John Gorlow
| Mar 10, 2023
Following a January rally, markets slumped in February after new reports signaled stubborn strength in the U.S. economy and job market. Investors hoping to see slower, smaller interest rate hikes had their hopes dashed when Fed Chair Jerome Powell indicated that additional tightening was likely necessary. Uncertainty deepened, even as the impacts of rate hikes began gathering like clouds over the economy, notably in construction, commercial real estate, and by early March, banking. We’ll look at the Fed’s tightrope act followed by a brief review of February markets.
What Now, Chairman Powell?
Once again markets are focused on how fast and how high rates are likely to rise. Will bold action by the Fed tip the economy into recession? Conversely, will smaller hikes steps require more aggressive action down the road?
Investors parsed Chairman Powell’s comments to Congress in early March. With the next Central Bank meeting several weeks away, Powell crafted his responses using the future tense, as if to say, we really don’t know where we’re going with this. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” he said, adding that “the ultimate level of interest rates is likely to be higher than previously anticipated.”
The prospect of faster, higher rates made markets dip, then regain their footing, perhaps reflecting the Fed’s own uncertainty. “The fact that a bigger move is again on the table underscores how much recent reports … have unsettled and confused policymakers,” reported the New York Times (Jeanna Smialek, 8-March).
Some members of Congress wanted Powell to state the obvious: that higher rates will drive up unemployment with a disproportionately painful impact on working class Americans. Powell responded that “Inflation is extremely high, and that is hurting the working people of this nation badly.” There was no discussion about the alarming depletion of savings and rising credit card debt that millions of lower-income households are grappling with as rates increase.
The Fed is walking a tightrope and pundits can only guess about future decisions and the cascading impacts of those decisions. It’s easy to point to the Fed’s earlier mistakes and applaud the aggressive action it has since taken. But with Powell hinting that future rate hikes are likely to be both higher and faster, it appears that the Fed’s goal now is to get inflation under control at any cost. This leaves investors searching for signs of recession. And they will certainly find it in headlines from PBS to CNN to Fox News, all seeming to support the idea that recession is on the way, if not already here.
All predictions must be taken with a grain of salt. Not all economic decline is due to higher interest rates. For instance, construction job losses topped 61,000 in February, driven by declining investment in commercial projects as well as severe winter weather. Crypto banks are failing, many of them victims of their own hubris. And this week we saw the collapse of Silicon Valley Bank, a regional lender to start-ups and venture capitalists. Did interest rates play a role in these failures? Yes, but cheap money also contributed to greed and stupid decisions.
Recessions always cause pain, as do rising interest rates. We’re all connected to the same underlying economic system. But guessing at the future trajectory of rate increases, unemployment and recession is of little help to the long-term investor. At Cardiff Park we stress-test client portfolios against a range of outcomes with individual long-term goals in mind. We don’t risk our clients’ capital on unproven investments or look for ways to outsmart the markets. We cannot control market risk, but we can establish parameters based on proven financial knowledge to modulate personal risk in the best and worst market environments. Right now our economy is in an extraordinary place, where even the Chairman of the Federal Reserve is guessing which way the wind will blow next month and the month after that. Trust your plan and your strategy, and hold on for the ride.
Do you have questions about your portfolio or asset allocation? Call me, I am here to help.
Regards,
John Gorlow
President
Cardiff Park Advisors
888.332.2238 Toll Free
760.635.7526 Direct
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February Market Snapshot
February markets responded swiftly to news that inflation had barely budged. In January versus December, rates of annual U.S. headline and core CPI slowed from 6.5% to 6.4% and 5.7% to 5.6%, respectively. Inflation also eased in Europe and the U.K., but remained notably higher than in the U.S.
The S&P 500 Index shed -2.44% in February but is holding on to a gain of 3.4% for the year. Non-U.S. developed markets stocks modestly outperformed U.S. stocks, while emerging markets stocks plunged and underperformed.
Most sectors of the S&P 500 Index declined in February. The information technology sector was the only positive performer, up 0.5%, while the energy sector was the weakest, down 7%.
In the U.S., small-cap stocks generally fared better than large-cap stocks, and growth stocks outpaced value stocks. In non-U.S. developed markets, large-cap stocks slightly outperformed, and value stocks generally outpaced growth stocks.
Amid ongoing inflation and interest rate worries, U.S. Treasury yields rose for the month. Bond returns broadly declined in February.
Fixed-Income Returns
Treasury yields reversed course from January and moved higher in February. All main sectors of the U.S. bond market declined for the month.
The Bloomberg U.S. Aggregate Bond Index returned -2.59% in February, as the investment-grade corporate bond and MBS sectors underperformed.
Wider credit spreads and rising yields weighed on investment-grade corporate bonds and mortgage-backed securities (MBS). Treasuries also declined but outperformed the broad bond market.
High-yield corporate bonds declined but outperformed investment-grade corporates.
Expectations for the Fed to lift rates higher than previously estimated drove the two-year Treasury yield 61 bps higher to 4.82%. The 10-year Treasury yield climbed 41 bps to 3.92%, and the yield curve remained inverted.
Annual headline CPI eased slightly in January, even as costs for food, energy, shelter and transportation services rose sharply. Meanwhile, the pace of monthly inflation increased from 0.1% in December to 0.5% in January, largely due to rising energy prices.
Municipal bonds declined but outperformed Treasuries and the broad U.S. investment-grade bond index.
Although TIPS declined for the month, they outperformed nominal Treasuries amid renewed inflation worries.