Hawkish Fed comments, lackluster earnings send stocks lower

 Price is a creature of the market’s mood. In booms, it is set by the greediest buyer; in busts by the most fearful seller. – Benjamin Graham

After a strong start to the year for the major stock averages, investors took some profits last week after Federal Reserve Chairman Jerome Powell gave some hawkish remarks about inflation and quarterly earnings results failed to impress. The biggest loser was the Nasdaq Composite Index as it fell nearly 2.5% after posting its best start to a year since 2001 while the S&P 500 Index declined slightly over 1%. There was little in the way of economic data to trade on and corporate earnings were a mixed bag. With more than two-thirds of S&P 500 companies having reported fourth quarter earnings results, about 70% of them have topped expectations, less than in previous quarters. More troubling could be the fact that companies are beating earnings estimates by a less amount than in prior periods, which might be an ominous sign that earnings in subsequent quarters may be set to fall. Mixed economic signals and uncertainty over future corporate earnings could lead to increased volatility in the stock market, something that investors have become accustomed to over the last year. Another source of uncertainty has been the Federal Reserve and last week, Fed Chairman Jerome Powell muddied the waters with comments made at the Economic Club of Washington, D.C. While he reiterated that disinflation has begun, he also pointed out that interest rates could rise more than markets anticipate if economic data doesn’t cooperate. These comments were in reference to the strong employment report in January that showed that nonfarm payrolls rose by 517,000, nearly triple the Wall Street estimate. At its most recent Fed meeting, the federal funds rate was increased by a quarter percentage point to a target range of 4.5%-4.75% and a similar hike is expected at its next meeting in March. The Fed has always maintained that it will be data dependent in formulating its interest rate policy, but it warned that interest rates will need to be kept at a restrictive level for a period of time to bring inflation down to its desired level.

Last Week

It was a quiet week for economic data as the preliminary University of Michigan consumer sentiment index was slightly better than in January and higher than expected and weekly jobless claims totaled 196,000, an increase of 13,000 from the previous week and above estimates of 190,000.

For the week, the Dow Jones Industrial Average dipped 0.2% to close at 33,869 while the S&P 500 Index dropped 1.1% to close at 4,090. The Nasdaq Composite Index lost 2.4% to close at 11,718.

This Week

Unlike last week, this week has several economic reports that will provide investors with insight into inflation and the current health of the economy. The consumer price index (CPI) for January is expected to increase 6.2% year-over-year, less than in December, while the producer price index (PPI) for January is expected to increase 5.4%, also less than in December. The core indices that exclude food and energy prices are also expected to be lower for both the CPI and the PPI. Retail sales for January are forecast to rebound strongly after falling in December and January housing starts are expected to be less than in December as the housing market continues to be weak. The Leading Economic Index for January is expected to decline again for the ninth straight month, a recessionary sign.

Among the most prominent companies scheduled to report quarterly earnings this week are Airbnb, Marriott International, Coca-Cola, Kraft Heinz, Hasbro, Draftkings, American International Group, Devon Energy, Constellation Energy, Southern Co., Consolidated Edison, Exelon, Analog Devices, Cisco Systems, Shopify, Applied Materials, Biogen, Deere, Owens Corning, Ryder Systems and Vulcan Materials.

Portfolio Strategy

While this will be another busy week for quarterly earnings results, the primary focus for investors will be on the inflation data, namely the consumer price index (CPI) and the producer price index (PPI). After a horrible year in 2022 that saw the Bloomberg U.S. Aggregate Bond Index decline 13%, fixed income has recovered this year as bonds have rallied on the hope that inflation will keep coming down. (Bond prices and yields move in opposite directions). This investment-grade bond index has risen 4% so far this year as inflation has fallen considerably and there is growing confidence that the Federal Reserve is near the end of its interest rate hiking cycle. Rightly or wrongly, the market believes that the Fed will raise the federal funds rate by a quarter percentage in March but places a greater likelihood that there will be no increase in May. This view contrasts with the Federal Reserve as it sees the terminal rate for federal funds above 5% and maintains that rates could remain higher for longer to bring down inflation. The hawkish comments by Fed Chairman Jerome Powell last week caused the yield on the 10-year Treasury to rise to 3.74% and the 2-year Treasury to climb to 4.53%. With so much uncertainty regarding the path of inflation and the Fed’s tightening cycle, it still makes sense to stay relatively short with any fixed income purchases. The Vanguard Ultra-Short Bond ETF (VUSB) has a current yield of about 4.7% and the JP Morgan Ultra-Short Income ETF (JPST) yields about 4.5% and both funds have average maturities of less than one year. Inflation and Federal Reserve policy moves to combat high prices will also have implications for the stock market with respect to the corporate profit outlook. Like bonds, stocks have rallied to start the year but 4,200 on the S&P 500 Index could pose resistance from a technical perspective. Yet the majority of NYSE stocks are trading above their 200-day moving average, which is a bullish sign. The positive start to the year for both stocks and bonds is welcome news, but it’s still early and the monthly gains that we saw in January are likely not sustainable.

I will be out of the office over the next week so the newsletter will not be sent again until Monday February 27^th.