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 may not be the 1970s when interest rates offered investors double-digit returns, but 5 percent on a six-month U.S. Treasury bill isn't bad.

 

We last saw that kind of return in 2007. To be sure, the rate still comes up short when compared to the 6.4 percent annual rate of inflation right now. Yet inflation is declining and has fallen for seven months in a row.

 

The dilemma investors faced last year was that there simply was no haven to park their cash. The stock market was treacherous and falling. The Federal Reserve Bank was hiking interest rates on an almost monthly basis to combat inflation, and most bond prices were falling almost as much as equities.

 

This year the stock market rallied for the first month and a half, but many investors have now turned less bullish. Over the last week or so, the bond market has begun to price in at least three more interest rate hikes in the first half of the year. The strength of the economy and a slight uptick in some of the most recent inflation readings has been behind the increase in bond yields across the spectrum. The rush for cash and cash alternatives has suddenly taken a front seat in preferred investments.  

 

At this point, investors can earn 5 percent or more on the six-month Treasury Bill, which is one of the safest debt securities in the world. Certificates of Deposits (CDs) are yielding 4.8 percent for the same three-month maturity. Buyers need to go out to one-year CDs and beyond to capture an equivalent 5 percent yield or above.

 

At this point, the three-month Treasury bill at 5.07 percent has a yield that is now competitive with far riskier assets like stocks as measured by the S&P 500 Index. Readers need to be aware that these "riskless" securities are not quite what they seem. Treasuries, while backed by the full faith and credit of the U.S. government, do have interest rate risk. If interest rates climb higher, the price of all notes, bills, and bonds declines. The longer dated the bonds are, the deeper the decline when rates rise.

 

However, there may be another, upcoming glitch in the risk profile of the six-month bill's perceived safety. Last week I wrote a column on the present political debate on raising the debt ceiling. The Congressional Budget Office is now projecting that the U.S. government will run out of cash to pay its bills sometime between July and September. The six-month U.S. note will mature sometime in that time, which puts it squarely in the crosshairs of this partisan battle. It is conceivable that some investors, wary that there may be a government default, are steering clear of the note, while others are willing to take the risk.

 

However, I noticed that both the one-year (5.08 percent) and 18-month (5.01) U.S. Treasury notes are now trading above 5 percent. That indicates to me that the present rise in yields is more about higher interest rates tethered to the Fed's intent to keep interest rates higher for longer than it is about fears of a debt crisis.

 

The question is whether yields on other government debt will follow suit.  Recently, weekly bill auctions have drawn strong demand. However, auctions this week indicated that bond investors, fearing future rate increases, were demanding higher yields. The U.S. Treasury sold $60 billion of three-month bills, $48 billion of six-month bills, and $34 billion of one-year paper as well as auctions of two-, five-, and seven-year notes.

 

For those who are waiting out the volatility in the stock market in cash, short-term U.S. Treasuries could be an interesting purchase right now.

 

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.

 

In a few months, be prepared for politicians of both parties to turn up the heat as the June debt ceiling deadline approaches. Normally, the stock market responds with increased volatility. The question is should investors pay attention at all?

 

That may sound like heresy given that we are talking about the full faith and credit of the United States of America. If the government defaults on its debt, the global repercussions of such an event would be momentous. Currencies would plummet, stocks would crash, and interest rates would soar. Armageddon would reign, or at least that's what is predicted to happen, but no one knows for sure because the U.S. has never defaulted on its fiscal responsibilities.

 

"But there could always be a first time," you might say. And that is exactly why politicians can hold the nation hostage to advance their political careers while making outlandish demands that they know will never become law.

 

Legislation establishing a debt ceiling was passed in 1939. Since then, Congress has revamped the limit 100 times since World War II. Back then, Congress was more heavily involved in federal borrowing, as opposed to today, where the focus is solely on spending. For those who are unaware, the debt limit is not in the Constitution, nor in any of its 27 amendments. It is at best, a statute (law) that gives politicians a chance to disrupt, lie, evade, and create headaches for the country whenever they please.

 

The biggest joke of all is that the debt limit reflects money that has already been spent and is now owed to others. Has it ever stopped Congress from spending more money? No, at most it just redistributes spending into different areas such as more in defense, less in social programs, or vice versa for a short time. Given that serves no policy purpose whatsoever, why have one?

 

Because it is an immense bargaining chip for some.

 

Fear of default gives leverage to those who have none. All that is necessary is to threaten while stretching out any compromise agreement to the last possible moment. By doing so, they are counting on the financial markets to become unwilling negotiators on their behalf. Those leading the opposition to raise the debt limit receive enormous coverage by the media.

 

Demands for programs and legislation, no matter how outlandish, that have nothing to do with the debt limit give politicians a national forum and unearned legitimacy. Debt limits become the saving grace for the economy and the nation for a few short months. However, when they finally do vote to raise the limit, few hear about it.

 

Unfortunately, all this rhetoric seeps into the national consciousness. In a recent poll by the Economist, only 38 percent of U.S. adult citizens (and only 20 percent of Republicans) think Congress should raise the debt ceiling.  Given those numbers, it is no wonder that agreeing to pay the debts we already owe has become an extremely partisan affair.

 

As for those on the other side of the debate, in this case, the Biden administration, there are a variety of avenues available to them if they choose to take them. The U.S. Treasury, for example, could stop making some payments (Social Security and Congressional salaries for example), while coupon and principal payments continue to be paid in full out of tax revenues.

 

A more drastic direction would be to keep the debt ceiling in place, but the Treasury borrows more money anyway arguing that failing to do so would be unconstitutional under the 14th Amendment. They could also mint a trillion-dollar platinum coin that could be used to fund new spending, including debt service on the national debt. The problem with pursuing any of the above would be that it would almost guarantee that the Republicans in Congress would have no incentive to vote to raise the debt ceiling.

 

Democrats have learned some hard lessons by giving in to debt limit demands in the past. Back in 2011, during a clash between former President Obama and the Republican Tea Party, the administration spent months negotiating without success.

 

At the eleventh hour, an agreement was fashioned by Mitch McConnell and some Democrats to avoid a debt default. But the credit markets, spooked by the close call and partisan behavior, downgraded the country's credit ranking for the first time, which resulted in raising the costs of our future borrowings.

 

The facts are that those who threaten default are part of the partisan political process, but some person, group, or party that causes a debt default will go down in flames along with the economy and nation. Politicians know this, or if they don't there are still enough level heads in Washington to get the deal done.

 

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.