This year will be about the interplay between stocks and rising bond yields and we are off to a good start. Inflation has forced the Fed’s hand as the benign 2% inflation environment we had over the last 10+ years is now gone. If you look back at the last 50 years, there has only been one year (1973) where the stock market did not have a positive return during a Fed tightening cycle. Rising rates don’t end bull markets as credit cycles are typically the culprit but valuations are something to consider in this environment.
The Yield Curve
The yield curve is steepest between 1-5yrs so the fixed income market is already pricing in rate increases by the Fed. This means dislocations are unlikely, however, the long-end of the curve does have a slight inversion and could flatten this year which means these high inflation levels will cool off eventually. By the way, if the curve did fully invert on the long-end, that would signal the odds of an economic contraction are rising but that is not the signal I am seeing right now.
I am watching the 5Yr tenor most closely as it tends to lead the front-end of the curve. As you can see, this tenor was trading over 3% during the Fed’s previous attempt in raising interest rates but backed off later that year. Suddenly, 2% on the five year does not seem far-fetched.
The Stock Market
One thing to consider about the indices is that leadership is thinning as 40% of the NASDAQ stocks are down 50% from the previous high and the S&P has about a third of its holdings trading below their respective 200-day moving averages. So, one could argue that many stocks have already been correcting for months in anticipation of a rising interest rate environment. The rotation among several sectors has propped up the S&P into new highs over the last six months so a larger corrective move is likely brewing.
The Fed has its next meeting on January 26th so maybe a corrective move happens later this month. Expectations are that the Fed will make its first rate hike in the March meeting but it wouldn’t surprise me to see that happen later this month as it is long overdue. If we look at the chart below, the most recent reversal was on Wednesday after the Fed minutes from the last meeting were released.
The pullback that started on Wednesday did change the technical pattern from an impulsive advance to a diagonal which is a terminating pattern and warns of a corrective move coming up after one more new high. A bottom would likely form about 8-10% lower from the 4800+ area if that projection came to fruition. It is possible that the S&P already topped but that is not my base case right now as there are some positive divergences in the short-term technicals and volatility remained relatively subdued. I have seen markets top/bottom around Fed meetings so the real question will be what happens leading up to that meeting later this month.
Chart of the Week!
According tothe International Robotics Federation, Asia leads the way in the shift to automated processes, with China in particular installing industrial robots at a breakneck speed. In 2020, China installed 168,400 industrial robots, amounting to 44% of global installations.
Economic & Central Banking Snippets
- Federal Reserve officials at their December meeting considered a faster timetable for raising interest rates – perhaps, as soon as in March. Minutes released on Wednesday showed Fed officials are concerned that rising inflation and a very tight labor market could call for lifting short-term rates “sooner or at a faster pace than participants had earlier anticipated.”
- The Bureau of Labor and Statistics said its establishment survey saw a rise in jobs of +199k which was less than half the estimate of +450k. However, the prior two months showed upward revisions of +141k. (WSJ)
- The December ISM services index fell to 62 from 69.1 and that was well below the estimate of 67. Of the 18 industries asked, 16 saw growth vs 18 in the two prior months. ISM said “Although there was a pullback for most of the indexes in December, the rate of growth remains strong for the services sector” but here’s the catch, “respondents have indicated that they continue to struggle with inflation, supply chain disruptions, capacity constraints, logistical challenges and shortages of labor and materials.”
- December auto sales clocked in at 12.44mm at a seasonally adjusted annualized rate, well below the estimate of 13.1mm and down from 12.86mm in November and which compares with 16.7mm in December 2019.
- The Labor Department on Tuesday said there were 10.6 million job openings at the end of November, a decrease from 11 million the prior month. The total number of quits reached 4.5 million after slightly falling in October from the previous month. The quits rate was 3%, up from 2.8% the prior month and returning to a record rate last seen in September. (WSJ)
- The average rate for a 30-year fixed-rate loan hit hit 3.22%, up from 2.65% one year ago. Mortgage rates are still low by historical standards, and with strong home demand, economists don’t anticipate an immediate or significant pullback in sales. (WSJ)
- Cryptocurrency scammers took a record $14 billion last year. Crypto theft rose 516% from 2020 to $3.2 billion worth of cryptocurrency, according to new data from blockchain analytics firm Chainalysis. (Investopedia)
- Japanese automaker Toyota Motor outsold General Motors in the U.S. in 2021, marking the first time since 1931 that GM has not led U.S. auto sales. Toyota sold 2.3 million vehicles in the U.S., compared to 2.2 million for GM.
- Deere unveiled a fully autonomous tractor at the CES. The company said it plans to sell the tractor this year, designed for large-scale farming.
- Macy’s plans to shorten its store hours as COVID-19 cases surge. The retailer will cut hours for the rest of January, as the retailer grapples with staffing shortages.
That is all for now and thank you for being a subscriber!
President – Kisco Capital