Stocks have been trading in a narrow range in recent months, with the S&P 500 yo-yoing between about 3,700 and 4,150 since last September, as economic uncertainty over inflation – and the response by the Federal Reserve (Fed) – continues.
The Fed’s monetary tightening policies, including rate hikes totaling 4.75%, have been effective in decelerating some sectors of the economy, but other areas have been slow to respond. The housing market has been rattled by higher mortgage rates, energy prices have dropped significantly off their peak, corporate earnings growth has slowed, and manufacturing output has declined. But, while corporate layoffs have increased, employment is still strong, consumers have been spending at a healthy clip, and inflation remains at an annualized level of around 6%.
The Consumer Price Index (CPI), a common gauge of inflation, was up 0.5% in January and 6.4% over the previous 12 months, according to the Feb. 14 Bureau of Labor Statistics report. Excluding food and energy, the index was up 0.4 % in January and 5.6% year-over-year. The only category that was down from a year ago was used vehicle prices, down 11.6%. By contrast, the price of new cars was up 5.8% from a year ago. The category with the largest increase outside of food and energy was transportation services, up 14.6%, although much of that increase was due to higher fuel costs.
Consumer spending was up in January, according to the latest report from the Department of Commerce issued Feb. 24. Personal consumption expenditures (PCE) jumped 1.8% over the previous month in January after declining 0.2% in December and 0.1% in November.
The PCE price index was up 0.6% in January, reflecting continuing inflation, and it was up 5.4% from a year earlier. Excluding food and energy, the index was up 4.7% year-over-year. Personal disposable income soared 2.0% in January, which equaled the increases from the three previous months combined. The sharp rise in income could be attributed, in part, to inflation-related salary increases.
The manufacturing sector continues to be adversely affected by the Fed hikes, with activity declining in February for the fourth straight month after 30 consecutive months of growth, according to the Institute for Supply Management (ISM) report issued March 1. Only four of the 18 industries tracked by ISM reported growth in manufacturing activity in February. According to the report, manufacturers have reported a decline in new orders, backlogs, and production activity, and an increase in prices. On the bright side, the earlier supply shortage problems seem to have improved, with faster delivery times and an increase in raw material inventories.
Outlook: The Fed is expected to raise rates again at its March 22 meeting. It has already hiked rates 4.75% in an effort slow the economy and curb inflation. While the hikes have driven down rising costs in some areas of the economy, prices are still rising in other areas. The March increase is expected to be in the range of 0.25% to 0.50%
As a result of the Fed hikes, income investors and savers are finally earning a meaningful return on bonds and money market funds. Currently, money market funds offer yields of approximately 4%, and those yields are expected to rise as the Fed approves further rate hikes. However, after factoring in inflation, “real” inflation-adjusted returns are closer to 0%.
Through the first two months of 2023, 12-month advanced earnings projections for S&P 500 companies have declined by 1.42%. As the economic growth slows, corporate earnings could continue to weaken in the short term, due to the impact of inflation on rising wages, corporate cost structures, and higher input costs.
Investors should be prepared for higher interest rates for an extended period as the Fed holds short-term rates at a high level. Longer-term interest rates, however, are likely close to peak levels as markets increasingly price in a slower economy and a possible recession in response to the Fed’s rate hikes, which act as a lag on economic activity.
In the equity market, we’ve already seen a rebound this year in the NASDAQ, which was up about 12% through March 6, with technology stocks leading the way. We are relatively close to home in our overall equity positioning, with a modest overweight in equities versus fixed income. The overweight is concentrated in domestic equities, and, in particular, small and mid-cap stocks, where valuations also look relatively attractive.
U.S. stocks sink
The S&P 500® Index was down 2.61% in February, from 4,076.60 at the January close to 3,970.15 at the end of February, as concerns mounted over lingering inflation. The total return of the S&P 500 (including dividends) was -2.44%. The total return for the year through February was 3.69%. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 large capitalization stocks.)
The NASDAQ Index was down slightly in February. It dipped 1.11%, from 11,584.55 at the end of January to 11,455.54 at the February close. But for the year, the NASDAQ was up 9.45% through February, as technology stocks rebounded off large losses in 2022. (The NASDAQ – National Association of Securities Dealers Automated Quotations – is an electronic stock exchange with more than 3,300 company listings.)