Are We There Yet?

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – were mixed this week with U.S. stocks (S&P 500) down -2.98% while international stocks (EAFE) rose 1.20%.
   
2. Fixed Income Markets – were mixed with investment grade bonds (AGG) up 0.63% while high yield bonds (JNK) fell -0.51%.
   
3. Powell Reaffirms Fed Capabilities – as some investors are beginning to lose faith in the Federal Reserve’s ability to fight inflation, Chairman Powell struck a tough tone this week in the Wall Street Journal noting that “no one should doubt” the Fed’s resolve in fighting inflation and shrugging off suggestions from some that the Fed should raise rates by as much as 0.75% in June instead of the expected route of a 0.50% hike. UK officials also faced tougher questioning this week on the news that inflation for the country hit 9% in April, the highest level seen in 40 years.
   
4. Shanghai Eases Restrictions – as China continues to enforce their strict ‘zero-COVID’ policy, Shanghai has achieved said status and plans to resume some semblance of normal life. China’s most populous city and commercial hub has set out a plan to allow its citizens to resume outdoor activities, with convenience stores and pharmacies slowly returning to business. This could be good news for supply chains as the severe restrictions have led to a slowdown in economic growth and have had, “spillover impacts on growth all around the world”, according to Treasury Secretary Janet Yellen.
   
   
5. Key Insight – [VIDEO] This week, Dave and Jon discuss what we can control as investors, trusting your plan, and how our behavior in good markets can often affect how we feel in down markets. [ARTICLE] Tim provides a market update including important technical levels to watch, as well as partner insights/outlooks that he believes investors would do well to heed as market fears continue to mount to an overblown level.
   
   

INSIGHTS for INVESTORS

“Are we there yet?” – every kid that has ever taken a car ride over 30 minutes

We recently took our girls back to my hometown to visit some old haunts and attend the county fair. We had a wonderful time and made a lot of great memories…once we got there. The car ride down was something right out of a skit, with the girls repeating the above question over and over and over and over. My seat belt thankfully kept me from throwing myself out of the car.

Investors these days can probably relate to both the parent and child in this situation, with each “red” day in the markets feeling just like the above painful/annoying prods, as well a strong desire to know when markets will eventually reach their “destination”, aka a new bottom from which they can begin a new ascent. They may even relate to my impulse to throw themselves out of a moving car (e.g., panic sell their positions) even though they know something so foolish isn’t going to actually get them to a better place.

So…are we there yet?

As I found myself repeating to the girls, not quite, but we’re close.

No one can perfectly time market tops and bottoms, but the 3750 level looks like a probable technical floor for the S&P 500.

Most importantly is where markets are likely headed in the months to come.

Tom Essaye summarized what we are hearing from several analysts we trust when he stated, “I’m not abandoning stocks here simply because I do think the “worst” of the macro influences have passed. We’ve likely hit peak hawkishness from the Fed, we’ve likely seen a peak in inflation, and I highly doubt the Chinese will lockdown their major cities again given the im-plosion in economic growth. That doesn’t mean markets will stop declining anytime soon, but combined with extremely negative sentiment, it does create an environment for a very powerful bounce if we get actual good news that refutes the near consensus “recession” outlook in the markets.”

Marko Kolanovic, who along with his team at JPMorgan was recently recognized by Institutional Investors as the top equity research team, has echoed similar sentiments stating that he also believes that equities “can climb out of this hole” as “most of the bad things have happened already this year.”

Key to these outlooks is seeing some breakthroughs on the three big headwinds to stocks: 1) Chinese lockdowns, 2) Inflation/Fed rate hikes, and 3) Geopolitical tensions and related energy costs.

The last couple of weeks have seen some breakthroughs on the first with China finally beginning to ease COVID restrictions and today announcing a larger than expected rate cut to their prime rate which likely signals greater support for their economy. With consumption currently shifting from products to services, beleaguered supply chains may finally get a chance to right themselves as well.

