There is a discrepancy growing between bond and stock markets. The bond vigilantes are betting the Fed is nowhere near done hiking rates. Stock jockeys disagree. Which camp will prove correct?

 

A look at the government's U.S. Treasury bond auctions this week resulted in most yields going higher. Buyers insisted on higher returns to purchase the billions of dollars in U.S. Treasury notes, bills, and bonds that are a weekly occurrence in the financial markets.

 

Overall sentiment in the markets has turned cautious and, for some, downright bearish once again after the January rally in stocks. Recession fears are once again taking center stage for many although there is still not enough evidence to prove it definitively.

 

Fourth-quarter Gross Domestic Product (GDP), for example, increased by a downwardly revised 2.7 percent annualized rate from the 2.9 percent pace reported last month. Slightly lower, yes, but the point is that GDP was still growing. And once again, the number of Americans filing new claims for unemployment benefits fell last week. The week-after-week decline continues to point to a persistently tight labor market in a growing economy.

 

The Personal Consumption Expenditures Price Index (PCE) for last month came in hotter than expected. PCE rose 0.6 percent and 5.4 percent year-over-year. Even after you strip out food and energy, core PCE rose 0.6 percent from 4.7 percent last year. The Commerce Department also showed that consumer spending rose 1.8 percent last month after falling the previous month and personal income rose by almost 1 percent.

 

Given the most recent macroeconomic data, it is hard to dispute that the economy is still growing, the decline in inflation is at least pausing, and that leads to the fear that the Fed may be at least thinking about increasing the amount of their next rate hike. 

 

This data is telling the bond market that the Fed may still have a long row to hoe before inflation gets back to the 2 percent target. They are certain that the central bank's tough interest rate regime will continue for much longer than the equity markets believe. Many analysts are beginning to think that the Fed funds terminal rate of interest could rise from its present range of 5.00 percent -- 5.25 percent to as high as 6 percent. It is the main reason that yields are rising, and bond auctions are suddenly problematic.

 

Over in the equity markets, these data points have taken some of the wind out of the sails of the bulls. The S&P 500 Index had a bad week, as did the Dow, NASDAQ, and the small-cap Russell Indexes. If the S&P 500 drops below the 3,950 level then we may see a decline into the mid-3,850 area.

 

As I wrote in my column this week, short-term, U.S. Treasuries are looking interesting for those who are sitting on a large amount of cash. In a down equity market, a 5.09 percent yield on a six-month Treasury note, or a 5.13 percent yield on a one-year Treasury bill is nothing to sneeze at. Investors are now receiving a yield equivalent to what equity investors can receive from the S&P 500 Index.  Granted, there is some interest rate risk if the terminal rate on Fed funds does rise to 6 percent. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

It has been a week of consolidation. A string of downside negative surprises has kept the markets in check but has failed to break anything. Given the macroeconomic data, that has been impressive.

 

Both the monthly Consumer Price Index (CPI) and the Producer Price Index (PPI) came in hotter than expected. The monthly CPI rose 0.5 percent, and the PPI came in at 0.7 percent. That spooked investors since higher inflation means the Fed will likely keep interest rates higher for longer. Yet, dip buyers took advantage of the declines and bid markets back up.

 

In addition, retail sales for January were almost double the average estimate, coming in at a 3 percent gain month over month versus the 1.7 percent expected. This was great news for consumers, who are benefiting from a hike in their disposable income. That is understandable, given that the job market remains strong. The number of Americans filing new unemployment claims, for example, fell to 194,000 this week, which was again less than expected.

 

The consumer's resiliency was impressive enough to convince economists at JPMorgan to raise their first quarter 2023 outlook for Gross Domestic Product to 2 percent from 1 percent. That economic strength must have also troubled at least some Fed members. St. Louis Fed President, James Bullard, one of the most hawkish, non-voting members of the central bank, along with Cleveland Fed President Loretta Mester, are not advocating for a 50-basis point interest rate hike at the bank’s next meeting in March.

