Sometimes It’s Not Whether You’re in … It’s Where You’re in

DJIA: 33,826

Sometimes it’s not whether you’re in … it’s where you’re in. A former colleague liked to say he always knew he was a good trader, all he needed was a bull market. Studies have shown as much as 80% of the movement in individual stocks can be a function of the market’s overall trend. It does indeed help to have that market wind at your back. If you look at this market, however, there is no wind, fair, ill or otherwise. Here around 4100 in the S&P is pretty much where we were a year ago. There’s always stock picking, but that’s hard. Similar but less difficult is identifying the group or sectors in favor. Being in the right place often is as important as simply being in, and that’s particularly so in a market like this. If there is always a bull market somewhere, you also have to keep up when it changes.

As the year began Tech was all the rage. It was so much so that many complained there were only five or ten stocks driving the market. By some measures this did seem the case, yet in February 74% of NYSE stocks were above their 200-day average, that is, in uptrends. The market wasn’t as narrow as it looked. By mid-March the number was in the upper 40s, a significant drop and the stocks driving even that number had begun to change. Even with the recent action in Microsoft (305) and Meta (239), the relevant ETFs show Tech has stalled. And since mid-March areas like Consumer Staples and Healthcare have come on to lead. In regard to the former you’re likely thinking Procter & Gamble (156) which gapped higher last week. However, Retail is also a significant part of the XLP (77), as stocks like Walmart (151) and Costco (501) also have outperformed. In XLV (132), it’s Pharma like Eli Lilly (390) and Merck (115) driving performance, with United Healthcare (490) being its usual erratic self. The Medical Device ETF (IHI-56) is a group of companies whose products we find ourselves using more and more.

Who knew First Republic (6) was so important. In retrospect, seems those big banks knew when out of the goodness of their heart they doled out that $30B lifeline. Then, too, it’s a matter of pay now or pay later – the cost of that FDIC insurance certainly would rise in a failure. When you lose 40% of your deposits, your options have dwindled. A rescue would be nice but if the first one didn’t work, would you trust the next one? The risk of course is contagion, but that takes a couple of forms. There’s the mechanics of the industry, which is above our paygrade, but we can say the charts all look the same. It is hard to believe FRC is the only Regional with a problem. The other contagion risk is what was evident in Tuesday’s selloff, the bank problem takes the market lower. The bears have worried all year about disappointing earnings dragging down prices. It’s more than a little ironic earnings like those of Microsoft seem to be holding the market together.

There are many reasons to like Gold except for the obvious, it’s Gold. When it comes to false starts, were it a runner or a swimmer, it would have long been disqualified. At this point the uptrend is well established and the stocks are in a needed consolidation. Conceptually, when money is being pulled out of banks, could there be a better backdrop? Of course, the same might be said of Bitcoin. A bit of an outlier among areas acting well are the Gaming stocks, BJK (46) being one of the ETFs there. Las Vegas Sands (62) is among the best individual charts, which despite its name has little or no presence in Vegas. Without wanting to read too much into this, seems someone might be benefiting from China’s reopening – it’s certainly not the Chinese stocks.
We dislike the idea of mechanical buy and sell signals as the market rarely lends itself to rigid determinations. That said, mechanical guides are useful versus just letting your wishful thinking, hope and fear run amok. So we have a sell signal, so to speak, as of yesterday’s close. By way of perspective the last such signal was back on 2/14, S&P 4136, with a subsequent buy on March 30, S&P 4151. While not much of a money maker, it did get you on the right side of what little trend there was. And unlike many “signals,” it didn’t whip you around every other day. So there’s this mechanical trend change as well as deterioration in indicators relating to New Highs/New Lows. And stocks above their 200-day now are back to 42%. There’s no magic number here, but clearly the number of stocks in uptrends has deteriorated, and to the point it’s time for a little more caution.

Frank Gretz

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US Strategy Weekly: Politics in the Wind

President Joseph Biden announced his reelection campaign for president this week, even though 44% of registered Democrats say the 80-year-old president is too old to run. Biden’s current leading Republican rival, Donald Trump, who is 74 years old, is not supported by 34% of registered Republicans. Although Biden’s announcement could be the first step toward a rerun of the 2020 presidential election race, the political polls indicate it is a scenario most Americans do not want to see. Still, a lot can happen in the next 18 months and the early leaders do not always make it to the finish line, particularly since both of these candidates are hampered by legal issues and Congressional investigations. All in all, we do not expect the presidential election to impact the equity market this year, or any time prior to when the parties confirm the selection of their candidates and their platforms at their respective national conventions.

Watch Over the Dollar

However, domestic politics is not tabled. The pressing political issue on the horizon is the all-important debt ceiling and this could prove to be more serious than any election outcome. Treasury data for the days following the April 18th deadline when most Americans file federal income taxes, suggests that the tax windfall for the Treasury is falling short of expectations. This shortfall could have several sources. There is a postponement of the tax filing deadline for disaster-area taxpayers in California, Alabama, and Georgia from April 18 to October 16.

