More Investors Realize the Fed Isn’t Bluffing
02/27/2023
Stocks closed lower in a holiday-shortened week, with the S&P 500 Index ending down 2.7%. The NASDAQ Composite slid 3.3%, down for a third-straight week, while the Dow Jones Industrials Average finished lower by 3.0%. The NASDAQ saw its worst week since early December, while the Dow has given back all its January gains and is now slightly lower on the year. The broader S&P 500 finished below the 4,000 level last week, with Growth and Value each declining by 2.5% or more. Yet, despite giving back some of their January price returns this month, the S&P 500 and NASDAQ continue to hold year-to-date gains.
Importantly, Treasury prices weakened across the curve, with the 2-year Treasury yield finishing the week at 4.80% and the 10-year yield ending at 3.95%. The Fed-sensitive 2-year jumped above 4.80% on Friday — the highest level since 2007. Notably, current yields are meaningfully higher than where they stood in mid-January. As a result, Treasuries and other conservative assets currently offer investors competitive returns for less risk compared to stocks. On the margin, stocks are seeing increased competition from bonds and money market funds this month. We believe this dynamic is contributing to the outflows seen across equity funds in February.
Interestingly, the 2-year/10-year U.S. Treasury spread continues to sit at some of its most inverted levels since the early 1980s. Over the last three U.S. economic downturns, a U.S. recession has followed once the 2-year/10-year spread has inverted (i.e., turned negative). Today, the mixed signals coming from economic data, combined with slowing earnings trends, rising yields, and a Fed determined to bring down inflation, have stock investors concerned the central bank will continue tightening monetary policy right into the next recession.
Investors With a Bullish Outlook Continue to Hold onto a ‘Soft Landing’ Scenario; The Bears Can Quickly Point to Headwinds
But the bulls continue to look through the backup in rates and an inverted yield curve, focusing instead on a solid labor market and positive macroeconomic surprises, such as the Citi Economic Surprise Index sitting at its highest level since April 2022. A soft-landing scenario is the central theme across this camp, with still benign credit conditions and consumer resilience as the pillars of support against a tightening Federal Reserve. But the bears can quickly point to equity headwinds, including a sharp backup in rates, falling earnings estimates, a higher for longer terminal rate, and stretched stock valuations. Combined, these bull/bear market dynamics show the investing environment remains highly fluid and uncertain at the moment, arguing for caution and a disciplined investment approach.
Outside of stocks and bonds, the U.S. Dollar Index rose +1.3% last week — posting its best week since September. The dollar has posted gains over four straight weeks following the steep decline from its September high to its late January low. West Texas Intermediate (WTI) crude settled the week down 0.3%, while Gold ended down 1.8%.
On the economic front, growth in the final quarter of last year, while positive, was less robust than initially reported after a second look at the data. Q4’22 U.S. GDP expanded +2.7% quarter over quarter annualized, following an initial reading of +2.9%. While the slight difference does little to alter the overall assessment of the final quarter of last year, hotter-than-expected inflation during the period reduced growth in real terms. Given that hotter-than-expected inflation trends are the Fed's primary focus today, the reduced growth in Q4 (due to higher prices) didn’t sit well with investors. Importantly, the Fed’s preferred inflation gauge also came in hotter than expected for January. Core Personal Consumption Expenditures (PCE) rose +4.7% year-over-year in January, well above the +4.3% expected. Along with upward PCE revisions for December and strong consumer spending in January, last week’s economic updates were not very market friendly. Meaning the Fed’s work to curb inflation and cool demand remains incomplete, which could pose more headwinds for stock prices in the months ahead.
