. We look at the data and find it difficult to believe we will have a recession in 2023. The indicators mentioned above are not harbingers of a recession. We are concerned about corporate profits, many of which will be published this week, and whether layoffs are spreading beyond the technology sector. Watch for the Fed’s announcement this week on interest rates, in which they are widely expected to raise rates +0.25% and watch this week’s EPS (Earnings Per Share) releases to offer direction on profits for 2023.