In addition, the Congressional Budget Office forecasts that capital gains tax receipts could be as much as 17% lower on a year-over-year basis. This is directly due to the performance of the stock market in 2022 versus 2021. Nevertheless, the tax shortfall has major implications for the debt ceiling debate on Capitol Hill. Most economists were expecting the debt ceiling standoff to take place in August; however, it may become an emergency as soon as June. Failure for both parties to come together to address the debt ceiling and spending would be a disaster. The dollar and US Treasury securities have always been the world’s global currency and the world’s safe-haven investment. To change that would weaken not only the US economy, but the global financial balance that has existed for decades. And this comes at a time when the dollar is already under pressure related to challenges from China, Russia, India and Brazil, countries that have been pushing for settling more trade in non-dollar units. Even French President Emmanuel Macron has recently warned against Europe’s dependence on the greenback. A French multi-energy conglomerate, TotalEnergies SE (TEF – 58.31 €) and China’s national oil company, CNOOC Ltd. (12.42 HK$), recently settled a major liquified natural gas transaction in the yuan. According to Bloomberg, Malaysia has initiated talks with China on forming an Asian Monetary Fund in a bid to decouple from the dollar. A weaker dollar could have many ramifications, but the most immediate one would be higher inflation.   

Earnings Season

Meanwhile, the first quarter earnings season is filled with surprises. First Republic Bank (FRC – $8.10) plunged nearly 50% after reporting that more than $100 billion in deposits left the bank during the quarter. Deposit flight has been at the center of investor concerns as clients continue to move capital out of regional banks and into money market funds where higher returns are available or to larger ‘too-big-to-fail’ institutions. However, First Republic is not the only bank suffering from deposit flight. The decline in commercial bank deposits reached $979 billion in mid-April, and only 25% or $251.8 billion exited the banking system since, or due to, the March banking crisis. See page 8. In short, the banking system has been suffering from disintermediation since the Federal Reserve began to raise interest rates a year ago. This trend is apt to continue throughout the year. And in our view, there is no guarantee that a 25-basis point hike in May will be the last rate hike. In other words, the banking system will continue to suffer from a decline in deposits and a painful inverted yield curve. The banking crisis of March will only add to the pressures and credit crunch that began months ago. 

Still, the banking system appears to be stabilizing from the March panic and loans from the Fed’s new Bank Term Funding Program fell modestly from the April 5, 2023 high of $79 billion to $73.8 billion on April 19, 2023. This is a ray of sunshine. But it is worth pointing out that now that the banks are no longer in crisis, the Fed’s policy of quantitative tightening has been reinstated. As seen on page 8, the Fed’s balance sheet contracted by $140 billion in the 4 weeks ended April 19, 2023. In short, the stimulus put into the banking system in March was temporary and is slowly reversing. This means that equities no longer have the wind at their back from this temporary liquidity boost. And this fading liquidity is beginning to show up in some technical indicators.   

Employment and Recession

A simple way to predict a recession is to monitor the year-over-year growth, or contraction, in jobs. See page 3. This indicator is simple, but useful, because the main characteristic of a recession is a decline in jobs. In the post-Covid recovery period job growth has been positive as people went back to work after the shutdown. And the year-over-year growth in both the employment and household surveys has been positive. The household survey has been the weaker of the two surveys recently and it decelerated to an “average” growth rate of 1.5% YOY in March. The interesting thing about job growth in the second half of this year is that comparisons will become more difficult when compared to 2022, and it is quite possible that job growth will stagnate of decline. We will be monitoring this in the coming months.  Meanwhile, consumer sentiment, which is normally a good indicator of a recession, has been extremely weak.

The Misery Index, which is the sum of inflation and unemployment, hit 12.7% in June 2022, a sign of household stress, but it dropped to 8.5% as inflation eased to 5% in March. However, March employment data included a small warning. The number of permanent job losers has been rising and was 26.6% of those unemployed in March. This is the highest percentage since December 2021. In sum, employment data could get weaker in the months ahead and job data will be the key to whether a recession appears in 2023 or 2024.

Technical Update

It has been a difficult equity market in which to maneuver and this can be seen by the year-to-date performances of the indices which are currently: S&P 500 up 6.1%, DJIA up 1.2%, the Nasdaq Composite up 12.7% and the Russell 2000 index down 0.9%. In other words, gains are concentrated in large-cap growth stocks this year, and we fear many of these large-cap favorites, with high PE multiples, may hit a major hurdle as interest rates continue to rise. See page 11.   The 25-day up/down volume oscillator is at positive 1.94 this week and neutral after recording one-day overbought readings of 3.0 or higher on April 18 and April 24. The inability of this oscillator to sustain either overbought reading reveals a weakness in underlying demand. We remain cautious.

Gail Dudack

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Don’t Fight the Fed … But That Fight Might be Over

DJIA:  33,786

Don’t fight the Fed … but that fight might be over.  They won’t ring a bell when the Fed is through, but it seems pretty clear May should do it.  Sure they won’t be lowering rates anytime soon, but at least the fighting part seems done.  If you think by data dependent the Fed means inflation dependent, there’s good news there as well.  To even the casual observer it seems inflation at least has peaked, but an article in Barron’s took this idea a step further.  If rather than a 12-month trailing measure of inflation, use numbers from the summer when hikes began to take effect.  The Fed-watched PCE rose at a 3.3% annualized rate in the eight months July through February, a lot closer to the Fed’s target than the 12-month 5% number.  Here again, the fight seems well along its way to having ended.