The Fed Continues to See Inflation as a Key Risk to Price Stability, Meaning They Will Likely Push Rates Higher for Longer
Regarding the Fed’s work, February FOMC meeting minutes showed all officials supported a 25-basis point hike at this month’s meeting, with a few favoring a 50-basis point move. And while all officials saw the benefit of slowing the pace of rate hikes, officials that supported a 50-basis point move believed moving quickly to a higher terminal rate would achieve sufficiently restrictive policy faster. As a result, the odds of a 50-basis point hike in the fed funds rate at the March meeting currently stands at 27%. One month ago, the figure was zero. Importantly, the minutes did not mention the term “disinflation” or make reference to a pause in rate hikes. Bottom line: The Fed continues to see inflation as a key risk to price stability, believes higher rates will likely help curb price pressures and is not signaling they are close to a pause, let alone considering cutting rates. Stocks dipped lower last week as more investors came around to the idea that the Fed will likely keep pushing rates higher this year and leave them at a higher rate for longer than was priced into the market just last month.
Looking ahead to this week, the economic calendar slows, with durable orders, home data, consumer confidence, and final looks at February manufacturing and services activity as the highlights. February manufacturing activity is expected to show levels remain in contraction while services activity continues to expand. And while the industrial side of the U.S. economy has been facing headwinds and slowing activity for months, the services side continues to experience tailwinds from pent-up demand, a tight labor supply, and an ability of companies to pass on costs. In addition, consumers focused on experiences, going to events, eating out, and traveling has contributed to a still strong services economy. Although we believe no one on the Federal Reserve wants to break the economy, expanding services activity (which could drive wages higher) certainly complicates the Fed’s job to curb inflation.
Companies Continue to Focus on Inflation and Controlling Costs; Stocks Remained Volatile as February Comes to a Close
In addition, the fourth quarter earnings season finally winds down this week, with 28 S&P 500 companies scheduled to report their results. With roughly 94% of S&P 500 fourth quarter reports complete, blended earnings per share (EPS) growth is down 4.8% year-over-year on revenue growth of +5.4%. The Index is on pace to record its first year-over-year EPS decline since Q3’20, with only 68% of S&P 500 companies surpassing earnings estimates. Notably, S&P 500 net profit margins declined in the fourth quarter, with nine of eleven sectors seeing margins pressured in the final three months of 2022. According to FactSet, fewer companies mentioned the term “inflation” on their fourth quarter earnings calls and relative to previous quarters. But the term remained a prominent theme across company commentaries and outlooks. Combined with reduced outlooks for net profit margins in the first quarter of this year, inflation, and companies’ ability to manage costs, remain a front-and-center issue for corporate America.
Finally, we expect stocks to remain volatile as February comes to a close and the final month of the first quarter kicks off this week. In its simplest form, volatility has been rising this month, as measured by the CBOE Volatility Index. Volatility in the S&P 500 Index is now above its three-month average but remains near its five-year average of 21. Bottom line: While February was more volatile for stocks, following the outsized jump in equity prices in January, some price giveback should be expected. However, how much giveback is appropriate is the real question. We suspect it will likely depend on how rates, the Fed, and macroeconomic conditions develop over the coming weeks and months. In our view, a cautious, disciplined approach that doesn’t lean too aggressively defensive is how most investors in the accumulation stage of their lives should navigate the current environment.
Important Disclosures
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources. This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor.
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
The fund’s investments may not keep pace with inflation, which may result in losses.
A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund’s income and yield. These risks may be heightened for longer maturity and duration securities.
Past performance is not a guarantee of future results.
An index is a statistical composite that is not managed. It is not possible to invest directly in an index.
The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees. It is not possible to invest directly in an index.
The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.
The Dow Jones Industrial Average (DJIA) is an index containing stocks of 30 Large-Cap corporations in the United States. The index is owned and maintained by Dow Jones & Company.
Definitions of individual indices and sectors mentioned in this article are available on our website at ameriprise.com/legal/disclosures in the Additional Ameriprise research disclosures section.
A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.
West Texas Intermediate (WTI) is a grade of crude oil commonly used as a benchmark for oil prices. WTI is a light grade with low density and sulfur content.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
The Personal Consumption Expenditure Index tracks the overall price changes for goods and services purchased by consumers.
The Chicago Board of Options Exchange (CBOE) Volatility Index® (VIX®) Index is based on real-time prices of options on the S&P 500® Index (SPX) and is designed to reflect investors' consensus view of future (30-day) expected stock market volatility.
