Markets Trying to Adapt
Investors have not yet come to grips with a rising interest rate and rising inflation environment. Eventually, markets will settle down, but in the meantime, we may be in for some choppy trading days ahead. Here are some of our thoughts for the week, so far:
Market Activity Explained. Ever since we shut down our own economy, investors have been searching for some type of normalcy. It seems like we encounter some new paradigm shift every time we turn around these days. For the past 9 months, institutional investors have been looking 6-12 months out when making investment decisions. The problem now - no one really knows what's about to happen next because we haven't seen rising rates and rising inflation in current form since 2006. This is evident in some of the pockets of stress in the repo market, but the Fed has stated they will remain unfazed by rising rates as long as market remain orderly, and that is still the case so far. Thank goodness we have history to look back at to determine what the path forward might look like. Equities, though volatile at times, are still one the best hedges against inflation through a full rising inflation cycle. The graph below shows the asset classes (many of them down for the past two weeks) that ultimately prevail when inflation is starting low and then rises.
Investors just need time to adjust. What about rising interest rates, you ask? Well, we have history to thank for that as well. When we look back at the last time interest rates (10yr Treasury) and Inflation (CPI) were rising over a 3 year period, the S&P 500 Index finished up more than 33%. It's incumbent upon us to remember that we've been here before and that markets will adjust.
So far this year, we've had 13 trading days with a move of +/- 1% or more. Last year by this time, we had 12 trading days with similar moves. However, the S&P 500 is still up 0.61% for the year (with the recent sell off) while we were in the throws of the pandemic beginning and the S&P 500 was down 8.2% at this same point last year! Perspective is always important. Another historical perspective to consider is how our Wealth Protection Signal was positioned at this same point last year. As the pandemic was beginning, March 4th, 2020 the Signal was at 32.3 and within days of triggering to raise cash in our portfolios. While the Signal is a little elevated this year, it still sits at 22.7 and would have to more than double to reach the first trigger. In addition, at this point last year our Recession Probability Tool had moved from "Low Probability" to "Moderate Probability." This year, it has done the opposite. We started the year with the Recession Tool in the "Moderate Probability" sector and it has moved in the last few weeks into the "Low Probability" sector. All-in-all, we think we're experiencing a short-term adjustment to life with higher inflation and higher interest rates.
Economic Updates for the Week. So far, the economic updates have been mixed this week. Manufacturing data showed improvement, while Services data was mixed. Despite some of the lower data month-over-month, the indices were still above 50, which indicates economic expansion. ADP Private Employment data disappointed yesterday. While jobs were added, it was well below what the market was anticipating and lower than last month's progress. Factory orders showed improvement, but Weekly Jobless Claims were close to expectations, so no real improvement week-over-week there. This morning the Jobs Report showed significant improvement as 379,000 jobs were added in February (versus 182,000 expected by analysts) and the Unemployment rate dipped for the 2nd consecutive month to 6.2%. Together with rising interest rates and inflation, a disappointing number could prove for a choppy trading session tomorrow. Overall, the economic conditions continue to remain stable as both the National Financial Conditions Index (Chicago Fed) and the Financial Stress Index (St. Louis Fed) both remain well below zero, which indicates the economy is stable.
Other Tidbits to Consider. The virus numbers continue to improve. The current Positivity Rate for testing (4.2%) is nearing the lowest levels of the pandemic (4.0%). The 7-day average for Daily Cases is down 75% from the peak on Jan 11th. Daily Deaths have followed suit, down 44% since the peak in January. The positive news on the vaccine front is that we are now averaging more than 2 million doses being administered on a daily basis. With the Johnson & Johnson vaccine rolling out, those numbers should continue to improve. Nearly 30 million people in the U.S. have been infected with COVID. The CDC estimates another 53 million unreported COVID cases. That, plus the already 53 million who have had at least one shot, there are approximately 136 million people in the U.S. with COVID antibodies. There are 328 million people in the country, so 41% of the population has the antibodies. If the current pace of vaccinations stays steady, we should reach herd immunity (70% with antibodies) within the next few months - good news to be sure. Meanwhile, several states are fully re-opening (TX, MS, AL are the latest) and others are sure to follow. This would provide an infusion of growth into the economy. The Senate is set to take up the $1.9 trillion "stimulus" package, but there appears to be some disagreement among the two parties. It remains to be seen if the bill is augmented or changed & sent back to the House before reaching the President's desk.