So there seems a case for a new bull market and a strong case the bear market has ended.  After all, last May almost 50% of the stocks that traded that week reached 12-month lows, a real washout unlikely to be revisited.  Then, too, at S&P 4100-4200 you can go back to last May and see the averages have gone nowhere – though there is an uptrend from the October low.  Everyone likes to complain it’s a market led by four stocks.  It’s true the four have accounted for half of the gains in the NASDAQ 100 this year.  However, only 25% of the NAZ is down 20% from their 52-week highs versus 80% a year ago.  It’s not as narrow as you might think.  If it doesn’t feel like a bull market it might be because of the somewhat incessant rotation.  For now you can find four Pharma stocks that look as good or better than those four NAZ stocks.

One place we don’t find the rotation so healthy is the late February/early March peak in economically sensitive stocks like Parker Hannifin (319), though by no means is the chart a disaster – look at the weekly.  The Fed may be through or close and inflation may be peaking, but there’s the concern about the economy in terms of the lagged effects of the Fed’s moves.  We would be a bit more comfortable with a fundamental back up from the charts.  And we would feel a bit better if those regional banks would find a pulse.  It’s not the banks themselves that worry us, it’s the implications for small business, especially commercial real estate.  In that regard, the news from Western Alliance Bank (40) on Wednesday was encouraging.  There is, too, a rather dramatic irony in this economic debate.  Where most layoffs have occurred is in Tech, and the stocks have rallied on the news.

They like to call the first hour of trading amateur hour.  That may be a bit unkind, but we tend to agree it has more than its fair share of reversals.  By contrast, the last hour is said to be when the pros play, whoever they may be.  The last hour is thought to have predictive capability to the point that an indicator was developed to capture this – cleverly called, “the last hour indicator.”  It simply calculates the gain or loss in that last hour of trading.  Positive readings typically mean it’s a good market, the logic of sorts is that traders want to be in before the next day’s likely up opening.  Whatever the logic, like the rest it has its moments, this seemingly one.  It has been positive for more than seven consecutive days.  In the past this has led to higher prices a month later some 80% of the time, according to

Say what you will about narrow markets, they have their virtues.  Back in the day when it was FANG and FANG only, at least you knew where to put your money.  The best Dow stock this week was probably Travelers (180) – can’t wait to get some of that good stuff.  Tesla (163) seems to cut prices every other day, yet margin contraction was a surprise?  While not a particularly good chart recently the market often gives Musk a pass, but not this time.  Big still seems best, and when it comes to Tech none are bigger than Apple (167) and Microsoft (286).  With its near 40% position in the two, the SPDR Tech ETF (XLK-148) would break out again around 152.  The overall market generated enough momentum off of the October low and again in late March to strongly argue for higher prices into year-end.  We’ve long noticed, however, the market is on its own schedule.

Frank D. Gretz

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US Strategy Weekly: An Important Earnings Season

Each earnings season is important since fundamentals are the underlying foundation for the equity market, and this is especially true for market rallies. And each earnings season has the potential of being a market-moving event, particularly if it is surprisingly good or bad. But in 2023, with the specter of a recession on the horizon, this earnings season seems even more important. To date, results have been mixed even though expectations have been dampened and earnings revisions have been heavily skewed to the downside prior to announcements.

Nevertheless, first quarter results may only be the tip of the iceberg in 2023. The mini-crisis in the banking sector which took place in March is widely expected to result in a credit crunch in coming quarters, and the impact of this will not be felt prior to the second quarter earnings season which will be reported in July and August. Therefore, investors will be forced to wait and see whether corporations are able to maneuver through the current minefield of inflation, rising interest rates, narrowing margins, and a hostile credit environment. Markets do not like uncertainty.

Our outlook is unchanged

Our outlook is unchanged. In our view, the risk of recession in 2023 is high since we believe the Fed’s policy of increasing interest rates will continue until inflation in the service sector and in wage growth has been broken. In other words, interest rates could go higher for longer. The banking crisis will increase the pressure on the economy, but we do not believe it will be enough to alter the Fed’s policy, at least, or until a recession is clearly in place. The consensus view of one more 25 basis point rate hike in May and the Fed is “done” could also be unwound if the rise in energy prices continues.

If energy prices continue to rise, the improvement seen in March inflation data will be a temporary phenomenon. And since earnings growth is apt to be modest or nonexistent this year, we believe the market will remain in a broad trading range in 2023. The best strategy for a rangebound market is to have core holdings of recession-resistant stocks, or companies with the most predictable earnings streams and dividend returns. However, a trading range market often includes a consistent rotation of sector leadership, and therefore shorter-term trading opportunities. Typically, value drives the rotation of leadership in a sideways market, and buying stocks which are depressed and holding them until the sector rallies is a tactical strategy for some investors. But this requires a nimble trading mentality and the discipline of selling once the stocks have been “discovered.”