Citigroup Economic Surprise Index (CESI) are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises. A positive reading suggests that economic releases have on balance been beating consensus.
Third party companies mentioned are not affiliated with Ameriprise Financial, Inc.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Ameriprise Financial Services, LLC. Member FINRA and SIPC.
Importantly, Treasury prices weakened across the curve, with the 2-year Treasury yield finishing the week at 4.80% and the 10-year yield ending at 3.95%. The Fed-sensitive 2-year jumped above 4.80% on Friday — the highest level since 2007. Notably, current yields are meaningfully higher than where they stood in mid-January. As a result, Treasuries and other conservative assets currently offer investors competitive returns for less risk compared to stocks. On the margin, stocks are seeing increased competition from bonds and money market funds this month. We believe this dynamic is contributing to the outflows seen across equity funds in February.
Interestingly, the 2-year/10-year U.S. Treasury spread continues to sit at some of its most inverted levels since the early 1980s. Over the last three U.S. economic downturns, a U.S. recession has followed once the 2-year/10-year spread has inverted (i.e., turned negative). Today, the mixed signals coming from economic data, combined with slowing earnings trends, rising yields, and a Fed determined to bring down inflation, have stock investors concerned the central bank will continue tightening monetary policy right into the next recession.
Investors With a Bullish Outlook Continue to Hold onto a ‘Soft Landing’ Scenario; The Bears Can Quickly Point to Headwinds
But the bulls continue to look through the backup in rates and an inverted yield curve, focusing instead on a solid labor market and positive macroeconomic surprises, such as the Citi Economic Surprise Index sitting at its highest level since April 2022. A soft-landing scenario is the central theme across this camp, with still benign credit conditions and consumer resilience as the pillars of support against a tightening Federal Reserve. But the bears can quickly point to equity headwinds, including a sharp backup in rates, falling earnings estimates, a higher for longer terminal rate, and stretched stock valuations. Combined, these bull/bear market dynamics show the investing environment remains highly fluid and uncertain at the moment, arguing for caution and a disciplined investment approach.
Outside of stocks and bonds, the U.S. Dollar Index rose +1.3% last week — posting its best week since September. The dollar has posted gains over four straight weeks following the steep decline from its September high to its late January low. West Texas Intermediate (WTI) crude settled the week down 0.3%, while Gold ended down 1.8%.
On the economic front, growth in the final quarter of last year, while positive, was less robust than initially reported after a second look at the data. Q4’22 U.S. GDP expanded +2.7% quarter over quarter annualized, following an initial reading of +2.9%. While the slight difference does little to alter the overall assessment of the final quarter of last year, hotter-than-expected inflation during the period reduced growth in real terms. Given that hotter-than-expected inflation trends are the Fed's primary focus today, the reduced growth in Q4 (due to higher prices) didn’t sit well with investors. Importantly, the Fed’s preferred inflation gauge also came in hotter than expected for January. Core Personal Consumption Expenditures (PCE) rose +4.7% year-over-year in January, well above the +4.3% expected. Along with upward PCE revisions for December and strong consumer spending in January, last week’s economic updates were not very market friendly. Meaning the Fed’s work to curb inflation and cool demand remains incomplete, which could pose more headwinds for stock prices in the months ahead.
The Fed Continues to See Inflation as a Key Risk to Price Stability, Meaning They Will Likely Push Rates Higher for Longer
Regarding the Fed’s work, February FOMC meeting minutes showed all officials supported a 25-basis point hike at this month’s meeting, with a few favoring a 50-basis point move. And while all officials saw the benefit of slowing the pace of rate hikes, officials that supported a 50-basis point move believed moving quickly to a higher terminal rate would achieve sufficiently restrictive policy faster. As a result, the odds of a 50-basis point hike in the fed funds rate at the March meeting currently stands at 27%. One month ago, the figure was zero. Importantly, the minutes did not mention the term “disinflation” or make reference to a pause in rate hikes. Bottom line: The Fed continues to see inflation as a key risk to price stability, believes higher rates will likely help curb price pressures and is not signaling they are close to a pause, let alone considering cutting rates. Stocks dipped lower last week as more investors came around to the idea that the Fed will likely keep pushing rates higher this year and leave them at a higher rate for longer than was priced into the market just last month.
