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Stocks close mixed as interest rates rise, yield curve inverts


In history, the evidence is overwhelming: Stock market bottoms happen and then stocks jolt upwards while the economy keeps getting worse – sometimes by a lot and for a long time. – Kenneth Fisher

The stock market was decidedly mixed last week as the Dow Jones Industrial Average edged lower, the S&P 500 Index was virtually flat and the Nasdaq Composite Index posted a modest gain. Although the performance of the major averages suggested that the markets were relatively calm, a closer look reveals that that were troubling developments beneath the surface, especially in the bond market. For the first time since 2019, the yield curve inverted with the yield on the 2-year Treasury rising to 2.44% on Friday and the yield on the 10-year Treasury settling at 2.38%. Normally, investors demand a higher yield on bonds that have longer maturities to compensate them for the additional risk and the yield curve is positive, i.e. the slope of the graph extends from the lower left to the upper right. Historically, an inverted yield curve between the 2-year and 10-year Treasuries portends a recession and this relationship has predicted five out of the last six recessions. While it is true that it can be a harbinger for a recession, it is not always the case and is not the most likely outcome now given the current strength of the labor market. The March employment report proved that last week as the U.S. added 431,000 jobs, only slightly below estimates, while the unemployment rate fell to 3.6%, which was better than forecast. January and February job numbers were also revised higher and wages rose 5.6% from a year ago, just above estimates. Even if a recession were to occur, it is more than likely that it could be a year away or longer. In other news last week, Russian defense officials said the country would drastically decrease military action in Ukraine, which helped buoy market sentiment even though there appeared to be no evidence that it actually occurred. Peace talks between the two countries yielded no results but investors remained hopeful for a cease fire at week’s end. There was some good news with regard to gas prices, though, as West Texas Intermediate crude oil fell below $100 a barrel as the White House pledged to release more strategic oil reserves to boost supply.

Last Week

Other jobs related data released last week was mixed as ADP reported that private firms added 455,000 jobs in March, compared to expectations of 450,000, but weekly jobless claims were 202,000, an increase of 14,000 from the previous week and higher than forecast. The core personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation, rose 5.4% from a year ago, the biggest increase in nearly 40 years but slightly below estimates. The March consumer confidence index came in slightly below expectations as consumers continue to struggle with high inflation while the March ISM manufacturing index was lower than in February and just below forecasts, but still comfortably in expansion territory.

For the week, the Dow Jones Industrial Average fell 0.1% to close at 34,818 while the S&P 500 Index closed virtually flat at 4,545. The Nasdaq Composite Index added 0.7% to close at 14,261.

This Week

There is little in the way of economic data this week as the ISM non-manufacturing or services sector index for March is expected to be higher than in February while February factory orders are also expected to be slightly higher.

The Federal Open Market Committee (FOMC) releases minutes from its meeting in March and the odds of a 50 basis point (a basis point is one hundredth of one percent) hike at its next meeting in May have increased substantially as inflation remains too high.

There are only a few companies that are scheduled to report quarterly earnings this week and the most notable of these include Acuity Brands, Levi Strauss, Conagra Brands and Constellation Brands.

Portfolio Strategy

Although the stock market rallied in March with the S&P 500 gaining 3.6%, the first quarter performance results were the worst quarterly performance since the beginning of the pandemic. The war in Ukraine, rising interest rates, high inflation and the prospect of further Federal Reserve tightening all combined to create a difficult environment for stocks to post a positive return. Fortunately for investors, April is historically the best month of the year for the stock market with the S&P 500 rising an average of 1.7%. With very few economic reports to be released this week and only a handful of corporate earnings reports on the agenda, the focus this week will be on developments in Ukraine and the Federal Reserve minutes scheduled for release on Wednesday. Inflation continues to be a major concern and oil prices remain elevated and show no sign of abating any time soon. This has caused bond yields to spike with the 10-year Treasury yield briefly hitting 2.55% last week after beginning the quarter at 1.51%.  The yield on the 2-year Treasury has also risen dramatically and now is higher than the yield on the 10-year Treasury, a worrisome signal that can portend a recession. For these reasons, the minutes from the most recent Fed meeting will be critical in assessing the central bank’s plans to tighten monetary policy going forward. Many economists predict that the Fed will raise the federal funds rate by 50 basis points in May and the Fed also has nearly $9 trillion in securities on its balance sheet that it plans to reduce over time. Investors will be looking for clues about the Fed’s timetable for reducing these holdings, which will be another step in its plan to tighten monetary policy. While high inflation and rising interest rates will be headwinds for the stock market, the biggest threat to the markets could be a misstep by the Federal Reserve.