Inflation Remains Sticky

March inflation data revealed a clear deceleration in pricing pressure, but it also showed a stubborn level of inflation in core prices. Headline CPI fell from 6% to 5% in March, but core CPI bucked the trend and rose from 5.5% to 5.6%. PPI for finished goods dropped from 6.4% to 3.2%, while core PPI eased only modestly from 6.8% to 6.5%. This discrepancy between headline and core inflation data is explained by crude oil’s 24.5% YOY decline in the same period. Meanwhile, import and export prices were both negative on a year-over-year basis for the second month in a row. In short, there has been good progress seen on the inflation front due to lower energy prices, yet core inflation remains high. See page 3.

Market pundits are focused on the decline in headline inflation in March, but the Fed Chairman Jerome Powell has been clear about his concern about wage inflation, particularly in the service-sector. This wage inflation will make the Fed’s job more difficult. As an example, the charts on page 4 from the Federal Reserve of Atlanta on the median year-over-year change in hourly wages show wage growth was 6.5% YOY in March. This was close to the highest growth rate seen since the survey began in 1983. The most recent cyclical peak was 7.4% YOY in June 2022. Wage inflation is nearly impossible to reverse without broad-based job losses – and job losses are the classic definition of a recession.

Total retail and food services sales fell for the second consecutive month in March but rose 2.9% YOY. Excluding motor vehicles & parts, sales rose 3.6% YOY. Gas station sales were the major drag on March sales, falling 14.2% YOY. As in the CPI, the falling price of crude oil and gasoline had a significant impact on March data. But as seen in the gasoline futures chart on page 9, this decline may be temporary. The only bright spots in the March report were nonstore retailer sales which were up 12.3% and food services and drinking places where sales jumped 13% YOY. See page 5.

Housing data was slightly better in March but remains in a longer-term slump. New residential building permits were 1.413 million (seasonally adjusted annualized rate) in March, down 25% YOY. Single-family permits rose 4.1% month-over-month but fell 29.7% YOY. Housing starts were 1.42 million, down 17% YOY. Single-family starts rose 2.7% month-over-month but fell 27.7% YOY. The March declines were concentrated in multi-family construction; however, both permits and starts in all categories were up from levels seen a few months ago. Homebuilder confidence inched up 1 point to 45 in April and though the index remains below the 50-benchmark denoting poor building conditions, there appears to be a bottoming process in confidence after the lows recorded in December 2022. See page 6.

Banking Crisis Aborted?

The Fed’s tightening policy and the historic 450 basis point increase in the fed funds rate in eleven months was destined to be disruptive to consumers and to the banking industry. The decline in commercial bank deposits totaled $967 billion at the end of March, and $473 billion of this exited the banking system in March alone. This drain on deposits was clearly at the crux of the banking crisis. However, this trend appears to be slowing a bit in April which should help stabilize the banks.

Bank loans through the Federal Reserve’s new Bank Term Funding Program fell from the April 5, 2023 high of $79 billion to $71.8 billion on April 12, 2023. This program was created to liquify the banking system and the fact that loans are being paid back suggests the liquidity crisis is abating. This is good news for the banks. However, it is unclear if higher interest rates and a weak commercial real estate sector is not going to be the next hurdle for banks in the months ahead. See page 7.

Technical Comments

The rally in the WTI crude future is not getting much attention but it does have implications for inflation later in the year. A downtrend line at $80 in the WTI is at risk of being broken, which would be bullish for oil prices. Gasoline prices have already had a positive break in a 9-month downtrend line. Gold is tentatively breaking out of a major consolidation with resistance at $2000. And lastly, the dollar is falling, which also has inflationary implications for the coming months. See page 9. The 25-day up/down volume oscillator is at positive 3.34 this week, to date recording one day with an overbought reading of 3.0 or higher. This overbought reading follows a 12-day oversold reading that ended March 23. In short, a flip-flop action between overbought and oversold readings has emerged since February and it defines the current market condition as being neither bullish, nor bearish, but in a long-term sideways trading range. More importantly, the longer the current overbought reading persists, the more likely it will be signaling an intermediate-term top. See page 11.

Gail Dudack

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If the Past is Any Guide, Things are Looking Up

DJIA:  34,029

If the past is any guide … things are looking up.  In the stock market history tends to repeat because human behavior tends to repeat.  And, too, sometimes it’s just a mystery.  Fund flows at the start of any year tend to boost prices for a time.  Just why that should carry forward throughout the year is hard to say, though it makes some sense that a good and usually predictive first quarter could set the tone for the year.  And, indeed, when the first quarter doesn’t take out the lows of December it has led to higher prices April through December some 93% of the time.  It makes some sense that following a bad year like 2022, a good start would follow through April to December.  In a bad year it makes sense that Tech might suffer most, so when the S&P Tech sector cycles from only 25% positive to 75%, it makes sense that it and the S&P would have a good April to December.  So maybe it’s not so much of a mystery.

The S&P peaked the first week of February and more importantly, most stocks peaked around that time as well.  The extent of the decline has been a bit surprising, not in terms of the S&P but in terms of the damage to most stocks.  NYSE stocks above their 200-day peaked at 74%, dropped all the way to 36%, and is only around 43% at present.  When fewer than half of the NYSE stocks are up in uptrends, that is, above their 200-day, we are still in a correction.  It has, however, affected stocks and even markets differently.  Until last week, Tech had been pretty much immune.  And while they haven’t exactly fallen apart, Tech has corrected as likely was their due.  This correction, however, was more rotation than correction as a number of Healthcare shares came to life for the first time since mid-December.

