Market Update

The S&P 500 fell 4.5% last week to finish at 3857. The Nasdaq declined 4.8%. The S&P peaked for the week Monday morning, rising to 4078.49 in early trading. It failed to break above 4080 despite several attempts over several hours. The index was sliding lower by 12:15. First way wrong way… again. It was downhill for the rest of the week. The S&P didn’t hit its low for the week until 1:45 pm Friday.

The S&P’s decline cut through both the 200-day and 100-day moving averages. The index also fell into the descending trading channel that prevailed last year. The short-term direction is down. Support is at 3800. Next support is the June low at 3639.77 followed by the October low at 3491.58. Resistance starts at 3928.

Of course, fundamentals will have their day, starting with the CPI on Tuesday. The S&P is not going to 3491 without a continuation of bad news. The bad news might be sticky inflation and higher for longer interest rates. It might be a continuing decline in earnings estimates. It could even by a widening of the war in Ukraine.

Earnings and interest rates drive stock markets long-term, not technicals. The next fundamental news will be Tuesday’s CPI report. The CPI number will determine whether the market keeps falling next week or not. A good number will send the market higher, at least for a few days. It's unlikely any rally will be able to clear 4078.49 though. A bad number means more selling and a possible retest of the October low.

Last week it was Powell’s hawkishness that supposedly sent stocks lower. The jobs report Friday added to the negative sentiment as it came in stronger than expected. The failure of SVB bank late last week added to the gloom. Silicon Valley Bank’s failure is the second largest ever. Only Washington Mutual’s failure in 2008 is larger. SVB has over $200 billion in assets.

Fed funds futures showed a near-80% probability of a half-point hike in March before the bankruptcy news, according to Barron’s. The futures market ended the week placing a 60% probability on a quarter-point cut instead. Financial stocks were hit as well. The SPDR S&P Regional Banking ETF fell 16% last week, including 4.4% on Friday. The fear among investors is that more banks will join SVB. Bond prices rose as well in reaction to the news. The two-year Treasury note yield fell 0.31% Friday and is down 0.48% since Wednesday. Big moves for the two-year bond. Moves comparable to those after the October 1987 stock market crash and the 911 terrorist attacks, according to Barron’s.

Lehman Brothers failure in 2008 was described as an isolated incident at first. The SVB failure is being described that way now. Yet the cause of the failure is the sharp rise in interest rates during 2022. SVB was forced to recognize a loss of $1.8 billion when it closed out bond positions recently. Other banks and insurance companies are also sitting on big losses from 2022. It's possible that other financial institutions are experiencing balance sheet stress as well. The Federal Reserve is likely on high alert for signs of contagion.

Paul Ashworth, chief U.S. economist at Capital Economics summarized the risk in a note to clients Friday. “Even if SVB doesn’t trigger a broader financial contagion, it could still lead to a further tightening of credit conditions that tips the economy,” he wrote.

A good CPI report on Tuesday may save the market for now. A bad CPI report will almost certainly lead to a test of 3,800 at a minimum. Meanwhile, the consensus earnings estimate for 2023 has fallen to $221.64. Earnings growth is forecast to be negative for the first two quarters of 2023. Analysts are hoping Q4 bails out 2023 earnings. The estimate is 10% growth for Q4 2023 and growth of 1.3% for the year. It seems unlikely. Earnings are more likely to come in closer to $200, down almost 10% from the current estimate. The stock market is not pricing in an earnings decline of 10%. Norwood Economics expects the S&P 500 to fall 15% or so sometime in the next few quarters as it prices in worse-than-expected 2023 earnings.

Economic Indicators

The big economic news last week was the jobs report. It came in at 311,000, above the 225,000 forecast. Average hourly earnings rose 0.2% in February, below the prior month’s 0.3%. The year-over-year number was 4.6% up from 4.4%. The unemployment rate rose to 3.6% from 3.4% as more people entered the workforce. The share of able-bodied people in the labor force climbed to a three-year high, according to MarketWatch.

The jobs market is strong. It has created an average of 408,000 jobs over the last two months. The unemployment rate ticked up because of people entering the workforce, not from a lack of jobs. The JOLTS report fell to 10.8 million job openings from 11.2 million. The labor shortage persists. Weekly jobless claims rose to 211,000 from 190,000. Jobless claims are still at a low level.

The Federal Reserve has more work to do if it hopes to bring inflation back to 2% by the end of the year.

Index Wins Again

Norwood Economics recommends index mutual funds for those who aren’t stock pickers. Actively managed mutual funds don’t keep up with index funds. A quick refresher for folks. Index funds track an underlying index. An index is created to track a particular asset class. The oldest index is the Dow Jones Industrial Average, created by Charles Dow in 1896. The S&P 500 was created in 1957, but its predecessor dates to 1923. The Russell 1000 index was created in 1984. The Morgan Stanley EAFE index was created in 1969. The EAFE index is an international index.

Today we have dozens of indexes tracking stocks, bonds, real estate, commodities, and even cryptocurrencies. They provide cheap exposure to the various asset classes and subclasses. We also have money managers who are paid a lot of money to beat those indexes. Unfortunately, they don’t. Last year was the 13th year in a row that most active funds underperformed their index benchmark. Standard & Poor’s S&P Indices Versus Active report (SPIVA) shows that index funds are superior to active funds. The longer the period the more lopsided the competition.

The percentage of all domestic funds underperforming is 93.14% after 10 years. It is 95.89% after 10 years for large-cap growth funds. It is 95.91% for large-cap core funds. It is 95.26% for small-cap core funds. It doesn’t get any better after adjusting for risk. Avoid actively managed mutual funds and stick with low-cost index funds.

Norwood Economics uses index ETFs for fixed-income, real estate, and emerging market stock exposure. We use individual stocks for U.S. and developed international exposure. We manage concentrated stock portfolios of 20-25 stocks for our clients. Concentrating on our best ideas while avoiding most of the stock market is an advantage that most mutual fund managers don’t have. They are required to own hundreds of stocks in most cases. No wonder they can’t beat the market when they are forced to mimic the market.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist