Weekly Summary: March 14 – March 18, 2022

Key Observations:

1. The bravery and resilience of the people of Ukraine have redefined for us the meaning of the “walk of life.”
2. We will continue to anticipate “tradable bottoms” in equity markets to add to our most favored stock selections. After a risk/reward analysis, stocks of high quality companies with strong balance sheets and at least somewhat predictable cash flows could be the preferred stocks to buy for many long-term investors. Although not always correct, we predicted such a tradable bottom this week.
3. As the overall consensus and we expected, the Federal Reserve (Fed) raised the federal funds rate by 25 basis points (bps) this week. Including this week’s hike, the Fed indicated that seven rate hikes should be expected in 2022. Many investors and analysts were surprised by the Fed’s hawkish approach. We were not.
4. The Russia-Ukraine war (war) will continue to be a source of increased uncertainty as long as it persists. We presume that the war and its repercussions will exacerbate inflation and slow global economic growth. Additionally, we foresee continued volatility for the war’s entire duration. However, we imagine that tradable opportunities will continue to appear.

The Upshot: Our basic approach remains the same as last week. We remain convinced that a diversified portfolio of high quality stocks and commodities is probably most appropriate for many long-term investors in these uncertain times. While exceedingly challenging, we continue to try to anticipate and recognize tradable bottoms in equity markets so that equity purchases might be executed during those times. We remain cognizant of the unknown risks of war and possible further downside to markets at any time. But we try to take advantage of the very large price movements of securities that are caused by uncertainty and volatility. We contemplate that the 10-year yield high point of 2.24% reached this week might be at least a short-term top for that yield. We will reassess our stance on the 10-year yield as we continue to analyze incoming data on economies, inflation and the war, as well as and any other data that we might deem relevant.

“Walk of Life” During Ukraine-Russia War

Like many others, we have been inspired by the bravery and resilience of the Ukrainian people. They have redefined for us the “Walk of Life” as depicted in a Dire Straits’ song. “And after all the violence and double talk; There’s just a song in all the trouble and the strife; You do the walk, yeah, you do the walk of life.” We are impressed by the Ukraine people’s “Dedication, devotion; Turning all the night time into the day” – showing us all how to look ahead to better times. The fate of Ukraine and its people will continue to greatly influence financial markets’ volatility and trends. We remain hopeful that the war might be resolved soon and on terms that are at least somewhat favorable for Ukraine. However, we wish to reiterate that we really don’t know how and when this war will end. As long as the war persists, we must remain vigilant about possible negative repercussions from the war and related sanctions. But this does not mean that we cease looking for opportunities to identify stocks that seem favorably priced after a careful risk/reward analysis.

Taking Advantage of Equity Market Volatility to Buy – Decisiveness Counts

Given the extreme market volatility in financial markets, opportunistic investors may wish to continue looking for attractive entry points suitable for taking advantage of such volatility and to initiate new positions or to add to existing positions of selected equities. Before the U.S. equity markets opened for trading on the morning of March 15, we recommended very strongly that selected equities should be bought from the moment that trading began. We viewed this opportunity as at least a “trading bottom.” For March 15 and 16 combined, Nasdaq gained about 6.8% and the S&P 500 gained 4.4%. The U.S. equity rally continued for a third day on March 17. We do not mean to imply that equities will continue to rise uninterrupted and we still expect volatility to continue – particularly as long as the war continues. However, many investors are still looking for opportune times to buy. The last time we made such a recommendation was February 24 – the day of Russia’s initial invasion into Ukraine. We strongly recommended that selected stocks should be bought from the moment the markets opened for trading on that day as well. On February 24, the equity markets opened much lower and we were able to take advantage of the lower opening prices. By the end of the day on February 24, equities staged a “massive” reversal and finished much higher. February 24 and 25 was the last time that both Nasdaq and the S&P 500 had consecutive positive days prior to March 15 and 16. We viewed the February 24 entry point as taking advantage of what we perceived as “maximum” uncertainty after an extended downturn in stocks leading to that day and as we described it further in our prior commentary. After another extended equity downturn, we similarly viewed the morning of March 15 as a very opportune time to buy selected equities. At that time before markets opened on March 15, equity futures stopped going lower on what we perceived as “bad” news. In addition, we also forecasted that U.S. equities would start trading lower from the very beginning of this year, which they did. While we have had a string of prescient prognostications, we are reminded that all predictions involve risks, uncertainties and assumptions that are not always correct.

Treasury Yields

As previously forecasted, the 10-year Treasury yield traded substantially above 2% in 2022. After the Fed released its decision on monetary policy on March 16 and during Fed chair Powell’s press conference (Fed decision day), the 10-year Treasury yield traded as high as 2.24% and the 2-year yield was as high as 2.008 %. The bottom of our target range for the 10-year yield was 2.25% and we did not have a specific target for the 2-year yield. After observing how these Treasury securities traded on Fed decision day and having observed how quickly fixed income markets tend to discount outcomes fully once they become more “knowable,” we now believe that the 10-year yield may have hit a peak, at least in the short term. We will continue to monitor incoming economic data and war developments, as well as financial market trends and fluctuations that will help us determine any new interest rate targets.

Fed Indicates Seven Interest Rate Hikes in 2022

In our last weekly commentary, we agreed with the consensus view that the Fed would raise the federal funds rate by 25 bps, which it did. From last week’s commentary: “We assume that the Fed will remain aggressive about reining in its monetary policies.” Many market participants were surprised to the extent of the Fed’s hawkishness. We were not. It was clear from the information the Fed released that most participants of the Federal Open Market Committee (FOMC) expected another six additional interest rate hikes, for a total of seven hikes this year that are needed to achieve a federal funds rate of 1.90% by end of 2022. This target rate is more than twice the federal funds rate expectations of 0.9% from the Fed’s December 2021 meeting. That meeting was the last time the Fed released its more detailed full year 2022 economic forecasts before this latest March meeting. A core PCE inflation forecast increase from 2.7% to 4.1%, and a reduction of real GDP expectations from 4.0% to 2.8% were the other notable changes in the Fed’s forecasts from the December to March meetings for 2022 indicated by median forecasts of FOMC members.

Powell’s Press Conference

After the release of the Fed’s decision midweek, but before Powell’s press conference, U.S. equity indexes traded lower and the Dow Jones Industrial Average briefly turned negative. By the end of the trading day, the major U.S. equity indexes finished at or close to their highs for the day. What did Powell say to propel this turn-around? Simply put, Powell reassured the financial markets. Powell readily acknowledged that inflation remained well above the Fed’s target of 2% as supply disruptions proved to be larger and longer lasting than the Fed anticipated. The war only exacerbated inflationary pressures as it also added to concerns of a global economic slowdown. The Fed now expected high inflation through at least mid-year before slowing its pace of growth into the second half of 2022. The Fed was “acutely aware” of the need to return the U.S. economy back to price stability. Because the Fed prepared the financial markets for its changed policies, Powell also acknowledged that although changes in monetary policies are effective after a “lag,” financial conditions had tightened somewhat already – essentially doing part of the Fed’s job. Powell stressed that the Fed’s goal was to ensure that high inflation did not become “entrenched.” To achieve this goal, Powell stated that the Fed’s “plan was to raise rates steadily over the next year.” Powell alerted financial markets that every subsequent Fed meeting this year would be “live,” meaning that further changes in monetary policy could occur at any such meeting. Additionally, Powell made it clear that no decision had been made about “front-loading” a tighter monetary policy. This supposedly referred to the possibility of 50 bps hikes in the federal funds rate in lieu of a more measured 25 bps pace of incremental increases. Although 50 bps hikes are now possible at any meeting, we conjecture that they would be more likely once the war is concluded. In answering a question, Powell stated that if the Fed had known of the very high and persistent nature of inflation ahead of time, they would have acted sooner.

Fed Balance Sheet Reduction

Powell informed us that the FOMC had made “excellent progress” on its plan for shrinking its balance sheet and could be ready to finalize and implement its plan at the Fed’s next meeting of May 3-4. Powell stated that the balance sheet reduction will be faster than the Fed’s last tightening cycle but would otherwise be “very familiar.” We are convinced that the Fed will both announce and implement its balance sheet reduction plan starting with its May meeting. We thought for some time that this was a probable time frame.

Powell’s Confidence and Reassurance

We understand that the “real” reason Powell was able to comfort investors was his confidence that the U.S. economy remained strong, that the U.S. labor market was extremely “tight,” that wage increases continued to be “strong,” that labor supply remained subdued and that U.S. recession risks were “not particularly elevated.” Powell seemed to exude confidence that the U.S. economy could “handle” tighter monetary policy. Powell was hoping that a slower growth economy would be able to better match supply and demand imbalances. Powell maintained his belief that price stability was a pre-condition to achieving the Fed’s goal of sustaining a strong labor market. We examined many surveys which appear to show that business and consumer confidence or sentiment perhaps at least somewhat is correlated inversely to inflation expectations. The higher the inflation expectations, the lower the sentiment for future business activity. We fully agree with the Fed on this point.

Latest U.S. Economic Data “Mixed” but Generally Supportive of Robust U.S. Economic Growth

We believe that although somewhat mixed, the U.S. economic data released this week continued to show a rather robust and resilient U.S. economy. Inflationary pressures remained very evident along with tight labor markets and supply chain constraints. In general, we concur with the Fed’s favorable assessment of the current state of the U.S. economy. The economic data we examined this week included the somewhat weaker-than-expected Producer Price Index (PPI) and the weaker-than-expected Empire State Manufacturing Index (Empire survey) compiled by the Federal Reserve Bank of New York (NY Fed). The Empire survey results were collected in early March and were most likely partly influenced by the war. The survey cited supply chain issues and slower delivery times, as well as high prices paid and received. The U.S. Bureau of Labor Statistics (BLS) reported that U.S. import prices for February remained elevated but below expectations. The U.S. export prices exhibited the largest monthly increases since 1989. The U.S. Commerce Department reported midweek somewhat disappointing retail sales for February, but revised January sales substantially upward. Inflation seemed to impact consumer spending. We were encouraged by the 2.5% month-over-month (m/m) gain in bar and restaurant sales. Based on responses collected in early March, the NY Fed Business Leaders’ survey of service firms in the New York City area showed a substantial gain in headline business activity. The Commerce Department reported that U.S. business inventories rose solidly in January, but at a slowing pace. Inventory growth is a key component of GDP growth. The latest housing data was mixed but still showed signs of continued strength. Finally, the Federal Reserve Bank of Philadelphia reported a much better-than-expected increase in its general manufacturing business activity index for March, which was its highest reading since November 2021. Prices paid and received continued to indicate higher and more-widespread price increases.

Source: J.P. Morgan US: Mixed details in February retail sales report (3/16/2022)

Source: U.S. Census Bureau: Manufacturing and Trade Inventories and Sales, January 2022 (3/16/2022)

J.P. Morgan US: February PPI strength is largely energy (and food) (3/15/2022)

Latest Assurances from Chinese Government Officials Encouraging

We were also encouraged by many “positive” statements from Chinese government officials this week. Some of these statements about changes in policies were seemingly very instrumental in reversing plummeting Chinese equity markets into stunning quick gains from very depressed stock valuations. Vice Premier Liu He, who chaired the Financial Stability and Development Committee, addressed financial markets’ concerns and reiterated China’s intent on continuing its accommodative policies with regard to economic growth to keep Chinese financial markets more stable. China seemed to adopt a more “favorable” stance in regard to financial markets and indicated that it would continue to support overseas listings and IPO’s of Chinese companies. Liu’s statement also promised more transparent and predictable regulation of China’s platform companies – big tech internet companies. Chinese authorities also indicated that they even might be willing to relax their “zero-COVID” policies in the next two to four weeks. China recently locked down as many as 51 million people, including the 17.5 million inhabitants of the city of Shenzhen, which is often called the Silicon Valley of China. These lockdowns were thought to contribute at least partly to concerns over possible diminished Chinese oil demand and potentially more supply chain disruptions.

War Related Supply Disruptions – Lower Auto Production

In our prior commentaries, we have referred to possible increased supply disruptions due to the war, which include possible disruptions of certain critical materials and components that could curtail production of light vehicles. CNBC provided on March 16 a stark reminder of such possibility. CNBC referred to a report issued by S&P Global Mobility on the same day that forecast a lower global light vehicle production rate. This report forecast 2.6 million fewer units for both 2022 and 2023. The research firm predicted that nearly 25 million fewer light vehicles will be produced from now until 2030. S&P’s explanation for this downgrade of production was that the war caused logistical and supply chain problems, as well as shortages of critical vehicle parts and components. European auto production was expected to be most affected. Volkswagen’s CEO Herbert Diess recently warned that the lasting economic damage caused by the war could be “very much worse” than the impact from COVID-19. Looks like Diess would be sympathetic to this report. If these forecasts are accurate, we could experience elevated auto prices and shortages for quite some time.