 

Readers need to remember that good news on the economy is normally bad news for the stock market. Why? Because continued strong growth on the macro level will keep inflation from coming down and give the Fed a reason to continue to tighten.

 

Yields on most interest rates have climbed higher as well this week. The yield on the benchmark 10-year, U.S. Treasury note rose to 3.843 percent. Six-month and one-year U.S. Treasury yields hit 5 percent. At the same time, the U.S. dollar Index also moved higher. Normally, this would provide added pressure on the stock market.

 

Up until now, every dip has been met with buying. Leading the charge, as I have written before, are the junkiest, most bombed-out areas of the stock market. What the markets are telling me is that fundamentals don't matter and neither does any of the macro data. However, that may be changing.

 

 Right now, investors are convinced that the Fed is just about finished tightening. And then most expect the Fed to either pause or to even begin loosening policy. If we do have a recession (and many are beginning to doubt it), then it will be a rolling one. Some sectors will still grow, while others decline a little, leaving the overall economy flat to slightly down. This is the ultimate Goldilocks scenario where even the ricketiest of beds will do just fine.

 

If fundamentals and macroeconomic data continue to be ignored, we are left with few guideposts to determine the direction of the markets. That is where technical and behavioral analysis comes in. The charts are telling me markets are in a consolidation phase. Stocks have had more than enough excuses to have declined a lot this week, but they haven't done so, which is impressive. The 4,100 level on the S&P 500 was broken on Friday but the 4,050 is fairly strong support and resistance is up at 4,200.

 

Equity markets have been consolidating for 11 days. Why is that significant? Normally, 13 days is about the maximum markets trade sideways before a break to the upside or downside occurs. Given that the markets are closed on Monday for Presidents Day, Tuesday should be interesting. While it is anyone’s guess which way it will go, I am betting the next move will be higher. I am using 4,340 as my guesstimate for an upside target. Wish me luck. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

 

They say you can't keep a good market down. That is proving to be the case thus far in 2023. Every dip continues to be bought and the technical charts indicate there may be more upside ahead.

 

I was expecting that January's bounce in the averages would reverse in February. So far, I have been wrong. I did provide some caveats. For example, I recognized that my forecast had become the consensus view, and that made me uncomfortable. I also wrote back at the end of January that if the Fed moved into a more dovish stance "my prediction fails to materialize, and the market continues to grind higher, we could ultimately see 4,370 on the S&P 500 Index, which is another 300 points higher from here, before all is said and done."

 

The S&P 500 this month climbed as high as 4,195. Presently, profit-taking is relieving some of the overbought conditions in the short term. However, profit-taking becomes something more serious if we break 4,070. So far, we have held that level. 

 

The practice of buying dips is also back in vogue. In case after case during this earnings season, companies that reported disappointing results have seen their stocks fall at first, only to be bid up within hours or days. Markets overall are doing the same thing. Short, sharp selloffs are almost immediately followed by gains. The technology index is leading, while the largest gains in stocks are from those companies with little to no fundamentals.

 

For those who like to follow the technical charts of the markets, most technicians would say the indexes remain bullish. Targets for the S&P 500 Index vary, but in the short-term 4,200-4,300-plus seems to be entirely possible.  

 

In past columns, I have written that the options market is now the main mover of stocks. Investors can buy one option which gives the owner the right to buy or sell 100 shares of a stock for a limited period. Over the past several weeks, one-day options represent more than 60 percent of all options trades. In short, welcome to the casino.

 

Each day, speculators buy zero-day-to-expiration call (or put) options and profit from fast moves in a stock like Tesla. They then cash in by the end of trading on the same day. It has little to do with fundamental things like earnings and prospects for a company and it is certainly not an investment. How long can this practice continue — until something changes? Remember also that the implied leverage in options works both ways. Stocks can move down just as rapidly as they have moved up.

