The $9 Trillion Question
The $9 trillion question (size of the Fed’s balance sheet) which is unnerving the financial markets is whether “normal” monetary policy can be restored without crashing the economy. We have recently and frequently heard the argument that since the strength in the markets and the economy was built on the ultra-accommodative Fed policies, that it therefore follows that the significant hawkish turn in tone will undoubtedly lead to a recession and a bear market. We don’t believe that the conclusion is warranted. The Fed has provided incredible transparencies about their intention to raise to short-term rates up to a target of around 2.5% in 2022, while it shrinks holdings of longer-term bonds which likely will result in the 10-year rate reaching 3.5%. Whereas the timing has been uncertain, this policy shift can’t come as a surprise to anyone with any sense of history and has been widely anticipated by the market. If zero percent interest rates and the Fed buying multiple trillion dollars worth of bonds annually were permanent policies, then stock prices would have no rational ceiling.
Once again it was Fed Speak dictating the mood, with comments from Fed governor Lael Brainard on Tuesday, and the release of the minutes form the March FOMC meeting on Wednesday both highlighting the emphasis on tightening monetary policy to fight inflation. The 10-year Treasury jumped 32 basis points to 2.72%, while the 2-year rate added just 3 basis points to 2.53%. We believe that steepening of the curve will likely continue as the Fed starts unwinding its holdings of longer dated bonds.
Turning to the economic data, we think the highlight was the weekly new claims for unemployment which came in at the lowest level since November 1968! We also view the 2.5% monthly increase in wholesale inventories as a positive sign that companies are navigating the supply chain challenges effectively. From our discussions with corporate managements, as well as from numerous conference calls and conference presentations, it seems clear that businesses are going to maintain larger inventories in the post-Covid world than was the norm in the pre-Covid world.
It was a tough week for equities, particularly the sectors that are considered more aggressive, with the S&P declining 1.3%, the Nasdaq slumping 3.9%, and the Russell 2000 sinking 4.62%. Small-cap stocks are suffering disproportionally due to their economic sensitivity given the mounting fears of a recession. We think terrific bargains are being created as a result. The Dollar and Gold both rallied over 1%, while Crude Oil slipped around 1%. The defensive Health Care and Utility sectors were top performers with gains of 2.5% and 1.5% respectively. The Utility sector outperformance was consistent with quantitative study results we recently published in our quarterly white paper that focused on the convergence of Utility and Energy sectors. The Financial sector suffered a 2.1% loss, which seems illogical given the steepening of the yield curve, possibly creating some interesting bargains. Feel free to contact us if you are interested in our thoughts on that sector.
Consumer Sentiment = Canary in the Coal Mine
Earnings season kicks off with 14 S&P 500 companies reporting results for the first quarter. Aggregate year-over-year earnings are forecasted to rise 6.1%, with most of that gain coming from the Energy sector.
The key economic releases will be the inflation reports with CPI on Tuesday and PPI on Wednesday. Those numbers are expected to be very ugly, with the PPI likely to post an increase of over 10%. As somewhat of a silver lining, inflation expectations are quite high, suggesting a possible positive reaction if the reported inflation statistics are cooler than expected. On a related note, on Thursday the results of the University of Michigan Consumer Sentiment Survey will be released, with a somber 58.9 reading forecasted. By way of reference, that level is substantially below the reading at the height of the pandemic, and similar to the level during the bottom of the 2008-2009 financial crisis. We would be thrilled to see a more upbeat reading, as we believe consumer sentiment is very important to the economy and markets.
U.S. stock and bond markets will be closed on Friday in observance of the Good Friday holiday.
Stocks on the Move
-14.5% LXP Industrial Trust (LXP) is a publicly traded real estate investment trust (REIT) focused on single-tenant warehouse and distribution investments across the United States. LXP seeks to expand its portfolio through acquisitions, development projects, and build-to-suit and sale/leaseback transactions. Last week, LXP announced its Board of Trustees had unanimously voted to suspend the Company’s previously announced strategic alternatives process. The Board members feel it would be best for the Company to continue to operate independently, but also remain open to future opportunities to maximize shareholder value.
-10.6% Qualcomm Incorporated (QCOM) operates as a multinational semiconductor and telecommunications equipment company. The Company develops and delivers digital wireless communications products and services based on code-division multiple access (CDMA) technology. J.P. Morgan cut its earnings estimates and price target for the Company noting a weak outlook for the Chinese smartphone market.
-16.5% Sono Group N.V. (SEV) manufactures and sells electric cars with integrated solar cells and panels. In addition, the Company monetizes its variable battery technology for integration in numerous types of vehicles, including buses, trucks, camper vans, trains, and boats, as it aims to reduce carbon emissions and provide clean and affordable transportation for the masses. Electric vehicle stocks fared poorly last week as Covid cases surge in Shanghai, causing concern around future supply chain distress.
-10.4% Starbucks Coffee Company (SBUX) has been committed to ethically sourcing and roasting high-quality arabica coffee since 1971. Today, with more than 34,000 stores worldwide, the company is the premier roaster and retailer of specialty coffee in the world. Starbucks slid last week as former CEO Howard Schultz announced he will be stepping back into his chief executive position for the third time in addition to suspending the company’s $20 billion buyback program.
+10.0% Target Corporation (TGT) operates general merchandise discount stores. The Company focuses on merchandising operations which includes general merchandise and food discount stores and a fully integrated online business. Target also offers credit to qualified applicants through its branded proprietary credit cards. Target rallied after Barclays analyst Karen Short presented the stock as a “best-in-class retailer at a sizable discount.”
-11.0% United Parcel Service Inc (UPS) delivers packages and documents throughout the United States and in other countries/territories. The Company also provides global supply chain services and less-than-truckload transportation; primarily in the United States, UPS’s business consists of air and group pick-up and delivery networks. Bank of America downgraded a slew of transportation stocks, including UPS, citing “deteriorating demand and falling prices.”
-11.9% Sharps Compliance Corp (SMED) operates as a provider of waste management services. The Company offers containment, transportation, treatment, and tracking of medical waste, and the disposal of unused medications as well as other used health care materials. Last week, the Company announced it had appointed Patrick Mulloy as its new CEO, replacing David Tusa. Mulloy has over 20 years of experience in the senior housing and long-term care industry.
+11.9% Value Line Inc (VALU) produces investment related periodical publications. The Company also provides investment advisory services to mutual funds, institutions, and individual clients. All total, Value Line collects data and provides analysis on around 7,000 stocks, 18,000 mutual fund and 200,000 options. There was no significant company news last week.
+19.4% Q.E.P. Co Inc (QEPC) manufactures, markets, and distributes tools and related products for the home improvement market. The Company’s brand names include QEP, O’Tool, and Roberts. Products include trowels, floats, tile cutters, wet saws, spacers, nippers, and pliers that are marketed for the use in surface preparation and installation of ceramic tile, carpet, marble, and drywall. There was no significant company news last week.
The stocks mentioned above may be holdings in our mutual funds. For more information, please visit www.nsinvestfunds.com.