The Week Behind

Courtesy of Fed Governor Waller backing 25bps at the next meeting, the major indices enjoyed a comfortable rally to end the week. Last week showcased the tale of two markets that has been developing since late last year. On one side, the tech-heavy, soft landing NASDAQ ended the week 0.55% higher. On the other, the old-economy, recession-resilient DOW fell 2.7%. Not to be forgotten, the S&P 500 finished in the middle-of-the-pack, down 0.66%. 

Highlights

• Registering levels not seen since the COVID-recession, the NY Empire State Manufacturing Index dropped to -32.9 in January. While only applying to New York State, this report suggests employment growth is stalling and inflation is falling.
• Retail sales missed consensus, -1.1% actual versus -0.8% consensus, which implies goods inflation can fall further as consumers continue to moderate spending.
• The Department of the Treasury has found a way to buy Congress until June 5th to resolve the debt ceiling. While this temporarily mitigates associated political risk, these revised estimates are not known for their accuracy. Furthermore, given deep partisan division and recent history, it is unlikely Congress seriously addresses the issue until the deadline.   

A Tale of Two Markets

We have witnessed two kinds of trading days this year. There are “soft landing” days and “hard landing” days. 

On soft landing days, the market sees weak eco-data, allowing the Fed to pause sooner, which takes pressure off of earnings and multiples. As a result, money flows to companies that have the most to benefit from that outcome: technology, software, high-multiple growth. These companies tend to trade on the NASDAQ. 

On hard landing days, the market sees a resolute Fed unimpressed by improved inflation data that will do enduring damage to the economy. As a result, money flows to companies that can perform despite that outcome: healthcare, aerospace/defense, staples, low-multiple value. These companies tend to trade on the DOW.      

Due to its constitution, the S&P 500 sits somewhere in the middle. However, 4000 appears to be the current battleground price. Above it, the market is pricing in a soft landing; below it, the market is pricing in a hard landing. The amount above or below suggests the probability of either outcome.

Last week, we saw both. In my view, these positioning rallies and sell-offs provide opportunities to buy companies that fit your investing objectives and economic thesis at a bargain as well as sell companies at a premium that no longer deserve a place in your portfolio. 

The Week Ahead

This is a loaded week for earnings – bellwether healthcare, defense, energy, housing, travel – with a macro chaser in Friday’s PCE. 

Tuesday, Johnson and Johnson (JNJ) will provide some insight on the different facets of healthcare. Lockheed Martin (LMT) and Raytheon (RTX) will show us if it is safe to dip our toes in defense stocks. DR Horton (DHI) will update us on the housing market. Microsoft (MSFT) will give us a first look on how mega-cap layoffs will play on an earnings call.

Wednesday, we hear from Freeport-McMoRan (FCX) and ASML (ASML). FCX is a diversified mining operation primarily exposed to gold and copper. Their thoughts on those markets imply their view on the dollar and inflation (via gold) and economic activity (copper). ASML is a major player in the semiconductor supply chain.

Thursday, American Airlines (AAL) reports. AAL needs to confirm the bullish narrative surrounding international travel as it could be the key to Europe skirting a recession. 

Friday, we get American Express (AXP). While best known for their credit card, AXP is better characterized as a bank leveraged to the upper-income consumer and travel. I am curious what management has done with their loan loss provision. It will be the best indication of what management really believes with respect to how upper-income households will fare as the economy slows.

PCE for December releases on Friday ahead of the open. Consensus for Core PCE is 4.4%, which feels achievable. Analysts have nailed the number back-to-back, and I have not seen any data to suggest a spike is looming. A cooler print would mark a third consecutive decline in core inflation, strengthening the case for 25bps. However, the market has no reason to expect a hot number. Therefore, a hot number could revive the end-of-week sell-off. Net-net, I am cautiously optimistic.   

The Fed No Longer Appears Data Dependent

Fed-speakers were out in force last week. Each speaker essentially acknowledged inflation data was improving but still feel rates need to get above 5%. This does not sound like a data dependent Fed. It sounds like a Fed hell bent on reaching an arbitrary 5% target, even if the data suggests it is unnecessary. That is why these statements are problematic. They imply the Fed sees the data is changing but is not changing with it. It implies the Fed may be prioritizing their credibility over the economy, even though ruining the economy means further ruining their credibility. While I think this is just more jawboning (posturing) to keep financial conditions tight – in other words, I do not necessarily believe they will do as they say – a Fed driven by factors other than data is troubling.