Market Update

The S&P 500 fell 0.8% last week to finish at 4136.25. The Nasdaq rose 0.1%. The Fed raised the funds rate by 0.25% Wednesday as expected. It also indicated it may pause its rate hikes. What the Fed didn’t do was give any credence to the idea of rate cuts this year. The bond market is pricing in three rate cuts by year-end. The Fed and the bond market are still at odds.

The S&P hit its high for the week of 4186.92 in early trading Monday. The index bottomed out for the week Thursday morning after falling to 4048.28. Friday’s big up opening was attributed to the jobs report, which came in stronger than expected. A stronger jobs report means less chance of a recession, according to the media. Bonds sold off on the same report. They sold off because it makes Fed rate cuts less likely, again according to the media.

Despite the Friday morning bounce, investors are concerned about the regional banking crisis. They fear it will lead to a credit crunch. The credit crunch will in turn lead to an imminent recession. The two narratives are at odds with one another. Credit crunch and imminent recession on the one hand. A stronger-than-expected jobs number underscoring economic strength and no imminent recession on the other hand. The dueling narratives will resolve at some point. They can’t both be right, at least not at the same time. Jobs are a lagging indicator. An inverted yield curve and restrictive credit are leading indicators. Perhaps resolution lies in the timing.

Regardless, Friday’s labor report casts doubt on the likelihood of a Fed pause, as does the latest wage data. April’s employment report showed a stronger-than-expected gain of 253,000. The unemployment rate fell to 3.4% from 3.5%. The unemployment rate is the lowest since May 1969. Average hourly earnings rose 0.5% in April and by 4.4% year over year. The 0.5% rise was more than expected.

“Based on the current wage data, history says the tightening cycle has yet to reach its peak rate, and the duration of the higher official rate cycle could extend much further than the markets expect,” writes Joseph Carson, former chief economist for AllianceBernstein. The price shocks resulting from the pandemic are becoming embedded in inflation psychology, according to a research note from JPMorgan chief economist Bruce Kasman.

It's unlikely the Fed will cut this year. It’s more likely that the Fed will raise rates again this year. The trimmed mean PCE rose 4.7% year over year through March, unchanged since November 2022. The unemployment rate is at a 54-year low. Wage gains are running at more than 6.0% using a three-month moving average of median wage growth. Interest rates will stay higher for longer. The stock and bond markets will likely struggle for the rest of the year as a result.

Economic Indicators

Economic indicators show an economy that is growing. The S&P U.S. manufacturing PMI was 50.2 in April up from 49.2 the previous month. The S&P 500 U.S. services PMI was 53.6 in April down from 53.7. Numbers above 50 indicate expansion.

Rising labor costs are still a problem. U.S. unit labor costs rose 4.5% in Q1 up from 3.3% in Q4 2022. U.S. hourly wages rose 0.5% in April up from 4.3% the prior month. The labor market is still tight. Initial jobless claims were 242,000, up from 229,000. Continuing jobless claims fell to 1.81 million from 1.84 million. U.S. job openings remained elevated at 9.6 million in March down from 10.0 the prior month.

We are heading toward recession. The inverted yield curve and Leading Economic Index are unambiguous. It might just take longer than expected to arrive.

Extreme Outcomes Rarely Happen

I provided annual 401(k) education to one of our plans last week. The company employees are almost all women. I made a point of encouraging the married women to stay informed about their finances. All too often wives allow husbands to have free rein. Women are at least as competent as men in handling financial planning.

I sat down with a participant who wanted to talk privately. Turns out her husband has gone off the deep end. He has repeatedly asked her to cash out her 401(k) and buy gold or silver with the money. He has already done so with his 401(k). The woman was visibly agitated as she listed her husband’s concerns. The stock market is going to crash. The war in Ukraine is going to widen. The dollar is going to lose all its value. The sky is falling. (I added that last one).

She wanted to know if she should stand her ground or do what he asked. I told her she should stand her ground. The world as we know it may end, but it's unlikely. Meanwhile, you've paid a 10% penalty and income taxes on your retirement funds. Further, you've turned your back on the wealth-building returns needed for retirement. And of course, you might have to quit your job first before you can access your 401(k) account.

Her husband is catastrophizing. He has convinced himself that one or more low-probability events will come to pass.

It is possible but unlikely that the stock market will crash. The economy would need to fall into a depression first. The economy is doing fine. We will have recessions from time to time but those aren't world ending. The Ukrainian war might spread to other European countries. It is unlikely but it could. The United States economy isn't likely to feel much of an impact. Inflation might run a bit hotter but that's about it. After all, there have been wars before, and the U.S. has been fine. In fact, the U.S. was at war for much of the last 35-years. During that period, we had two Gulf wars and the Afghanistan conflict, the latter only ended a few years ago. An expanded war in Europe will have little impact on the U.S. in any case.

There is no chance of the dollar losing most of its value in a short period of time. The dollar is the world’s reserve currency. Central banks hold some 66% of their reserves in dollars. The dollar is used in over 85% of all international trade. There is no current substitute. Nor is there likely to be anytime soon. A substitute would need to be freely convertible. The substitute’s country would need to have deep and liquid capital markets as well. No currency and country exists at present.

In short, the 401(k) plan participant’s husband wants her to do immediate harm to her future. He wants her to take those harmful actions out of fear of being bitten by a shark, struck by lightning, or dying from a tornado. Humans aren’t good at estimating probabilities. It’s why many of us play the lottery. Low probability events are just that, low probability. You shouldn’t act based on those low probabilities. Her husband’s fears shouldn’t result in her suffering.



Ladies, stay involved in the decision making. Make sure you know what you and your spouse have for investments and where those accounts are. Not every husband is a Warren Buffet. In fact, none of them are. It is your future too. Stayed involved in it.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist