A Landmark Shift

This week, just as the Federal Reserve begins to debate a possible reversal of tight monetary policy, the Bank of Japan implemented its first interest rate increase in 17 years. Considered by many to be a landmark shift, this rate hike marked the end of a long era of ultra-easy monetary policy and eight years of negative interest rates. However, the Bank of Japan remains behind most central banks which have been combating inflationary pressures by hiking rates at an unprecedented speed in recent years. In most developed countries policymakers are still wrestling with post-Covid distortions created by policies of negative interest rates (Europe and Japan) and fiscal stimulus. This combination has left the global financial system awash in cheap money — with most of this liquidity parked at central banks earning an easy no-risk profit.

But the move by the BOJ suggests that the era of low interest rates and low inflation is probably over. In addition to increasing rates, Japan’s central bank announced it will cut back on its limit of buying Japanese government bonds in order to manage the yield curve and will also end purchases of riskier assets such as ETFs to support the Japanese stock market. The Japanese stock market was shaky after this news but closed with a small gain. Although not gathering much attention, the Japanese stock market has been an outperformer in 2024. The iShares MSCI Japan ETF (EWJ – $70.92) is up 10.6% year-to-date versus the 8.6% gain in the S&P 500 Composite. See page 13. It will be interesting to see if the Japanese stock market can continue its solid performance since the move by the BOJ means that banks in Japan will raise ordinary deposit rates for the first time in 17 years.

The Federal Reserve is meeting this week, and the current consensus is for no change in policy. We believe Fed Chair Jerome Powell when he says that the Fed will be data driven, but the data is not always, or often, truly clear. The real fed funds rate has been averaging 200 basis points for most of the last nine months, which is a major change from the negative real rates seen for much of the last twenty years. Nonetheless, it is still below the long-term average of 233 basis points. See page 3. In our opinion, the current real fed funds rate is not high enough to expect a rate cut in March, or until headline inflation falls closer to the Fed’s 2% target. Nevertheless, the FOMC will have its hands full as it debates a combination of strong headline retail sales (but weak real retail sales), slowing inflation, falling consumer confidence, and rising oil prices.

Economic Releases

Headline retail sales for February rose 1.5% YOY, and retail sales excluding motor vehicles and parts and gasoline stations rose 2.2% YOY. But after inflation, real retail sales fell 1.6% YOY. This was the 12th year-over-year decline in the last 16 months, a pattern in retail sales that is typical of an economic recession.

The best year-over-year gains were seen in nonstore retailers (6.4%), food services and drinking places (6.3%), and miscellaneous store retailers (3.2%). Since December 2019, the percentage of total retail sales has increased substantially for nonstore retailers, food service & drinking places and miscellaneous stores, but declined for all other categories. This means for many retailers the pie is not growing and growth comes from taking sales from your competition. It is a survival of the fittest scenario in the retail industry. See page 4.

Consumer confidence was on the rise at the end of 2023, but it seems to have peaked in January. The University of Michigan consumer sentiment survey for March was 76.5, down from February’s negatively revised reading of 76.9. Present conditions were unchanged from a negatively revised reading of 79.4 in February. Similarly, expectations fell to 74.6 from February’s negatively revised reading of 75.2. According to the University of Michigan report, rising gasoline prices weighed on inflation expectations and reversed recent gains in confidence. The Conference Board Consumer Confidence survey was down in February and results for March will be released next week. See page 5.

The National Association of Home Builders (NAHB) confidence index rose 3 points to 51 in March, surpassing the breakeven point for the first time since July. All components increased with sales, sales expectations, and traffic each up 2 points; but absolute levels in the index remain well below 2020 peaks. However, this confidence from home builders may be a result of February construction trends. New residential construction jumped in February with permits and starts up nicely from January levels in all categories, including single-family, multi-family, and condominiums. Nevertheless, some of the increase in February could be a recovery after poor weather in January. See page 6.

PE ratios keep rising

A strategist on CNBC stated this week that fundamentals are not good timing devices and do not work in the short term. We agree with that statement, but we disagree with the thought that they should be disregarded. The S&P 500 trailing 4-quarter operating multiple is now 24.0 times and well above all its long- and short-term averages. The 12-month forward PE multiple is 21.9 times and when added to current inflation of 3.2% sums to 25.1. The importance of this is that this sum is well above the top of the normal range of 14.8 to 23.8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. However, for the bulls, we would point out that the 12-month trailing PE ratio reached 26 to 30 before these market peaks. See page 7.

Technical Indicators

The S&P 500 made a new high this week, but the Dow Jones Industrial Average made its last high on February 23. The Nasdaq Composite index made its high on March 1, but did manage to fractionally beat its November 2021 high of 16,057.44. The Russell 2000 had been trading above the key resistance level of 2000 for the first time in two years but has since retreated closer to the 2000 level. The Russell 2000 index remains nearly 17% below its all-time high of 2442.74 made on November 8, 2021. See page 9. The 25-day up/down volume oscillator is at 2.22 and neutral after being overbought for two consecutive days on March 13 and 14. These were the first overbought readings since the string of overbought readings of 3.0 or higher in 22 of 25 consecutive trading days ending January 5. Nevertheless, this indicator is yet to confirm the string of new highs seen in the S&P 500 index in recent weeks. To do so, this oscillator must remain in overbought territory for a minimum of five consecutive trading sessions, See page 10. The 10-day average of daily new highs is 402 and new lows are 52. This combination of new highs above 100 and new lows below 100 remains bullish, but the new high list is down from a week ago when it was well above 500. The NYSE advance/decline line made a new record high on March 13, 2024 for the 3rd time since November 8, 2021. Overall, technical indicators are mixed.

Gail Dudack

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