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WEEK AHEAD
August 14-18, 2023
Market technicals were indifferent to last week’s equity decline due to fundamental support from Healthcare, Industrials, and Energy sectors. Sowell’s tactical models remain in full position (100%).
The past week's comparison of year-over-year Consumer Price Index (CPI) and Producer Price Index (PPI) revealed a 3.2% and 0.80%, respectively. Despite a downward trend from the previous month, these figures exceeded forecasts, sparking anticipations of additional interest rate hikes in response to the updated stance from the Federal Reserve. Diminishing prices was not enough to lift equity markets as the S&P 500 index fell by a modest 0.27%, led by technology stocks falling 2.95%. Tech heavyweights, including Apple, Microsoft, Alphabet, NVIDIA, and Meta, weighed on the market.
Investor confidence was rattled by an unexpected downgrade of Moody's ratings for ten midsize U.S. banks, along with the emergence of negative rating reviews for several major Wall Street financial institutions. Adding to the turmoil, President Biden issued a formal executive order last Wednesday, prohibiting U.S. investment in various Chinese technologies, including semiconductors, quantum computing, and artificial intelligence—this sequence of events culminated in a widening of bond yields and a subsequent decline in prices. Notably, the Bloomberg US Aggregate experienced a 0.64% decrease, mirrored by an 11 basis points increase in the 10-year yield from 4.05% to 4.16%.
The upcoming week will mark the completion of the Q2 earnings season as more than 80% of S&P 500 companies have already reported, with nearly 80% surpassing analyst expectations. Renowned companies such as Applied Materials, Cisco, Home Depot, Target, and Walmart are scheduled to disclose their earnings. The economy's trajectory and Federal Reserve expectations will be influenced by a slew of economic reports, including Retail Sales, Business Inventories, and, notably, Industrial Production.
"The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy." — Ludwig von Mises, Economist.
Inflation is a Policy
The most recent measurements of the inflation rate provide evidence of a significant decline over the last year. The data show the year-over-year inflation rate has declined from 9.0% in June of 2022 to 3.2% in July of this year. While this inflation rate is not at or below the Fed's target of 2.0%, the Fed has made progress in controlling inflation in the near term.
At the heart of the Fed's policies has been an increase in the Fed Funds rate from 0% to 5.3%. The Fed has, until recently, made efforts to reduce the money supply as well. The rate of change in the monetary base, a measure of the money supply, turned negative in February 2021 and became positive in May 2023. The Fed's effort to reduce liquidity has paused at least temporarily. The Fed has also signaled that it may pause Fed Funds rate increases as well.
The Fed increased the Base in 2008 as a response to dislocations in the financial markets precipitated by the collapse of the subprime mortgage market. In 2020 the Fed once again increased the Base as part of an effort to reduce the depth of the recession brought on by a reduction in economic activity that flowed from policies put in place as a response to the Covid-19 pandemic. In total, the Fed added about $5 trillion to the base above the trend line growth. Much of that amount remains on the Fed's balance sheet.
The pause in the reduction of excess liquidity may reflect a new reality. The Federal Budget is about to produce deficits in the range of $1.5 trillion to $2.0 trillion for the next ten years, according to the Congressional Budget Office (CBO). Without a willingness on the part of the Fed to finance these large deficits, there is no obvious source of financing. Foreign holders of dollars might step up under normal circumstances, but the current circumstances are not normal. Fitch has downgraded Treasury debt, a credit rating firm, and several banks have seen their credit ratings downgraded by Moody's, another credit rating firm. Holding dollar-denominated financial assets may not look attractive or safe.
The Fed faces a dilemma. In the post-WW II period, the Fed stepped up and bought the Treasury's debt, and an increase in the rate of inflation followed.
When the Fed was established in 1913, the market price for gold was about $20. In 1971 when we shut the gold window and would no longer allow foreign governments to redeem dollars for gold, essentially ending the gold standard, the price of gold was about $40. The price of gold is just over $1900 per ounce currently. The price has increased almost 100 times since the Fed was established. The Price of oil in 1971 was just under $25 per barrel. Oil is now about $82 per barrel. Oil has tripled in price since we cut the dollar loose from gold.
Investors should remember the insight von Mises offered as we move forward. For instance, what long-term impact will the Russia-Ukraine war and U.S.-China trade war have on globalization and the price of goods? Inflation may have abated, but it will return. Inflation is a policy.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.