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Stocks rally despite war in Ukraine, record high inflation

If you are shopping for common stocks, choose them the way you buy groceries, not the way you would buy perfume. – Benjamin Graham

Despite the escalation of the war in Ukraine by Russia and a Federal Reserve interest rate hike last week, the Dow Jones Industrial Average broke its five-week losing streak and posted a gain of 5.5%. The Nasdaq Composite Index and the S&P 500 Index also surged and ended their two-week skid to turn in the best performance for the three major stock averages since November 2020. The week began on a negative note when it was learned that an outbreak of Covid-19 had broken out in China and Shenzhen, a major manufacturing city, was forced to shut down nonessential businesses and impose mandatory testing, raising concerns it could spread and impact the global economic recovery. The producer price index (PPI) for February was also released and it showed that wholesale prices were up 10% from a year ago, tying the month of January for the biggest gain ever. But the monthly PPI increase was actually less than expected and the core PPI that excludes food and energy prices was well below estimates, enabling investors to breathe a sigh of relief. Oil prices also dropped back below $100 a barrel after hitting a high of $130 a barrel just last week. The most significant event, though, was the Federal Open Market Committee (FOMC) meeting and, as expected, the Fed approved a 25 basis point (a basis point is one hundredth of one percent) interest rate hike, the first increase since December 2018. It also forecast rate increases at each of the remaining six meetings in 2022 while reducing its forecast for economic growth this year and raising its outlook for inflation. In addition, the Fed will begin to reduce its holdings of Treasury securities, Federal Agency debt and mortgage-backed securities in future meetings, possibly beginning in May. Federal Reserve Chairman Jerome Powell said that the U.S. economy was very strong and capable of handling tighter monetary policy, suggesting that it will sacrifice growth to get inflation under control. The remarks were generally perceived as being more aggressive and hawkish than anticipated and the 10-year Treasury yield rose and ended the week at 2.15%. The stock market had been deeply oversold and it rallied partly on optimism that talks between Russia and Ukraine would lead to a cease-fire. Absent one, a drawn out conflict could produce continued high inflation and rising interest rates, both of which could pose headwinds to U.S. economic growth.

Last Week

Retail sales in February rose modestly and were less than expected as inflation appeared to impact consumer spending, but January retail sales figures were revised higher. Leading economic indicators in February also increased moderately but the results did not reflect the full impact of the Russian invasion of Ukraine, which could portend slower than expected economic growth. Existing home sales in February fell more than expected as mortgage rates rose and the supply of homes remained tight. Weekly jobless claims fell by 15,000 to 214,000 as demand for labor remains strong, which should keep layoffs low. The March National Association of Home Builders/Wells Fargo Housing Market Index fell as builder sentiment was affected by building material supply side constraints, rising construction costs and the prospect of higher interest rates.

For the week, the Dow Jones Industrial Average gained 5.5% to close at 34,754 while the S&P 500 Index jumped 6.2% to close at 4,463. The Nasdaq Composite Index surged 8.2% to close at 13,893.

This Week

February new home sales are expected to be roughly in line with January numbers while February durable goods orders are forecast to decline modestly. Excluding transportation, orders are expected to increase by the same amount as in January.  Weekly jobless claims will be reported on Thursday and claims should be relatively low as the job market remains tight with job openings continuing to outnumber those looking for a job.

The most prominent companies that are scheduled to report quarterly earnings this week are Nike, General Mills, Darden Restaurants, KB Home, Winnebago, Adobe and Cintas.

Portfolio Strategy

Now that the Federal Reserve has approved the first of what many believe will be a total of interest rate hikes this year, investors will be watching to see if the stock market can hold and possibly add to its huge gains last week. As a general rule, investors do not like uncertainty, but apparently the Feds’ actions and revised interest rate forecast for the next two years eliminated some questions about its future monetary policy and gave much-needed assurance to investors. The Fed is expected to be cautious and will likely be data dependent as it makes these rate decisions throughout the year. While this may be comforting for investors, there are no signs that the war in Ukraine will end anytime soon and the Covid-19 virus is spreading again in China and Europe, threatening to slow global economic growth. The calendar this week for corporate earnings reports and key economic data is light so the focus will be on the war and its broad implications even though a number of Federal Reserve officials are also scheduled to speak. The path of Treasury yields also bears watching as the 10-year Treasury yield rose last week to 2.15% while the 2-year Treasury yield climbed to 1.97%, a difference of only 18 basis points. This flattening of the yield curve is worrisome as it portends slowing economic growth and a possible recession if it inverts with the 2-year Treasury yield higher than the 10-year Treasury yield. Higher yields also are problematic for technology and growth stocks as they make the value of their future earnings worth less. The stock market could resume its upward trend this week, but it’s more likely that stocks will consolidate their gains and remain in a range with a continuing eye on developments in Ukraine.

I will be out of the office on vacation next week and will not return until Monday April 4th. The next weekly market commentary will be sent on this date.