This Week in Review:
Bonds Rebound, Crypto Crashes
Over the last month, inflation continued to clock a fast pace (albeit a bit slower than in prior periods), Federal Reserve policymakers have signaled they will continue to hike the fed funds rate (possibly also a bit slower) and corporate earnings growth was the lightest since the pandemic.
Still, it’s been a happy month for stock and bond investors. Why?
Well, inflation remains high but not as high as feared. The Fed is (most likely) going to raise interest rates at the next several meetings, but by less than previously anticipated. And while earnings aren’t growing as quickly as before, some 70% of companies in the S&P 500 still reported better results than analysts expected.
When your expectations are low, it doesn’t take much to be pleasantly surprised. The news doesn’t even need to be that good—just better than feared.
- Shop till you drop? Retail sales rose 1.3% in October compared to September despite inflation’s pinch. Shoppers spent more on gas, food and even big-ticket items like cars and furniture. Holiday shoppers are expected to spend between 6% and 8% more this season than in 2021.
- Mixed results from the country’s leading retailers suggest that there’s a shift in how and where consumers are spending:
- Target’s third-quarter profits fell shy of expectations and the retail giant lowered estimates for holiday spending, noting that customers have become more discerning about discretionary items while spending more on food and household essentials. This suggests consumer budgets may be coming under strain.
- Discounter Walmart’s sales rose 8.2% in the third quarter compared to the previous year as consumers hunt for bargains. The question is whether that means holiday shopping got an early start and the traditional fourth-quarter season will disappoint.
- Amazon announced plans to lay off about 10,000 of its corporate employees even as it ramps up to the holiday shipping maelstrom. (The company hired some 800,000 workers during the pandemic to meet increased demand from quarantined consumers.) This latest move in the e-tail Goliath’s cost-cutting campaign repositions it for a potential recession.
- Speaking of shopping, companies in the S&P 500 are on pace to set a quarterly record for spending—about 20% more than in the fourth quarter last year. While the expenditures have run the gamut, “reshoring” (bringing operations back to the U.S. from overseas) has been one recurring theme on earnings calls. Meanwhile, energy companies have been bolstering their capabilities to keep up with demand.
Chart of the Week: A Rally with Breadth
The recent rally in equities has many investors wondering: Have we reached a real turning point or is this just another bear market rally.
Bear market rallies often occur when a small volume of trades sparks a sharp rise. And they’re often followed by a quick fall.
Last week’s market certainly featured a sharp rise: The S&P 500 finished the week up 5%, while the NASDAQ posted an even more impressive 8% increase.
But we think it’s significant that last week’s move also came with breadth.
Market breadth refers to the number of stocks participating in a move, either higher or lower. When the majority of stocks move in the same direction, the odds of that change leading to a more enduring trend increase. Conversely, when a small number of large stocks are the main force behind a shift, that move is said to lack breadth—and may be more indicative of the trends in a given sector or industry than the market or economy overall.
Last week’s rally exhibited considerable breadth: More than 50% of stocks in the S&P 500 moved above their 200-day moving average for the first time since spring. That is a very good thing.
The 200-day moving average (DMA) is the average price on a security or benchmark over the past 200 trading days. When the 200 DMA is increasing over time (producing an upward slope on a chart), prices are rising, and analysts consider it a bullish signal. When it is falling, the opposite is true.
With more than 50% of stocks surpassing their 200 DMA for the first time in more than half a year, it suggests last week’s moves may mark a positive change in overall market direction.
We consider the change in the 200 DMA a positive sign about market trends. But we’d like to see prices continuing to increase, solid trading volume and breadth behind the rally before declaring it the start of a new bull market.
The Bond Rally’s Mixed Message
Over the past week, the yield on the 10-year Treasury bond hit a high of 4.16% before dropping to Wednesday’s low of 3.67%. (Remember, yields fall as prices rise.) Meanwhile, the 3-month Treasury’s yield has moved in the opposite direction—rising to 4.24%. The result: The inversion between the 3-month and the 10-year passed a historically significant 0.50% gap (actually 0.57%, but who’s counting?).
The Federal Reserve has often cited this difference in yield between 10-year and 3-month Treasurys as a signal of incipient recession—though there has been a tendency by various Fed officials in recent years to downplay its importance. As you can see in the chart below, there have only been a handful of periods in the last 60 years where the yield curve inverted by 50 bps or more (a rather small dataset). A recession followed each occurrence.
Note: Chart shows daily difference in basis points between the 10-year Treasury and 3-month Treasury yield from 1/2/1962 through 11/16/2022.
Source: U.S. Department of the Treasury.
The yield curve inversion tells us that bond investors’ moods have clearly changed. As the Fed has fought inflation with aggressive fed funds rate hikes, fixed-income traders have been pricing in an eventual economic slowdown. Stronger-than-expected retail sales will keep interest-rate hikes on the front burner.
So as longer-term bonds rose in price, bringing some reprieve to that segment of the bond market, the cause is not necessarily one based upon optimism for the economy—the lingering fear is that Fed activity will catalyze recession and investors are seeking safety.
Chart of the Week: Crypto Chaos, Not Contagion
The noise from the cryptocurrency space his past week has been deafening as FTX, the second-largest exchange, melted down and declared bankruptcy. FTX was led by Sam Bankman-Fried, an unlikely media star who made headlines just months ago by bailing out some failing crypto-related firms while bashing politicians and their suggestions that the crypto industry would benefit from regulatory oversight. The tables turned quickly for Bankman-Fried, FTX and his crypto-trading firm Alameda as well as a host of other crypto companies.
It sounds bad, but for investors who didn’t go overboard or simply ignored the crypto hype, the impact is minimal and self-contained. Cryptocurrencies do not pose the same systemic risk to the traditional banking or financial system as did, say, subprime mortgages in 2007. Less than 2% of the big banks’ “tier one capital” (core assets that fund business activities and are part of the calculation of their overall financial strength) is in cryptocurrencies.
We estimate that the total value of all cryptocurrencies is equal to just 2% of the U.S. stock market’s value. If all those coins went to zero overnight, it would be a bad day in the market, but nothing close to a financial disaster for a diversified investor.
As our chart this week comparing bitcoin (a proxy for the crypto market) to past market bubbles makes clear, bitcoin is a gamble, not an investment. It could be a home run. It could be a zero. It could be both depending on your timing!
But it’s a speculative asset class, at best, and you should size the position accordingly—which means don’t buy more of it than you are willing (and able) to lose. And remember Munger’s insights on expectations.
Next week, markets and Polaris’ offices will be closed all day Thursday as well as on Friday afternoon for the Thanksgiving holiday. You’ll see next week’s email in your inbox on Friday morning.
In the shortened trading week, we’ll be looking at fresh reads on durable goods, manufacturing and the service sector, consumer sentiment and five-year inflation expectations, new home sales and the minutes from the Federal Reserve’s early November meeting.
If you’d like to learn more about our tactical or fundamental strategies, please contact our team at 800-268-9046 or email@example.com.
Please note: This update was prepared on Friday, November 18, 2022, prior to the market’s close.
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