Bottom Line

Given the myriad of uncertainties at present, we assume continued volatility across virtually all financial markets as long as the war persists. Our preferred approach is to anticipate and recognize “tradable bottoms” in equity markets so that we might take advantage of attractive entry points to purchase selected equities. We suppose that a well-diversified portfolio of selected high-quality stocks that includes some commodity exposure could be the best strategy for many long-term investors.

We foresee that most global economic growth rates will be revised lower and that most inflation forecasts will be revised higher due to the war. Additionally, we assume that downward earnings revisions for many companies might soon reflect those patterns. Predictable margins should become increasingly important in evaluating appropriate investments.

We will strive for a high level of “dedication” and “devotion” from the NewEdge team for the benefit of our clients.

Source: J.P. Morgan US Market Intelligence: Morning Briefing (3/18/22)

Definitions

S&P 500 Index – The S&P 500 Index, or the Standard & Poor’s 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S.

DJIA Index – The Dow Jones Industrial Average (DJIA) is a price-weighted index that tracks 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the Nasdaq

NASDAQ – The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

Federal Funds Rate – The term federal funds rate refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.

Federal Open Market Committee (FOMC) – The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System that determines the direction of monetary policy specifically by directing open market operations. The committee is made up of 12 members: the seven members of the Board of Governors; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents on a rotating basis.

Inflation Hawk (Hawkish) – An inflation hawk, also known in monetary jargon as a hawk, is a policymaker or advisor who is predominantly concerned with the potential impact of interest rates as they relate to fiscal policy. Hawks are seen as willing to allow interest rates to rise in order to keep inflation under control.

Real Gross Domestic Product (Real GDP) – Real gross domestic product (real GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year (expressed in base-year prices) and is often referred to as constant-price GDP, inflation-corrected GDP, or constant dollar GDP.

Producer Price Index (PPI) – The producer price index (PPI), published by the Bureau of Labor Statistics (BLS), is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time. It is a measure of inflation based on input costs to producers.

NY Fed’s Business Leaders (Services) Survey – A monthly survey of service firms in New York State, northern New Jersey and southwestern Connecticut, conducted by the New York Fed.

The NY Empire State Index – The NY Empire State Index is the result of a monthly survey of manufacturers in New York state. Known as the Empire State Manufacturing Survey, it is conducted by the Federal Reserve Bank of New York. The headline number for the NY Empire State Index refers to the main index of the survey, which summarizes general business conditions in New York state

The Financial Stability and Development Committee – A financial regulatory body under the auspices of China’s State Council that was established in 2017, for the purpose of strengthening coordination between financial regulators and supplementing regulatory shortcomings.

Core PCE inflation – The “core” PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.

Neutral Rate – The neutral rate is the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability. SPX index

VanEck Oil Services ETF (OIH) – VanEck Oil Services ETF (OIH) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVIS® US Listed Oil Services 25 Index (MVOIHTR), which is intended to track the overall performance of U.S.-listed companies involved in oil services to the upstream oil sector, which include oil equipment, oil services, or oil drilling.

The United States Oil Fund LP (USO) – The United States Oil Fund LP (USO) is an exchange-traded security whose shares may be purchased and sold on the NYSE Arca. USO’s investment objective is for the daily changes, in percentage terms, of its shares’ net asset value (NAV) to reflect the daily changes, in percentage terms, of the spot price of light sweet crude oil delivered to Cushing, Oklahoma, as measured by the daily changes in the Benchmark Oil Futures Contract. Specifically, USO seeks for the average daily percentage change in USO’s net asset value, for any period of 30 successive valuation days, to be within plus/minus 10% of the average daily percentage change in the price of the Benchmark Oil Futures Contract over the same period.

The SPDR® S&P® Metals & Mining ETF (XME) – The SPDR® S&P® Metals & Mining ETF (XME) seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P® Metals and Mining Select Industry® Index (the “Index”)