Weekly Market Update – February 17, 2023

Quick Takes

• Stocks were mixed and bonds were down for the week as inflation pressures reemerged as consumer and wholesale inflation showed some hotter-than-expected prices and retail sales came in stronger-then-expected.
• For the week, the S&P 500 index slipped while the Russell 2000 and Nasdaq advanced. Overseas, developed market stocks eked out gains while MSCI Emerging Markets fell. Bonds were down as yield rose and the 2-year/10-year yield curve inverted further.
• The Q4-2022 earnings season is winding down, with 407 of the S&P 500 companies reported. Results are subpar, with earnings surprises well below the 5-year and 10-year averages and earnings growth on pace for the first negative quarter since Q3-2020.

Stocks were mixed and bonds fell as inflation worries return

Markets continue to wrestle with the possibility of further Fed monetary tightening to mitigate inflation pressures that reemerged with last week’s economic data, which showed persistent consumer and wholesale inflation. Volatility picked up as markets reacted to the release of January’s consumer price index (CPI) and producer price index (PPI), which both showed some hotter-than-expected prices at the consumer and wholesale levels. If the data alone wasn’t enough to spook traders, several Federal Reserve Officials also made public remarks confirming that the Fed may not be ready to relinquish its battle to halt inflation. “My overall judgment is it will be a long battle against inflation,” St. Louis Fed President James Bullard told reporters on Thursday, while the Cleveland Fed’s Loretta Mester said she saw a “compelling case” for a 50-basis-point increase at the central bank’s meeting earlier this month and that bigger rate hikes are not out of the question. And Fed Governor Michelle Bowman said the central bank should keep raising rates until there is much more progress on inflation. Other data such as initial jobless claims and the January employment report continue to point to a tight labor market, which strengthens the evidence that higher interest rates have yet to significantly dent the economy and further boosts the case that short-term interest rates may need to be higher for longer than the market is currently pricing in. Paradoxically, the case for recession was also strengthened during the week with the tenth-straight monthly decline in the Leading Economic Index (LEI) and a lower-than-expected improvement in small business optimism.

As a result, stocks mixed for the week, with the S&P 500 index down for the second straight week, albeit with a modest -0.3% decline. On the other hand, the small cap Russell 2000 managed to advance +1.4% and the tech-heavy Nasdaq was up +0.6%. Non-U.S. stocks were also mixed as developed international stocks (MSCI EAFE Index) eked out a +0.1% gain while the MSCI Emerging Markets dropped -1.4%.

Bonds were a little more conclusive in their pessimism during the week, with virtually all bond sectors dropping as yields increased (bond yields move inversely with prices). The benchmark 10-year U.S. Treasury note rose to 3.81%, the highest level in more than a month, and the 2-year U.S. Treasury yield surged +10 basis points to 4.62%, its highest level since November. That leaves the yield on the 10-year Treasury 0.81 percentage points below the two-year yield, near its widest point set in December which was marked the most inverted level since 1981. An inverted Treasury yield curve has long been considered by Wall Street as a recession warning. The Bloomberg U.S. Aggregate Bond Index fell -0.5% for the week and the Bloomberg Global Aggregate Bond Index ex U.S. (the benchmark for Non-U.S. bonds) dropped -1.4% the week.

Q4-2022 earnings season is beginning to wind down with 407 of the S&P 500 companies having reported results. FactSet data shows about 68% have beat earnings estimates, below the 5-year average of 77% and the 10-year average of 73%. In aggregate, earnings are +1.3% above estimates, which is below the 5-year average of +8.6% and below the 10-year average of +6.4%. If +1.3% is the actual earnings surprise percentage for the quarter, it will mark the second-lowest beat rate reported by the index since 2008. The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings decline for the fourth quarter is -4.7%, which would mark the first time the index has reported a year-over-year decrease in earnings since Q3-2020 (-5.7%).

Chart of the Week

January’s Core Consumer-Price Index (Core CPI), which excludes volatile energy and food prices, rose +5.6% from a year earlier, down from +5.7% in December. Many economists see Core CPI as a better predictor of future inflation than the headline CPI measure. While January’s small decrease is welcome, undercurrents suggest that inflation could remain elevated for some time. Core Goods prices rose at their slowest annual pace since February 2021, but Core Services prices rose at their fastest pace since 1982. The Fed has been especially focused on services and an unofficial category often dubbed Supercore Inflation, which is services less energy and shelter. Federal Reserve officials have recently emphasized so-called core services ex-housing because they view it as a “sticky” category that is particularly sensitive to changes in labor costs. Chairman Jerome Powell has for the past three months justified continued interest-rate increases by noting that tight labor markets and rising wages are fueling inflation in labor-intensive service industries.