Given how long Healthcare had remained dormant, this change seems an important development for those stocks.  And it seems important development for the market as well.  It’s one thing to just have a group like Tech consolidate for time, but in this case there has been something, and a not a so insignificant something, come along to take its place.  That has kept NYSE Advance-Decline numbers reasonably healthy, something we obviously consider important.  Indeed, the A/Ds were even flat in Wednesday’s confused market, and have been positive 11 of the last 14 days, something we think keeps recovery prospects intact.  Those numbers are not bad, especially considering the still lagging Financials, of which there are many.  And, of course, be wary of any bad up-days.

While the bank crisis might be over for now, try telling that to the bank stocks.  The banking crisis is one thing, the crisis in banking seems another.  There almost seems an excitement that a bank like First Republic (14) will survive, missing the point will it ever thrive.  To look at the charts, it’s rare to see such uniformity and unanimity in any group.  And it suggests the problems besetting the banks are affecting them all.  The charts for now suggest exactly that – survival.   Even that, however, is tentative in that the stocks merely have stopped going down, consolidating in their downtrends.  With barely a pulse, there’s the risk of new breakdowns.

We have been waiting for a pullback to buy Gold, and you know how that works.  We should have done what we usually do, try a little, more if it works, if it doesn’t – kick it.  So that’s our intention and our advice now.  Meanwhile, we have noticed the breakout in Bitcoin stocks like Riot (14), Grayscale (18), Marathon (12) and BITO (18).  Aside from the charts, and recognizing Bitcoin is pretty much synonymous with controversy, we can’t help but be impressed by how well it has acted in light of the collapse of FTX and Silvergate, and the regulatory problems for Coinbase (69).  BITO is an ETF which holds futures contracts while GBTC is a trust which would like to become an ETF, so far without success.  The kicker here, so to speak, is a successful switch would likely narrow the spread between the current price and NAV closer to 25.

Frank D. Gretz

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US Strategy Weekly: Not Complacent About Inflation

April has a good track record in terms of equity performance. Since 1931, April ranks second with an average gain of 1.6% in the S&P 500 index, bettered only by November with an average gain of 1.7%. In the Dow Jones Industrial Average, April ranks at the top of the performance list with an average gain of 1.9%, followed by November with an average gain of 1.7%. In both indices, December ranks third in terms of positive price performance. September ranks last for both indices, registering an average loss of 0.7% in the S&P 500 and a loss of 0.8% in the Dow Jones Industrial Average. In short, April has positive seasonality.

FOMC Update

Supporting the prospect of gains this April is the current expansion in the Fed’s balance sheet. However, this expansion was not due to normal quantitative easing but by the emergency measures put in place to calm the banking system after the bank run at Silicon Valley Bank. This liquidity spurt by the Fed was done through primary loans and the new Bank Term Funding Program and is expected to be short-lived. The good news in terms of the overall stability of the banking system is that these loans and credit lines have declined from the $390 billion dollar increase seen in the four weeks of March $287 billion as of April 5. So, while the recent increase in the Fed’s balance sheet could continue to boost stock prices in the very near term, it is already dissipating and should soon cease to be a positive factor for equities. See page 3.

In the longer term, we fear the banking system will continue to face problems in several areas due to the Federal Reserve’s tightening policies. Over the past year, deposits have been and will continue to drift away from the banking system and into higher-yielding securities like those found in Treasury bills, money market funds and mutual funds. This will decrease the banking system’s ability to make loans. And when one looks out into the future, it is likely that banks will encounter a second problem. A rise in corporate failures is a fairly normal event a year or two after a sharp rise in interest rates and this means banks may face a rise in defaults over the next twelve months. This phenomenon will decrease the desire of banks to make loans. In short, the banking system is getting squeezed in several directions which means a credit crunch is on the horizon. See page 4.

This credit crunch is the underpinning of an emerging consensus view that the Fed is apt to raise rates at the May 2, 2023 FOMC meeting by 25 basis points, but this rate hike will mark the end of the Fed’s tightening cycle. We are not convinced this will be accurate. There are a number of economic releases prior to the Fed’s May meeting, such as this week’s March inflation data as well as last month’s retail sales. A preview of auto sales for the month of March showed a steady deceleration from February’s pace. See page 6. Unless all these data releases show a notable decline in inflation coupled with a steady decline in household spending, we believe the Fed will continue to focus on getting to its 2% inflation target. The employment statistics for March, which showed a gain of 236,000 new jobs and a small decline in the unemployment rate to 3.5%, were clearly not going to convince the Fed to stop raising interest rates.

First Quarter Earnings Season

Although April has a good record of producing gains in the equity market, this year could be different. The first quarter’s earnings season will set the tone for earnings for the full year and to date, the quarter has been challenging.

