Market Update: February 3, 2023

The 2022 rally continues for the equity markets. Last week, the S&P 500 broke through the year long downtrend line and hasn’t turned back since. Currently, the market is up about 17% from the October bottoms.

In the news this week, the European Central Bank raised their benchmark rate by 50 basis points. The tech giants are struggling a bit this quarter to generate the same amount of growth they’re use to. And earlier this week, the Federal Reserve raised its benchmark rate by 25 bps and signaled there would be another increase again in March.

Now that we’re about a year into this rate hiking cycle, the question remains, how high will the Federal Reserve raise its benchmark rate? While I don’t think we’re at the end here, I do think we’re getting pretty close as the Fed appears to be sufficiently tight on money supply and is driving down inflation. The Core Personal Consumption Expenditures index, shown here in blue, is a reasonable way of measuring expenditure costs for the typical consumer. It has obviously spiked throughout 2021 and has started to fall beginning in 2022. Currently, the Fed Funds rate, shown in red, is above the Core PCE rate which is typically a decent marker for when the Fed is sufficiently tight on the economy. Likewise, growth of M2 money supply continues to collapse and has even reached negative territory meaning there is less cash in the economy today than there was a year ago. Typically you don’t see M2 growth collapse like this unless there is significant economic pressure.

Despite the strong rally in the equity markets, the bond market is signaling the opposite. The yield curve, shown here, is deeply inverted meaning that investors are willing to accept less return on 30 year bonds than with 6 month bonds. Typically, long term bonds come with more risk due to the long-time frame. So, for investors to accept less return on the 30 year implies that the short-term bonds have higher risk. It is unusual for the bond and equity markets to signal completely opposite economic outcomes like this.

So if we assume the bond market is correct, and we’re due for a recession, the question for the equity markets is: “was the October -25% bottom, THE bottom for the equity markets?” If the recession hits sometime this spring or summer and we don’t retest those -25% lows, then that would mean equity markets bottomed before the recession began. Even if this is the most telegraphed recession ever, never in the history of the United States have equity markets bottomed before a recession began.

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Sources:

1.FactSet Research Systems. (n.d.). S&P 500 (Interactive Charts). Retrieved February 3, 2023, from FactSet Database.

2.FactSet Research Systems. (n.d.). Core PCE & Fed Funds Target Rate (Interactive Charts). Retrieved February 3, 2023, from FactSet Database.

3.FactSet Research Systems. (n.d.). M2 Money Supply YoY% (Interactive Charts). Retrieved February 3, 2023, from FactSet Database

4.FactSet Research Systems. (n.d.). US Government Yields (Interactive Charts). Retrieved February 3, 2023, from FactSet Database

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