Inflation Looks a Little Sticky
Core CPI, 12-month change

Note: Core CPI refers to consumer-price index less food and energy. Core services refer to services less energy services. Core goods exclude food and energy items.
Source: Labor Department, The Wall Street Journal.

Economic Review

• The Conference Board’s Leading Economic Index (LEI) for January declined -0.3%, matching expectations and an improvement from December’s unrevised -0.8% drop. Still, the index recorded its tenth consecutive monthly decline, as ISM new orders, consumer expectations, yield curve, and credit conditions were negative contributors, which more than offset positive contributions from jobless claims and stock prices. The Conference Board noted in its report, “While the LEI continues to signal a recession in the near term, indicators related to the labor market—including employment and personal income—remain robust so far. Nonetheless, The Conference Board still expects high inflation, rising interest rates, and contracting consumer spending to tip the US economy into recession in 2023.”
• The January Consumer Price Index (CPI) rose +0.5% for the month, matching expectations and up from December’s positively revised +0.1%. Compared to last year, prices were +6.4% higher, slightly above expectations for a +6.2% rise, but slightly below the prior month’s unrevised +6.5% increase. Core CPI, which strips out food and energy, went up +0.4% for the month, also matching expectations and in line with December’s positively revised growth rate. Year-over-year Core CPI was up +5.6%, above expectations of +5.5% and slightly below December’s unadjusted +5.7%.
• The January Producer Price Index (PPI) showed prices at the wholesale level in January rose +0.7% for the month, well above expectations for a +0.4% gain, and following December’s upwardly revised -0.2% decrease. Year-over-year, headline PPI was +6.0% higher, above expectations of a +5.4% increase, and compared to the prior month’s upwardly revised +6.5% rise. Core PPI—which excludes food and energy—was +0.5% higher for the month, above expectations for a +0.3% increase, and in line with the prior month’s upwardly revised +0.3% gain. Year-over-year Core PPI was up +5.4%, above expectations of +4.9% but below December’s upwardly revised +5.8% rate.
• The Import Price Index declined -0.2% in January, a bigger decline than expected for it to match last month’s negatively revised -0.1% decrease. Year-over-year, import prices were up +0.8%, below December’s negatively revised +3.0%, and expectations for a +1.4% increase. However, import prices excluding petroleum rose +0.2% for the month, above expectations for a -0.3% decline, but below the prior month’s negatively revised +0.7% gain.
• Advance Retail Sales for January were up +3.0% for the month, far above the Bloomberg consensus forecast for a +2.0% increase and December’s unrevised -1.1% drop. Sales Ex-Autos rose +2.3% for the month, also well above expectations of a +0.9% rise and December’s upwardly revised -0.9% decline. The control group, a figure used to calculate GDP, grew +1.7% for the month, above expectations for +1.0%, and the prior month’s unrevised -0.7%.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index for January increased to 90.3, slightly below expectations of 90.9, but above December’s 89.8. According to the report, 26% of small business owners noted that inflation was their single most important problem in operating their business. In addition to optimism remaining weak, the most recent month also saw a surge in economic policy uncertainty. Rising 5 points month over month to 76, that index is at the highest level since July 2021 and saw its biggest one month jump since last July. Breadth was mixed with six of the ten inputs into the headline optimism number moving higher while the other four fell. Multiple categories—in addition to the headline index—are in the bottom decile of their historical ranges. The NFIB said, “While inflation is starting to ease for small businesses, owners remain cynical about future business conditions. Owners have a negative outlook on the small business economy but continue to try to fill open positions and return to full staff to improve productivity.”
• According to the Federal Reserve, January Industrial Production was flat for the month, below expectations of a +0.5% gain, but above December’s negatively revised -1.0% drop. Manufacturing and mining output both rose, offset by a drop in utility production. Capacity Utilization unexpectedly fell to 78.3%, well below expectations of 79.1% and slightly below the prior month’s downwardly revised 78.4% rate.
• Business Inventories rose +0.3% in December, matching expectations, and November’s downwardly revised increase.
• The February Empire Manufacturing Index, a measure of activity in the New York region, improved more than expected but remained in contraction territory (a reading below zero), rising to -5.8 from the -32.9 reading that was posted in January, far better than expectations of a move to a level of -18.0.
• The Philly Fed Manufacturing Business Outlook Index unexpectedly tumbled further into contraction territory (a reading below zero) in February, dropping to -24.3 from -8.9 in January, well below expectations for an improvement to -7.5.
• Homebuilder sentiment improved more than expected in February as the National Association of Home Builders (NAHB) Housing Market Index (HMI) rose to 42 from January’s unrevised 35 level, beating expectations for an improvement to 37. Despite the solid gain, this was the seventh-straight month that homebuilder sentiment was below 50—which suggests poor conditions. The depressed sentiment has come amid the backdrop of rising interest rates and elevated home prices, which have caused affordability to plunge, as well as elevated materials and labor costs.
• January Housing Starts fell -4.5% for the month to an annual pace of 1,309,000 units, below expectation for a decline to 1,355,000 units from December’s downwardly revised 1,371,000 units. Building Permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, inched up +0.1% to an annual rate of 1,339,000 units, below expectations of 1,350,000 units, but slightly above December’s upwardly revised 1,337,000.
• The weekly MBA Mortgage Application Index fell -7.7%, following the prior week’s +7.4% gain, as the Refinance Index slumped -12.5% and the Purchase Index slipped -5.5%. The drop came as the average 30-year mortgage rate rose 21 basis points to 6.39%, which is up 2.34 percentage points versus a year ago.
• Weekly Initial Jobless Claims fell by -1,000 to 194,000 for the week ended February 11, above expectations for 200,000 and the prior week’s unrevised 195,000. Continuing Claims for the week ended February 4 rose by +16,000 to 1,696,000, above expectations of 1,695,000.