 

One of the chief macroeconomic drivers for the equity markets has been the decline in the U.S. dollar this year. Higher interest rates normally mean a strengthening currency. If interest rate yields remain stable or decline in the U.S. (as they have been doing lately), while other countries continue to raise their interest rates, then the dollar weakens. That is what has been happening now for several weeks.

 

Global currency traders are betting that the U.S. Central Bank is closer to pausing interest rate hikes in their program of tighter monetary policy. If the Fed doesn't cooperate with that assumption, the dollar could resume its rise. That would be bad for stocks. 

 

I still think the markets are getting ahead of themselves. If we do hit 4,300 or more on the S&P 500, we would be up 12 percent for the year. If you add in dividends, it is probably closer to 15 percent. The market would then be trading at 19.5 times earnings. That appears a little too expensive for me unless the bulls are right — the Fed pivots and begins to cut rates by this summer.

 

I am hearing just the opposite. Some Fed watchers are upping their target for the terminal interest rate the Fed is targeting from 5 percent to 6 percent. Some Fed officials are now hinting that might be necessary to get inflation down to their target 2 percent rate. If so, that flies in the face of investors' expectations that the fed won't be raising interest rates after their March meeting. No one knows for sure, which gives the markets a window of opportunity to continue to rally.  

 

My take is that if the technical charts are right, and the markets continue to rise, I am happy to go along for the ride, but I wouldn't be chasing stocks at this point.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

 

The gains of January are extending into February. Leading the gains are those stocks that suffered the worst declines last year. Can this runaway breakout in the averages continue?

 

The critical trigger that could have broken the markets has come and gone. The Federal Open Market Committee occurred on Wednesday, ending with another quarter-point hike in the Fed funds rate. The bears were convinced that Fed Chairman Jerome Powell would come out swinging with a hawkish monologue. It didn't happen.

 

In the Q&A session, Powell kept to the line that another rate hike is probable, headway against inflation is encouraging, and the central bank is on track to achieve its monetary goals.

 

"We can now say, for the first time, that the disinflationary process has started. We can see that," Powell said in answer to a question.

 

That sentence was worth more than a one percent gain on the S&P 500 Index and more than 2 percent on the NASDAQ in the last hour of the day on Wednesday, Feb. 1. For those who are scratching their head wondering why markets should be rallying in the face of a mild recession, continued higher interest rates, declining corporate earnings, and gloomy guidance from many corporate managements, the answer is simple.

 

Markets discount events six to nine months into the future. If the Fed feels confident in winning its inflation battle, then we are likely heading toward the end of additional interest rate hikes. That means the pressure on the economy and corporate earnings should begin to wane. The bull case is that by late summer, or sometime in the fall, we could see the end of the tightening regime of the Federal Reserve Bank.

 

Bulls say that at that point, the Fed might begin to loosen policy. I don't think that is in the cards, but simply a cessation of tightening would be enough for stocks to rally. Stocks that would benefit the most from such a scenario are growth stocks, with no earnings, but plenty of future potentials. These are the Kathy Wood stocks that were decimated last year. That group of equities has been soaring since the beginning of the year.

 

It is also the reason that so many companies that have reported disappointing earnings saw their stocks decline at first, but then swiftly recoup losses and forge higher. The reasoning behind those moves is that the present hit to profits and sales will likely disappear and be replaced by better earnings in the quarters ahead, so any dips should be bought.

 

Is there any guarantee that this bullish scenario will come to pass? Of course not, but for now the most recent data (CPI, PPI, PCE) support a continued decline in inflation. Yields on a variety of bonds from U.S. Treasuries, Corporate, and junk bonds have declined as a result. The only fly in this goldilocks scenario has been the continued strength of the economy and the continued strength in the labor market.

 

At the end of the week, a spate of disappointing earnings results from three of the largest companies in the world — Apple, Amazon, and Google — seemingly dented the upward momentum in growth stocks. Those results were followed by the non-farm payrolls report on Friday morning that featured a blowout gain of 517,000 jobs. Economists were expecting 188,000-plus new jobs at best. The unemployment rate dropped to 3.4 percent versus the 3.6 percent expected.