The S&P Dow Jones and Refinitiv IBES earnings estimates for 2022 have stabilized at $196.95 and $218.09, respectively. (One reason for this 11% discrepancy is that S&P adjusts all estimates for GAAP accounting. IBES simply aggregates individual analyst estimates.)

Earnings estimates for 2023 are $217.78 and $219.83, and fell $0.60 and $0.62, respectively, this week. EPS growth rates for 2023 are now 10.6% and 0.8%, respectively, due to the discrepancy in 2022 estimates. However, we expect both of these consensus estimates will decline in the coming months. Our 2022 estimate is adjusted to match the S&P but our 2023 estimate of $180 is currently well below consensus since we have been anticipating an economic slowdown, a decline in top line revenues for many companies and a continuation of the margin pressure seen in 2022. Our estimate implies an 8.6% decline in earnings this year. Note that for the first quarter, now being reported, IBES is estimating a 5.2% decline in earnings for the S&P 500. This falls to a 6.7% decline if the energy sector is excluded. But keep in mind that most economists are now forecasting a credit crunch later in the year which means many businesses will face rising financing costs. In short, the first quarter’s earnings season could prove to be the best of the year. See pages 7 and 15.

Signs of a Slowdown

Last week we wrote that the ISM manufacturing index fell from 47.7 in February to 46.3 in March and that this was the fifth consecutive month below 50 for the manufacturing sector. All 9 components of the ISM manufacturing index were below 50 and order backlogs had a substantial decline from 45.1 to 43.9.

This week the March ISM non-manufacturing main survey was reported, and it showed a decline from 55.1 to 51.2. This is just slightly above the benchmark of 50 that divides expansion from contraction. All components of the survey fell with the exception of inventories and three components (order backlog, exports, and imports) fell below the 50 benchmark. In the service survey, exports experienced the biggest decline, dropping from a healthy 61.7 to a contractionary level of 43.7. See page 5. To sum up, an economic slowdown appears to be expanding to the service sector.

Technical Review

The long-standing inversion of the yield curve, the weakness seen in both ISM surveys, the sluggishness seen in recent auto sales, and the potential of corporate defaults after a year of rapidly rising interest rates, all point to the likelihood of a recession in coming months. Nevertheless, the technical condition of the market has improved! Still, the charts getting too little attention are on page 8. The rally in WTI crude futures has implications for inflation later in the year and at present, a downtrend line at $80 is being broken. Gasoline prices have already broken a 9-month downtrend line, which is positive for prices. Gold is close to breaking out of a major consolidation if and when it moves decisively above $2000. And lastly, the dollar is falling. The positive changes in these four charts all point to higher inflation this year, and therefore, more rate hikes ahead.   Meanwhile, our 25-day up/down volume oscillator remains in neutral, but the four popular equity indices have broken through downtrend lines that began at the 2021 highs. As a result, these chart patterns are currently favorable. Nonetheless, the Russell 2000 remains the best index to represent our view on the market. We are not chasing the current rally because we expect the market will remain in a relatively-flat and wide trading range. This range is best represented by the Russell 2000 which is trading between support at 1650 and resistance at 2000. See pages 9 and 10.

Gail Dudack

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US Strategy Weekly: News and Headlines

Geopolitical News

Although it was a relatively quiet week, there was a flurry of news items of some consequence. Finland, a country that borders Russia, officially joined NATO on April 4, drawing a threat from Moscow of “countermeasures.” Days earlier, in what could be a connected event, a Wall Street Journal reporter, Evan Gershkovich, was arrested and accused of espionage by Russia’s Federal Security Bureau.

The CEO of JP Morgan Chase & Co. (JPM – $128.42), Jamie Dimon, wrote in an annual letter to shareholders that “the current banking crisis is ongoing, and its impact will last for years.” In Dimon’s 43-page document, he also stated that he feels the odds of a recession have increased. At the company’s annual meeting in Zurich, the Chairman of Credit Suisse Group AG (CSGN – $0.81), Axel Lehmann, apologized to shareholders for taking the company to the brink of bankruptcy which required a government-sponsored rescue by UBS Group AG (UBS – $21.00).

Virgin Orbit Holdings Inc. (VORB – $0.15), founded by billionaire Richard Branson, filed for bankruptcy on April 4 after struggling to secure long-term funding after a failed launch.

NASA named the first woman and the first African American as part of the four-member team chosen to fly on the first crewed voyage around the moon in more than 50 years. Last, but far from least, Manhattan District Attorney Alvin Bragg led a team of prosecutors that charged former president Donald Trump for falsifying business records in order to conceal a violation of election laws during his successful 2016 campaign. It was a controversial legal move, but one that would make Donald Trump the first sitting or former US president to face criminal charges.

Economic News

On the economic front, this week’s surprising cuts to the OPEC+ group’s output targets, plus an extension of Russia’s output cuts from June to the end of the year, sparked a rally in crude oil futures (CLc1 – $80.71). Analysts indicated that oil prices could reach $100 a barrel later this year, given the existing tightness in the market. If so, it would complicate the Fed’s fight against inflation which is already compromised by the turmoil in the banking industry. The run-up in oil prices added fuel to a rally in gold (GCc1 – $2022.20) where the technical chart looks poised to break out of a three-year trading range. The top of the range for the gold future is currently at $2030. See page 8.

