Key Takeaways
  • The S&P 500 closed at 4,392.65 down from 4,488.46 Friday. The VIX closed at $22.60.
  • More hot inflation data came in. CPI was 8.5% and PPI was a whopping 11.2%. Despite this development expectations for Fed hikes for the year fell.
  • Bank earnings showed a wide divergence. Banks like Goldman and Morgan Stanley beat because of trading revenues while more consumer-oriented Wells Fargo missed.
  • The War in Ukraine continues to rage, and a Russian offensive has started. The prospect of Marine La Pen getting elected in France could be problematic for Western unity.

The market had another down week. While last week was firmly led by defensives, this week showed a bit more of a mix. Technology and Communication Services were the main losers. Energy, Materials, and Staples led but Consumer Discretionary and Industrials were also slightly in the green as well. Elon Musk’s Twitter saga continued, and the world’s richest man made an offer to buy Twitter for about $43 billion, or $54.20 per share. Mr. Musk of course also used the opportunity to criticize the SEC and even called some at the agency “bastards.” Musk has spoken about his vision as making Twitter a more inclusive arena for free speech: a digital town square.

More hot inflation data came in and markets certainly didn’t act as you might expect. If you thought that the highest inflation numbers in four decades would result in Fed Futures pricing in more hikes, you would be wrong. Even though these incredibly high readings came in, the expectation for Fed Futures hikes for 2022 declined from an expectation of 9 to an expectation of 8. However, there were still some worrying elements in the report. Food, energy, and shelter costs all were a bigger portion of the gains than in previous months. Given the prominence of these items in the average consumer wallet, some fear that inflationary pressure is on the way to curtailing growth. However, there is also evidence that some contributors to inflation, like used cars, will begin negatively impacting the headline number. Our Head of Research, Tom Lee, will walk you through some of his nuanced thinking on inflation and why our base case is that we are near a peak despite the doom and gloom being professed across the Street.

Many pundits have been casting doubt on the Fed’s stated intention of achieving a soft landing. Some at the Fed have said the economy is strong enough for aggressive tightening. Others are not so sure. Larry Summers for instance, who was at least a lot more right about inflation than many FOMC members has suggested that the odds for a hard landing are possibly higher than two-thirds. His comments seemed to be congruent with the thoughts of some folks from Black Rock which we discuss in more detail below. He postulated in his interview with Bloomberg that the Fed would not be able to achieve its inflation target without meaningfully elevating the unemployment rate. Mr. Summers brought up an interesting statistic: there has never been an instance when inflation was above 4% and unemployment was below 5% where a recession didn’t occur within 2 years.

Of course, Janet Yellen who ended up becoming Fed Chair instead of Mr. Summers said she thought it was possible for the Fed to engineer a soft-landing. Let’s remember that spirited intellectual disagreement is essential to markets. Markets allow everyone to place their bid, to put their money where their mouth is so to speak. Whether Summers or Yellen is right will only be discerned with time. There is a lot of disagreement in the air. Some of it is the result of the incredibly unique situation we are emerging from. It is definitely harder to orient one’s self as to where we are in the cycle.  Even on our team, we are having some divergence of opinion. Brian Rauscher has been shifting his views to more muted because he believes the Fed is determined to hike until they see sustained progress on inflation, like 3-4 months of declining momentum. Some short-term bearish catalysts may have just been removed like selling associated with tax season.

Tom Lee brings up the point that the Fed is not as all-knowing and all-seeing as we’d like to think. There is a reason why they are regularly talking with major bond market participants and talking heads on Wall Street and not simply dictating. We also like to remind people that the fire and brimstone, Old Testament Fed of Chairman Volcker simply isn’t the same animal. Before a wave of deregulation that started in the 1980s, the Fed had a very direct and abrasive mechanism for directly affecting the economy and causing the behavior they deemed necessary for their economic goals.Regulation Q allowed them to set interest rate ceilings on things like bank deposits. So, when they raised short-term rates high enough money would flow out of banks into money market funds chasing the yield. This direct form of credit intermediation that helped Volcker tackle inflation is no longer available to the Fed. So, in other words, one of the strongest bones in the body of the world’s most powerful central bank is indeed the jawbone. As Tom Lee stated recently in an interview with Scott Warpner, 80% of what the Fed does is talk.

The war in Ukraine continues to rage on, although Moscow’s decision to move the goalposts in the wake of their disastrous opening moves has made the fighting centered in the South and the East. There were unconfirmed reports of a chemical weapons attack in besieged Mariupol. Of course, the fact that it is surrounded by Russian soldiers makes it impossible to gather the physical evidence necessary to prove the allegations. Amazingly, Ukrainian resistance is still holding out against Russian forces with an overwhelming superiority in both firepower and personnel. The firepower parity is closing though. Western governments are stepping up the support of heavier weapons to help Ukraine continue its impressive progress against Russian forces. Today, it appears Ukraine successfully deployed an indigenously produced anti-ship missile against a Russian cruiser (the flagship of the Black Sea fleet) about 60 miles off the coast. This makes an expected amphibious assault against Odessa, also the headquarters of the Ukrainian navy, much less likely. While Western unity has been far more cohesive than Vladimir Putin appears to have planned for, it is getting its first major challenge. The French Presidential race is pretty close and Marine La Pen may be able to ascend to the French Presidency. She has expressed decidedly pro-Putin sentiment in the past and NATO leaders are definitely sweating at the prospect. We discussed how Bill Dudley said the stock market would need to come down this week. Evidence from real-economy credit markets like mortgages seems to be casting water on that assertion. Mortgage rates have gone up to the highest level in more than ten years. We have also noticed that 30-day and 60-day delinquencies have started to tick up. The average 30-year fixed-rate mortgage was 5%.

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