 

Markets declined on the news, but it was not a rout by any means.

 

Last week, I wrote that my bearish case for the markets in February might not be correct. A bearish decline had become the consensus view, something that always makes me uncomfortable. The evidence seems to indicate stocks want to go higher from here not lower in the short term. Let's see what happens.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The economy grew faster than most expected in the fourth quarter. Unemployment continues to remain tame and corporate earnings, while not stellar, have been good enough to support financial markets this week.

 

Good news on the economy has been bad news for the stock market at least since the Fed has been tightening interest rates. The reasoning has been that stronger growth and employment would feed the inflation rate forcing even further tightening by the U.S. central bank and ultimately choking off the economy.

 

Now that inflation appears to be coming down, a bullish case is building that says we might get away with just a mild (as opposed to a full-fledged) recession. If so, corporate earnings would slow, but not fall off a cliff. Unemployment would rise, but not decidedly so, and a quarter or two of flat to slightly down GDP growth could suffice to continue pushing inflation lower. I call that the Goldilocks Scenario.

 

This week's macro data appeared to support that theory. U.S. fourth-quarter Gross Domestic Product for 2022 came in higher than expected at 2.9 percent versus an estimate of 2.6 percent. But that was down from the third quarter's 3.2 percent gain. Unemployment claims for the last week of 2022 fell by 19,000 to a seasonally adjusted 204,000. However, the number of temporary jobs, which usually leads to the overall unemployment rate is starting to decline.

 

The Fed's favorite inflation gauge, the Personal Consumption Expenditures Price Index, (PCE) came in a bit cooler in December. And corporate earnings, while not great, are still good enough for most stocks to maintain price support.

 

Most readers know that the quarterly earnings reports are a dance where the Street reduces earnings estimates low enough that most companies can "beat" estimates. Future guidance is therefore the focal point for investors. Coming into this week, traders were positioned for a "worst-case" scenario for most earnings announcements.

 

Microsoft is one of the most important stocks in the equity universe. It announced so-so earnings, but the stock leaped higher by 6 percent after the announcement because it could have been much worse. In the discussion after the announced results, however, management guided investors to expect fewer sales and profits in the quarters to come. The company's stock swooned in the after-hours. It dropped even further the next day and took the entire market down with it.

 

Traders decided at some point during the next day that the bad news was fully discounted and preceded to bid the stock back up to close even on the day. The same exercise occurred several times throughout the week on many stocks that announced earnings. On a macro level, the same thing happened on Thursday after the positive GDP quarterly data was announced. The markets spiked higher, but then gave it all back as the "good news is bad news" crowd reasserted themselves. In short, investors are grabbling to find a happy medium between the strength in the economy, the Fed's intentions toward future tightening, and the proper level for the markets given these unknowns.

 

It had been my view that the stock market could retest or even break last year's lows as early as February. I had predicted this unraveling as far back as early November of last year. It has now become the consensus view, which has made me increasingly uncomfortable.

 

If the bearish view were to come true, equities, as well as commodities and precious metals around the world would decline, interest rates would spike higher, and the U.S. dollar would skyrocket. I believe that would be a fantastic generational opportunity to buy the dip. Materials, gold, and silver as well as miners, would be high on my list of areas to accumulate. China and emerging markets would also be up there. 

 

If, on the other hand, my prediction fails to materialize, and the market continues to grind higher, we could ultimately see 4,370 on the S&P 500 Index, which is another 300 points higher from here, before all is said and done.

 

In the end, it all comes down to what the Fed will decide to do in its February FOMC meeting next week. The problem is that the higher the markets climb, the more dovish the Fed would have to be to support the market.

 

A continuation of their hawkish stance will disappoint the markets while sending the U.S. dollar and interest rates higher. If they moderate their message and hint at a possible pause to assess the results of past tightening, markets will continue higher. I wish I had a crystal ball, but I don't. However, either way, in the longer term, it seems that we end up in the same place, which is higher going into the second half of the year.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.