Job openings in February fell by 632,000 to 9.9 million, their lowest level in nearly two years. This survey was taken prior to the recent financial crisis, which means the next report may show a further decline. If so, it could be a positive for the Fed, and a sign that tight labor market conditions may finally be easing. The March job report from the Bureau of Labor Statistics will be released on Friday and it should also show a slowdown. If not, it may disappoint investors.  

The ISM manufacturing index fell from 47.7 in January to 46.3 in February, recording its fifth consecutive month below 50, i.e., the breakeven level. All components of the manufacturing survey were below 50 and order backlogs fell from 45.1 to 43.9. It was a report that signaled a deceleration in an already weak manufacturing sector. The ISM non-manufacturing survey will be reported later this week and it has been the strongest and steadiest segment of the economy over the last decade. The service sector typically represents over 43% of domestic GDP and it is on the Fed’s radar since it also represents the area of inflation where prices are yet to show a deceleration. See page 3.

The Conference Board’s consumer confidence index for March rose 0.8 points to 104.2, offsetting some of January’s hefty decline of 2.6 points. Conversely, the University of Michigan’s sentiment index fell from 67 to 62, offsetting some of the gains seen in January. The University of Michigan survey indicated that expectations dropped from 64.7 to 59.2 in the early days of March. In both surveys, consumer sentiment regarding present conditions fell during the month. This could deteriorate further if credit conditions continue to tighten, and energy prices rise. See page 4.  

Federal Reserve News

As we noted last week, the default of three regional banks resulted in a reversal in the Fed’s quantitative tightening policy. To settle the nervousness in the banking system the central bank is providing liquidity to the banking system in the form of primary loans and the newly established Bank Term Funding Program. Loans and credit lines on the Fed’s balance sheet increased from the $350 billion reported last week to more than $390 billion dollars this week. It has all been done since March 8 as an emergency measure to calm the global banking system and we believe this added liquidity could be a boost to stock prices in the near term. In fact, the positive correlation between an increase in the Fed’s balance sheet and equity gains is stronger than the negative impact on equities from rising interest rates. This makes us optimistic about the near-term outlook, but it comes with a caveat. This new quantitative easing is only temporary and could last for a period of weeks not months. See page 5.

In the intermediate term we expect the Fed to get back into tightening mode. Even after last week’s Fed rate hike of 25 basis points and the deceleration in February’s CPI to 6% YOY, the real funds rate narrowed to negative 100 basis points. But note, this spread is still negative. Historically, a Fed tightening cycle has ended with a fed funds rate averaging a positive 400 basis points. Statistically, this implies that if inflation were to fall to 3% this year (unlikely), the fed funds rate could rise to 7% by year end! This 7% fed funds rate may not appear in the current cycle, but overall, it points out that rates could go higher than any economist is currently expecting in 2023. See page 6.

Technical News

Last week the S&P 500, Dow Jones Industrial Average, and the Nasdaq Composite index, all rebounded from support created by the convergence of the 50, 100, and 200-day moving averages. This creates a positive technical chart pattern for the near term. However, the Russell 2000 index remains the best guide for investors in coming months. In our view, the market is and will continue to be in a wide trading range and this is most clearly seen in the Russell 2000 between support at 1650 and resistance at 2000. See page 9. The 25-day up/down volume oscillator is at negative 0.15 this week and in neutral territory after being in the oversold zone for 12 consecutive trading days in March. This oversold reading followed an eleven-day overbought reading that ended February 8. The February overbought reading represented a shift from a bearish to a positive trend, or at least from bearish to neutral. But this recent return to oversold territory clearly defines the current market as being neither bullish, nor bearish, but in a long-term sideways trading range. Trading ranges tend to include many short-term shifts in leadership. Note that the OPEC+ production cut appears to have shifted leadership from technology back to energy and staples.

Gail Dudack

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A Year of Volatility

The first quarter of the year closed with a gain of 7.0% in the S&P 500 index and a smaller 0.4% rise in the Dow Jones Industrial Average. Yet these numbers do not accurately reflect the market’s action in the first three months of 2023. The year started off with a bang as the S&P 500 soared 6.2% in January, but this quickly reversed to a swoon of 2.6% in February and this was followed by a 3.5% rebound in March. It was an extremely volatile quarter with nearly half the individual trading sessions generating gains or losses in the S&P 500 of 1% or more. January 6 posted outsized gains of over 2% in all three indices while the February 21 session posted a loss of 2% or more in all three indices.

But the quarter’s best price action was concentrated in stocks that had been the biggest losers in 2022. The worst sector performances last year were communications services (down 40%), consumer discretionary (down 38%), and technology (down 29%). However, it is important to note that the communications service sector includes not only companies like Verizon Communications Inc. (VZ – $38.89), but also familiar tech-like names such as Meta Platforms Inc. (META – $211.94), Alphabet Inc. Cl A (GOOGL – $103.73), Alphabet Inc. Cl C (GOOG – $104.00); and Netflix (NFLX – $345.48). The consumer discretionary sector includes large capitalization favorites like, Inc. (AMZN – $103.29) and Tesla, Inc. (TSLA – $207.46). The technology sector includes Microsoft Corp. (MSFT – $288.30); Apple Inc. (AAPL – $164.90), and Nvidia Corp. (NVDA – $277.77).

