July 31-August 4, 2023

Tactical Signal 9

Last week’s rise in consumer confidence, positive GDP report, and the Fed’s rate decision endorse Sowell’s technical signals to remain in a full position (100%).

Communication stocks, in particular, Google and Meta Platforms earnings and AI leader NVIDIA paved the way for growth stocks to regain strength last week, pushing the S&P 500 Index to return +1.03%, bringing the YTD gain to +20.47%. Following the last CPI and Core CPI release of 3% and 4.8%, respectively, after June's skip, the Fed resumed its hawkish rate policy by raising the benchmark rate by 25 bps to 5.50% to reach its inflation rate goal of 2%, in line with market expectations. More importantly, given the resiliency of corporate earnings and jobs market strength, the Fed lifted its expectations of the possibility of a recession, boosting market sentiment going forward.

After three Fed Chairs (Bernanke, Yellen, and Powell) and 15 years of zero interest rate monetary policy, the Fed Funds target rate has risen to its highest since 2001. CDs and High Yield savings rates are now paying consumers in excess of 5%, while the national average 30-year fixed mortgage rates have reached a high of 7.23%. The Fed continues to stress it remains vigilant in combating inflation and will assess meeting by meeting. The FOMC's next scheduled meeting is September 19.

The week ahead will be the center of earnings seasons, with industry leaders including Apple, Amazon, Caterpillar, Merck, Qualcomm, and Starbucks reporting on earnings. Importantly, unlike 2022, companies are beginning to provide forward-looking statements on improved market conditions. Although Microsoft reported record top-line and bottom-line results last week, its sales outlook for Azure and AI was less than consensus resulting in the stock losing -1.57%. In contrast, Google gained +10.46% on improved digital advertising and AI's growth outlook. Lastly, investors will continue to seek positive strength in the economy with this week's jobs reports, productivity, and factory orders to round the month.

"The staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession."

— Fed Chair Jerome Powell, FOMC Press Conference, July 26, 2023.

Tic-tac-toe: Inflation and Deficits

Tic Tac Toe

Market participants appear to be looking past the Fed's effort to reduce inflation to a level below 2%, the stated target rate. While the rate of inflation has declined substantially in recent months, the Fed may be compelled to choose between maintaining its effort to lower inflation and funding large budget deficits.

The CBO, Congressional Budget Office estimates the Federal budget deficit for the current fiscal year will be $1.5 trillion. This estimate is up from the original estimate of $1.0 trillion at the beginning of the fiscal year. The CBO is required to "score" the budget by looking forward over ten fiscal years. Over that period, the Federal Government's outstanding debt is expected to increase by $21 trillion. How will the deficit be financed? Will the Fed relent in its effort to lower inflation to 2%?

The Fed has managed to lower the year-over-year rate of increase for the CPI to about 3%, but some of the components of the index are increasing at a rate significantly above 3.0%. The rate of increase in food prices has been lowered to about 5.7% on a y-o-y basis. While this rate of increase remains troublesome, it is well below the peak rate of increase of about 11.4%. Similarly, housing costs are now increasing at a rate below the recent peak, 6.3% vs 8.3%. If these trends remain in place, the Fed's effort to reduce inflation is incomplete.

The Fed has reduced the rate of inflation by lowering the level of the Monetary Base, a measure of liquidity supplied by the Fed, and by raising the Fed Funds rate. The $21 trillion dollar question is, Will the Fed persist in the face of the Treasury's requirements for financing the budget deficits going forward? There is an indication the Fed will not persist. The rate of increase of the monetary base was negative in recent months as the Fed sought to reduce its balance sheet. However, the latest reading shows almost no change on a y-o-y basis. The level of the base remains far above its level before the 2008/2009 credit market chaos and the 2020 shutdown of the economy. It may take some time, but if the Fed adds to its balance sheet to help finance the deficit, inflation will increase. The Treasury has shown no interest in reducing the rate of growth of spending, and a tax increase is not likely to pass the Republican-controlled House. An increase in the growth rate of real GDP would increase tax receipts and help lower the deficit, but no pro-growth policies are on the table. If not the Fed, then who?

Economic Reports

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.


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