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WEEK AHEAD
January 29-February 2, 2024
Robust technical support continues to fortify our indicators on stronger economic fundamentals as the model remains in full position (100%).
With bellwether companies like Intel, Tesla, and Boeing tumbling last week on weak forward guidance, all indications would point to a downturn for the stock market. Contrary to expectations, it was quite the opposite, with the S&P 500 gaining +1.07% as the breadth of the market widened on superb, relatively speaking, GDP results of 3.3%, well above the consensus estimate of 2.0%. Although there were signs of economic slowdown with a rise in wholesale inventories, personal spending continued to advance, with +0.70%, much higher than expected.
Offsetting the major declines of bellwether stocks were rises from Microsoft (+1.32%), Alphabet (+3.97%), Berkshire Hathaway (+5.02%), and Exxon Mobil (+6.24) as financials, energy, and communication sectors exhibited market breadth largely absent from 2023. Support from a strong U.S. economy and softening inflation were far greater than any company-specific issues to advance the market beyond historical highs.
As attention now shifts to the first Federal Reserve meeting in 2023, the current economic indicators and momentum make a convincing case against an imminent rate increase. The pivotal question looms: Will the FOMC shed light on a much-anticipated interest rate cut widely expected by the markets as firm indications of what is a definitive 'soft landing' remains to be seen? Instead, the market-moving catalyst should focus on expectations of how long interest rates will remain status quo.
The outlook for next week will also come from the jobs report with job openings, unemployment, and participation rate reports. On the earnings front, five of the Magnificent-Seven will be reporting: Apple, Alphabet, Amazon, Meta, Microsoft.
"The business model for online journalism is just tough. And the oncoming train is A.I. Suppose you wake up in the morning and say, A.I., tell me what happened in the Middle East. Well, the bots take all of our news organizations material, which we paid for to get, and then they synthesize it and give it away for free."
— David Brooks, PBS Newshour Brooks and Capehart, Jan. 19, 2024.
The Fiscal Road Ahead
The stock market, as represented by the S&P 500 Index, was valued at close to 22 times trailing twelve months' price-earnings today. In an environment with several serious threats to economic stability, this valuation is generous compared to the median valuation of 18 observed over the long term. The origins of the threats are both foreign and domestic.
The Fed has signaled over 11 interest rate hikes it will continue its battle to control inflation by raising short-term interest rates and slowing economic growth if necessary. The Treasury has yet to demonstrate a willingness to reduce the growth rate of spending, and as a result, budget deficits will amount to an estimated $1.6 trillion per year for the next ten years. There are two major conflicts underway in Ukraine and the Middle East.
American support for chosen allies and other forms of intervention are expensive, but more importantly, the conflicts could escalate and spread beyond the areas affected currently. Any one of these sources of instability could be eliminated over time, but it is unlikely all of them will fade away.
The Fed has raised short-term interest rates to lower the inflation rate to the targeted 2%. Unfortunately, raising interest rates has not reduced liquidity appreciably. Much of the almost $6 trillion increase in the Monetary Base associated with the financial crisis in 2008 and the recession that followed the implementation of COVID-19-related restrictions on economic activity in 2020 remains in place.
An understanding of the relationship between changes in interest rates, liquidity, economic activity, and inflation has eluded the Fed. The Fed remains convinced of the efficacy of the Phillips Curve model despite almost 70 years of empirical evidence that the model cannot explain. The Fed's behavior has been consistent with the belief that reducing economic activity will lower inflation. This belief needs to be corrected. Reducing the supply of goods and services relative to the supply of money is not an effective way to reduce inflation.
The behavior of the Monetary Base suggests the Fed has either stepped back somewhat from its commitment to lower inflation or has its eye on the wrong target. The Monetary Base has increased over the last five months.
The Fed must decide if it will help the Treasury raise the funds necessary to cover the looming budget deficits. If the Fed steps up and supplies liquidity, inflation will likely rise above the desired 2% rate. If the Fed does not buy the Treasury's bond offerings, there is no obvious buyer with the resources necessary to absorb $1.6 trillion per year for the foreseeable future. Interest rates will likely rise as the Treasury "crowds out" other borrowers.
There is a growing risk the deficits will be larger than the Congressional Budget Office estimates. In the most recent measurement periods, tax receipts have been declining on a year-over-year basis. In addition, expenditures driven by the wars in Ukraine and the Middle East have escalated in an election year. The Treasury is scheduled to begin to sell bonds over the next few months. The threat to economic stability will start to materialize over that period. The current price-earnings ratio assigned to the stock market does not accurately reflect the level and the likelihood of these threats.
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.