Looking ahead to this week, the economic calendar slows, with durable orders, home data, consumer confidence, and final looks at February manufacturing and services activity as the highlights. February manufacturing activity is expected to show levels remain in contraction while services activity continues to expand. And while the industrial side of the U.S. economy has been facing headwinds and slowing activity for months, the services side continues to experience tailwinds from pent-up demand, a tight labor supply, and an ability of companies to pass on costs. In addition, consumers focused on experiences, going to events, eating out, and traveling has contributed to a still strong services economy. Although we believe no one on the Federal Reserve wants to break the economy, expanding services activity (which could drive wages higher) certainly complicates the Fed’s job to curb inflation.
Companies Continue to Focus on Inflation and Controlling Costs; Stocks Remained Volatile as February Comes to a Close
In addition, the fourth quarter earnings season finally winds down this week, with 28 S&P 500 companies scheduled to report their results. With roughly 94% of S&P 500 fourth quarter reports complete, blended earnings per share (EPS) growth is down 4.8% year-over-year on revenue growth of +5.4%. The Index is on pace to record its first year-over-year EPS decline since Q3’20, with only 68% of S&P 500 companies surpassing earnings estimates. Notably, S&P 500 net profit margins declined in the fourth quarter, with nine of eleven sectors seeing margins pressured in the final three months of 2022. According to FactSet, fewer companies mentioned the term “inflation” on their fourth quarter earnings calls and relative to previous quarters. But the term remained a prominent theme across company commentaries and outlooks. Combined with reduced outlooks for net profit margins in the first quarter of this year, inflation, and companies’ ability to manage costs, remain a front-and-center issue for corporate America.
Finally, we expect stocks to remain volatile as February comes to a close and the final month of the first quarter kicks off this week. In its simplest form, volatility has been rising this month, as measured by the CBOE Volatility Index. Volatility in the S&P 500 Index is now above its three-month average but remains near its five-year average of 21. Bottom line: While February was more volatile for stocks, following the outsized jump in equity prices in January, some price giveback should be expected. However, how much giveback is appropriate is the real question. We suspect it will likely depend on how rates, the Fed, and macroeconomic conditions develop over the coming weeks and months. In our view, a cautious, disciplined approach that doesn’t lean too aggressively defensive is how most investors in the accumulation stage of their lives should navigate the current environment.
Important Disclosures
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources. This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor.
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
The fund’s investments may not keep pace with inflation, which may result in losses.
A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund’s income and yield. These risks may be heightened for longer maturity and duration securities.
Past performance is not a guarantee of future results.
An index is a statistical composite that is not managed. It is not possible to invest directly in an index.
The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees. It is not possible to invest directly in an index.
The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.
The Dow Jones Industrial Average (DJIA) is an index containing stocks of 30 Large-Cap corporations in the United States. The index is owned and maintained by Dow Jones & Company.
Definitions of individual indices and sectors mentioned in this article are available on our website at ameriprise.com/legal/disclosures in the Additional Ameriprise research disclosures section.
A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.
West Texas Intermediate (WTI) is a grade of crude oil commonly used as a benchmark for oil prices. WTI is a light grade with low density and sulfur content.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
The Personal Consumption Expenditure Index tracks the overall price changes for goods and services purchased by consumers.
The Chicago Board of Options Exchange (CBOE) Volatility Index® (VIX®) Index is based on real-time prices of options on the S&P 500® Index (SPX) and is designed to reflect investors' consensus view of future (30-day) expected stock market volatility.
Citigroup Economic Surprise Index (CESI) are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises. A positive reading suggests that economic releases have on balance been beating consensus.
Third party companies mentioned are not affiliated with Ameriprise Financial, Inc.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Ameriprise Financial Services, LLC. Member FINRA and SIPC.
