Ryan P. Johnson, CFA, CFP® - Managing Director of Investments
Last month, we noted that the early January stock market rally seemed to be signaling “mission accomplished” by the Fed and inflation. Stocks have continued to rally since then, but the Fed headwind is not abating just yet. Recent reports on employment and inflation point to more Fed Funds rate hikes than the market expected just a month ago.
The Federal Reserve has a stated dual mandate of pursuing both price stability and maximum employment. With 3.4% unemployment marking a 50-year low, the maximum employment box is clearly checked. The Fed has been raising short-term interest rates to slow the economy by making borrowing more expensive. This is an attempt to bring inflation back down closer to its preferred level of 2%. As expected, the Fed raised rates by 0.25% on February 1st and is very likely to raise rates again on March 22nd. Odds of further rate hikes in May and June have recently increased, which would push short-term rates above 5%. The Fed may continue raising rates until it sees higher unemployment, which would go hand-in-hand with slower wage gains, which in turn would ease pressure on inflation growth. Of its dual mandate, the Fed is currently much more concerned with price stability and seems willing to sacrifice jobs to reach its inflation target.
Inflation and economy:
The CPI (Consumer Price Index) report for the month of January was 6.4%, showing slower inflation for the seventh month in a row. The PPI (Producer Price Index) report was 6.0%, yet another improvement from the prior month’s reading. The latest monthly read on manufacturing still shows contraction, while the larger services portion of the economy flipped back into growth territory in January.
Interest rates have increased over the past month: 3-month Treasury yields rose slightly to reflect the coming Fed rate hikes while 2-, 5-, and 10-year yields have increased 0.35-0.50%. Recently, the 3-month Treasury yield was 4.66% while the 10-year yield was 3.85%. Interest rates declined into the end of January and mortgage activity increased as 30-year mortgage rates approached 6%. In a late 2022 report, it was noted that the average age of first-time homebuyers was 36 and the median distance between moves was 50 miles, both record highs in decades of data.
With weak sentiment headed into earnings season, stocks rallied even though the overall sales and earnings “beat” rates were below average. The S&P added to Q4 gains with a gain of 6.3% in the month of January. In the past 70 years, when the S&P gained at least 4% in January after posting a decline in the prior year (eight instances), the index rallied at least 10% for the remainder of the year all eight times. From its closing low on October 12, 2022, the S&P 500 has not yet rallied 20% to officially start a new bull market. Recently the index was about 4% below that threshold, which is 4292.5.
We recently released a 4-minute video, Where Do Stock Returns Come From? that can also be found at www.mybuckingham.com under Resources – Video Library.
We were recently asked to discuss share repurchases, or stock buybacks. Buybacks are when a company buys its own stock on the open market with cash. Neither buybacks nor dividends are tax deductible to a company. Theoretically, the buyback is better because it does not force income onto the shareholder, but it also is less of a commitment from the company and typically does not warrant a higher valuation multiple. Assuming a stock’s valuation stays the same, with a lower share count the stock price should increase in proportion with the buyback. Decades ago, buybacks were viewed as manipulation, but it is now a normal practice. Not all buybacks add value and not all buybacks decrease share count, but instead may be used to offset dilution from stock options or mergers and acquisitions (M&A) activity.
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