In other words, the early part of 2023 was a time of bottom fishing for investors. A trading strategy of buying the losers and selling the winners is what drove performance early in the year. As a result, the Nasdaq Composite index, home of many of the beaten down “large capitalization growth stocks” rose nearly 17% in the first quarter, outpacing all the other indices. However, we are not convinced that the first quarter represented the beginning of a new bull market move. First, it did not have the participation of the financial sector. Second, value usually outperforms growth during a period of rising interest rates because higher interest rates will limit speculative activity and goes hand in hand with lower PE multiples.

Making History

Financial stocks did not do well in the early part of the year. In fact, the first quarter of 2023 will go down in the history books because it contained two of the three largest bank failures in US history. Silicon Valley Bank, a regional bank in California, the second largest bank failure on record, was taken over by regulators on March 10, 2023, and Signature Bank, a New York-based regional bank, and the third largest bank failure in the US, closed on March 12, 2023. This led to ripples of uneasiness throughout the regional banking industry. Banking angst also increased on March 19, when Swiss regulators orchestrated a $3.25 billion takeover of Credit Suisse Group AG ADR(CS – $0.89), the second largest bank in Switzerland, by UBS Group AG (UBS – $21.34), the largest of Switzerland’s banks.

Some Swiss financial leaders are already criticizing this shotgun deal for reasons including the fact that the total value of exotic securities – like options or futures contracts – held by the combined merged bank could be worth 40 times Switzerland’s total economic output. The Swiss Parliament indicated it will quickly organize a special session to discuss the takeover, including “too big to fail” legislation and possible penalties against Credit Suisse managers. All in all, the global banking system was on edge in the first quarter, and it remains under pressure. Still, none of this is surprising in view of the fact that the Federal Reserve had just increased interest rates by 450 basis points in less than 11 months. The rise in short-term interest rates puts pressure on the balance sheets of most banks, and also leads customers to shift money from checking accounts into money market funds and other higher interest rate paying investments. The second quarter will continue to be a tricky time for bankers.

Pause, Raise, or Pivot

Nevertheless, as expected, the Federal Reserve increased the fed funds interest rate by 25 basis points on March 22, lifting the range to 4.75% to 5.00%. Some forecasters thought the Fed might pause or reverse its tightening policy due to the instability in the global banking sector. And though we agree that recent bank failures will result in tougher credit conditions for households and businesses, and this will have an impact on the economy similar to higher interest rates, we do not think the Fed’s job in terms of fighting inflation is over. It will, however, make the central bank’s task trickier.

The banking crisis forced the Federal Reserve to reverse its quantitative tightening policy. It moved quickly to add reserves to the banking system in order to calm the markets; and to date, the Fed’s balance sheet has expanded by more than $366 billion dollars. The quick response from the Fed appears to have assuaged depositors and the crisis seems halted for the moment. However, it also neutralized the Fed’s tightening policy.

Nevertheless, history shows that there has been a strong relationship between the Fed increasing its balance sheet (adding liquidity to the banking system) and rising stock prices. In sum, equity prices could rise in the near term. But we would not be complacent about a near-term rally. In our opinion, the Federal Reserve will take every opportunity to raise rates again in the future.

Federal Reserve Chairman Jerome Powell has stated that fighting inflation is a key priority and to do this the real fed funds rate needs to shift to positive, i.e., the fed funds rate needs to be measurably above the rate of inflation. Yet even after February’s personal consumption expenditure deflator (the Fed’s preferred measure of inflation) declined from 5.3% to 5% in February and the March rate hike lifted the top of the fed funds range to 5%, the real fed funds rate only “improved” from negative 60 basis points to zero. This means the Fed needs to see more improvement in inflation data and even so, is likely to raise interest rates at every opportunity in the coming months.

We do not expect to see a Fed pivot in 2023 unless the economic or financial backdrop becomes extremely unstable and such an event would not be good for equities. In sum, the bullish camp looking for a pause or a pivot may be disappointed in upcoming months, and this means the volatility seen in the first quarter is likely to continue.


The March expansion in the Fed’s balance sheet is apt to be a positive for the equity market in the near term. However, history suggests that whenever inflation reaches more than one standard deviation above the norm, or above 6.5%, the US economy experiences a series of rolling recessions; therefore, we would not be in favor of chasing rising prices because we believe the market will be rangebound for most, if not all, of 2023. This range is best seen in the Russell 2000 index between support at 1650 and resistance near the 2000 level.

In terms of recessions, the first in a series could have been the two consecutive quarters of negative GDP recorded in the first half of 2022. It would not be surprising to see another mild recession in the next twelve months. If so, the current earnings estimates for the S&P 500 companies are far too optimistic. We remain defensive and would protect portfolios as much as possible early in 2023. This means emphasizing areas of the stock market with recession-proof revenue growth and predictable earnings streams such as that seen in many energy, staples, utilities, aerospace & defense stocks.

*Stock prices are as of March 31, 2023 close

Gail Dudack, Chief Strategist

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