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Volume 12, Edition 5 | February 20 – February 24, 2023

Bargain Hunters, Look Elsewhere…

Doug Walters, CFA
This week, stocks sold off as investors pondered the possibility of “higher for longer” on the interest rate front. Driving that sentiment were hawkish comments from Fed officials, robust economic data, and higher-than-expected PCE inflation.

Contributed by Doug Walters, Max Berkovich, David Lemire, Eh Ka Paw

This week, stocks sold off as investors pondered the possibility of “higher for longer” on the interest rate front. Driving that sentiment were hawkish comments from Fed officials, robust economic data, and higher-than-expected PCE inflation. (see Headline of the Week below).

One implication of prolonged higher interest rates is the effect on Growth stocks (aka expensive stocks). These securities look expensive because their value is based more on expected future growth than on current profits. Those future profits are worth less as interest rates go up. Why? Money in your hand can earn interest today. The higher the interest rates, the more valuable it is to have money in your hand today than at some point down the road. We saw this dynamic in spades in 2022. As interest rates rose, Growth stocks, drunk on 0% interest rates, had a major hangover. The Russell 1000 Growth Index was down 29%, while its Value equivalent was down just 7.5%.

Growth has had a resurgence in the early months of 2023. But this may be premature. There is some bargain-hunting happening, which is understandable. But if rates remain elevated, Value stocks may be poised for another good year relative to Growth.

As evidence-based investors, we are naturally drawn to segments of the market that have shown the ability to persistently outperform – namely Quality, Value, Momentum, and Small Size. In the long-term, such an approach favors Value over Growth (aka cheap versus expensive). But some Growth is good. You will find that if you own stocks displaying Quality, Momentum, and Small Size characteristics, some of those will be Growth stocks. We just would not recommend owning Growth for the sake of Growth…, particularly in today’s high-rate environment.

4.7%

Core PCE Inflation

Core PCE Inflation came in much higher than the 4.3% consensus expectation.

Headline of the Week

Up, Up and Up

The Fed’s preferred inflation measure – the personal consumption expenditures – rose in January, both the headline number and the core figure. In addition, consumer spending ticked higher. While some of the spending increases resulted from higher prices for goods and services, there was still underlying strength from consumers. Household income moved higher, as did the personal savings rate. Even with fourth-quarter GDP growth being revised lower, the economy and consumers are showing resilience, much to the Fed’s consternation.

Inflation pressures had been easing modestly over the past year but still hover at levels higher than the Fed is comfortable with. The pandemic supply chain issues are essentially a thing of the past, but other factors, such as historically low unemployment, continue to fuel inflation.

The likely net result of this week’s reports indicates that the above-quoted phrase “higher for longer” might have just moved higher and longer.

The Week Ahead

The end of February should bring with it a Jobs report, but the short month pushed that out another week, leaving us with very few market-moving events. However, the Purchasing Managers Index is hands down the most important release that can nudge markets.

Too many I’s

The Institute of Supply Management’s (ISM) Purchasing Managers Index indicates the prevailing direction of economic trends as viewed by the people doing the purchasing for businesses, 400 of them.

  • Above 50 is economic expansion, and below is a contraction.
  • The report comes in two flavors: manufacturing and service. They are released on different days.
  • The manufacturing release is expected to come in slightly under 50, while the service one above 50.
  • Furthermore, a move higher from the previous report is a positive.
  • Expectations are divergent, manufacturing is expected to climb a bit, but the service report is expected to drop from 55.2 in February.
  • The January number was a major bounce to expansion from the sub-50 reading in December.

The new guy

With a slow news week, Japan’s incoming central bank governor Kazudo Ueda’s speech is expected to get significant coverage.

  • Ueda, in a testimony to Parliament, indicated he is a proponent of ultra-low interest rates to support the economy but signaled a willingness to tweak the yield curve control policy.

Another Minute

Minutes of the European Central Bank’s (ECB) last policy-setting meeting are out Thursday.

  • The odds are heavy that ECB will lift rates another half of a percent during the next meeting, but economic data has been coming in positive, pushing the odds for a bigger hike to as high as 30%.
  • The meeting’s notes will impact those odds.

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