As I touched on last week, I think there is good reason to believe the pace of inflation, to date tepid, retreat will pick up as well as energy prices are stabilizing.

With stocks within the S&P 500 now trading at attractive valuations (see JPMorgan chart below), continuing on the whole to post solid earnings with over 55% of companies beating expectations this quarter (see second chart from Goldman Sachs), and expectations for growth of 9-10% investors have good reason to be optimistic moving forward. Regarding recent earnings results, Goldman Sachs noted, “Corporate fundamentals remained resilient through the first quarter, with a majority of S&P 500 companies having reported earnings. Earnings surprises to the upside exceeded the long-term average, while surprises to the downside have been less common than the long-term average. We think corporate earnings strength can stay strong amid a volatile equity market, with companies most able to pass on higher costs best positioned.”

Bearish investors/analysts are of course calling for a recession, as they always do during market declines, but analysts/economists such as Kolanovic and Brian Wesbury who we’ve found to be far more trustworthy in their forecasts are still both solidly in the camp that recession fears are overblow (see also Wesbury’s article below).

If they prove to be right, and corporate resiliency continues, investors will once again be glad they found the patience to “stay in the car” and reach their destination.

Have a wonderful weekend,

Tim and the team at TEN Capital

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Recession Unlikely in 2022

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 5/16/2022

The consensus among economists puts the odds of a recession starting sometime in the next year at 30%, according to Bloomberg's most recent survey. No wonder the S&P 500 is deep in correction territory and flirting with an official bear market.

We think the near-term pessimism is overdone. Yes, a recession is likely on the way, but it probably has about two more years before it arrives, which means corporate earnings have plenty of room to exceed expectations in the year ahead and for equities to rebound before year-end.

Plenty of reasons suggest we are not about to have a recession that starts in 2022 or early 2023.

First, the most probable cause of the next recession is the tighter monetary policy needed to wrestle inflation under control. But, so far, monetary policy isn't tight. The Federal Reserve has raised short-term interest rates by less than one percentage point and, although it's been announced, Quantitative Tightening has yet to start. Yes, the growth in the M2 measure of the money supply has slowed recently, but the time lag between tighter money and slower economic growth should be at least twelve months.

Second, tax rates haven't gone up and are increasingly unlikely to do so anytime soon. The gradual demise of the President's Build Back Better agenda means tax rates remain at the lowered levels set by the Tax Cuts and Jobs Act, which was enacted 2018.

Third, although businesses are replenishing inventories at a rapid pace – a pace that will eventually slow and then reduce the real GDP growth rate – the level of inventories at manufacturers, retailers, and wholesalers are still very low relative to sales, which means plenty of room for businesses to keep restocking shelves and showrooms in the months ahead.

Fourth, although higher mortgage rates will almost certainly be a headwind for home sales in the months ahead, home builders have under-built housing in the past decade, and so total home construction should not falter significantly. Fewer home sales, yes, but rental units have to be built, too.

Fifth, there were 11.5 million job openings as of March compared to 7.0 million immediately prior to COVID. Demand for workers remains robust.

Some investors fear that the rise in long-term interest rates and drop in stocks, all by themselves, represent a form of financial tightening that could tip the economy into recession, but the size of the recent movements in financial markets have not been automatically linked with recessions in the past.

Meanwhile, debt service costs are low for both consumers and US companies. As of the fourth quarter, consumers needed to use only 14.0% of their after-tax incomes to meet their financial obligations, which are debt service payments plus rents and payments for car leases and similar costs. For comparison, that's lower than it ever was pre-COVID, dating back to at least 1980.

We track the debt securities and loans of nonfinancial companies relative to their assets as well as their net interest payments relative to their profits. Both measures are low by historical standards.

Again, we want to be clear that we are not dismissing the risk of a recession. We think one is on the horizon given the overly loose stance of monetary policy in the past couple of years, and the response necessary to correct the resulting inflation. But market pessimism has gotten ahead of itself and there is room for economic news to come in better than expected in the immediate year ahead.