The Week Ahead

All U.S. markets were closed on Monday in observance of the Presidents’ Day holiday, but the economic calendar is still stacked. The preliminary February S&P Global Manufacturing and Services PMIs will be released Tuesday and the first revision (of two) to Q4 Gross Domestic Product (GDP) comes on Thursday. January housing data will be watched with Existing Home Sales on Tuesday and New Home Sales on Friday. Other prominent reports include the Chicago Fed National Activity Index and the final February University of Michigan Consumer Sentiment Index. The Fed will also be in focus as a host of Fed official speeches are on the docket as well as Wednesday’s release of the Federal Open Market Committee (FOMC) minutes from the early February meeting, after which it continued to decelerate rate hikes with a 25 bps increase, and Friday brings the release of the Fed’s preferred inflation gauge, the Personal Consumption Expenditures index.

Did You Know?

AI INVASION – Chat Generative Pretrained Transformer (ChatGPT) has stormed into the world’s mainstream and reached 100 million active users in January 2023, just two months after its launch. That puts the artificial intelligence (AI) tool years ahead of other consumer tech apps like Google Translate (78 months), Uber (70 months), Spotify (55 months), and Instagram (30 months). Even TikTok took nine months to reach the 100 million active users milestone (SOURCE: UBS, MFS).

GAMING THE GAME – According to a survey from the American Gaming Association (AGA), an estimated 50.4 million American adults bet on a team in last Sunday’s Super Bowl, representing a +61% increase from 2022’s record. The amount that Americans are willing to bet has also surged. This year’s estimated total of $16 billion more than doubled estimates from 2022 (source: MFS, American Gaming Association).

CARD MARKET – The sports cards and collectibles industry saw prices soar along with other speculative assets in the months after the COVID pandemic hit in 2020. The industry has not been immune from the downturn either. Using a popular Lebron James rookie card as an example, its price rose 4,400% from pre-COVID levels to its high point in February 2021, but it has now fallen -83% from that peak (Source: MFS, Sportscardinvestor.com, Lebron James 2003 TOPPS Chrome RC)

This Week in History

HAPPY 30TH – In January 1993, the Standard & Poor’s Depositary Receipts (SPDR) S&P 500 Trust ETF (SPY) was the only exchange traded fund (ETF) in existence. Ten years later in January 2003, 94 US domestic ETFs had assets under management (AUM) of more than $50 million. That number grew nearly tenfold to 877 by January 2013, and as of January 2023, there were 2,464 US ETFs with at least $50 million in AUM (source: Bloomberg).

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment and offers a host of long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.