Dumaine Investments

09/06/2023

Stocks retreat in the face of rising rates and oil prices...

· Having finished August with a slight rally on optimism about a Fed pause, US stocks resumed their pullback in the first week of September. Rising Treasury yields, a strong dollar, and an extended rally in crude oil prices have continued to serve as headwinds to a market priced for perfection. After briefly falling below 4.1% at the end of August, the 10-year Treasury yield is again approaching its recent 15 year high of 4.3%, while WTI crude oil had been holding firm above $86/barrel.

· The CME Fedwatch tool is now forecasting a 90%+ probability of a pause at the September Fed meeting. While recent economic data have been mixed, markets appear to expect the Fed to abstain from raising rates due to figures suggesting a softening picture for the labor market and manufacturing, including a higher-than-expected August unemployment report.

· WTI crude oil prices have accelerated sharply in the last few weeks - you would have to turn the clock back more than a year to June 2022, to find petroleum prices so elevated.

· The renewed advance in the US dollar is raising concern in Asian countries as their currencies fell to multi-month lows, prompting policymakers in Japan and China to step up defense of their beleaguered exchange rates. Japan issued its strongest warning in weeks against rapid declines in the yen while China’s central bank also offered forceful guidance regarding its targeted rate for the yuan as the currency weakened toward a level not seen since 2007.

08/30/2023

Markets rebound despite murky outlook for interest rates and economy...

· After posting meaningful losses in the first half of August, US stocks rebounded over the past week on optimism about a possible pause in interest rate hikes by the Federal Reserve. Job openings for July were meaningfully lower than consensus forecasts, and markets responded by rising sharply on the view that Fed officials would be more likely to take a pause in raising interest rates at their September meeting. Hawkish comments by Fed Chair Powell last week in Jackson Hole have been largely discounted by Wall Street.

· In our view, there continues to be a conspicuous dislocation between Fed policymakers and the direction of the market. In his remarks last week, Chair Powell alluded to concerns about recent economic growth being above expectations as well as consumer spending remaining robust. He also emphasized the Fed’s ongoing focus on core inflation, which continues to be well above trend and has proven to be more persistent than headline CPI. Perhaps most significantly, Powell closed his speech with this simple declaration: “We will keep at it [the task of restoring price stability] until the job is done.” By using this specific wording, Powell was wrapping himself in the mantle of Paul Volcker - widely respected for his success in the early 1980s for quelling the biggest burst of inflation in the modern era.

· With a large batch of economic data released Wednesday, the overall picture for the US economy continues to be mixed. While second-quarter GDP came in slightly below expectations, the closely-watched consumption component of the report rose modestly. Likewise, ADP employment data once again came in below expectations, but the July number was also revised upward by roughly 50K jobs. Additionally, European inflation continues to be stubbornly high, as data for both Spain and Germany were slightly above forecasts.

· Looking forward, all eyes will be on Thursday’s inflation and personal spending data, as well as Friday’s unemployment and non-farm payrolls. These reports will be closely monitored by the Fed as it considers an interest rate action at their meeting on September 19.

08/23/2023

Markets tread water amid bank downgrades and lackluster earnings...

· After two consecutive weeks of declines, stocks have traded flat over the last week as markets digest rising long-term rates, mixed economic data, and the final stages of earnings season. Investors hoping for a rebound from a rough first half of August had to tap the brakes as disappointing earnings from big retailers combined with bank rating downgrades dampened enthusiasm. On Monday, S&P downgraded ratings for several US banks including KeyCorp and Comerica, two weeks after Moody’s cut ratings for ten American lenders. Many depositors have “shifted their funds into higher-interest-bearing accounts, increasing banks’ funding costs,” S&P wrote in a note summarizing the moves. Non-interest-bearing deposits have fallen 23% in the past five quarters as Fed rate hikes prompted consumers to seek higher deposit rates elsewhere.

· Nvidia’s highly anticipated earnings announcement will come after market hours Wednesday, and will be heavily scrutinized as a bellwether for the generative AI thematic and the tech sector more broadly. While the options market is pricing in a 10% increase in the stock – on an assumption revenue will beat forecasts – anything less than an exceptional result could trigger a sharp selloff for Nvidia with knock-on effects in broader markets. Next, investors will shift their focus to Federal Reserve Chairman Jerome Powell's keynote annual speech on Friday at Jackson Hole. His speech will be closely dissected for clues to the Fed's next moves on interest rates. A string of stronger-than-expected economic data have recently raised concerns that the Fed may not yet be done with its current rate-hike cycle.

· As the outlook for China continues to darken, global investors have offloaded the equivalent of more than $10 billion of Chinese blue-chip stocks in under 13 days. The most-sold stocks in the latest rout were among the largest companies in the benchmark CSI 300 Index, which has extended its loss this month to almost 8% — among the worst performances in equity markets globally.

08/15/2023

Markets continue to slide as China contagion fears grow...

- US stocks have traded lower for the second consecutive week, as rising long-term interest rates and growing concerns about China’s economy are dominating market sentiment. Disappointing data from China and an unexpected rate cut by its central bank renewed worries about the country's economy, stalling Monday’s market recovery and sending all major indexes into negative territory on Tuesday. The most concerning Chinese data was that their year-over-year industrial production came in sharply below consensus estimates, and retail sales were also well short of forecasts. Moreover, Tesla recently announced price cuts for the Chinese market and a large property developer recently suspended trading on its bonds. These latest setbacks for China are causing increased fears of economic contagion both within the Asia-Pac region and globally.

- Economists at Goldman Sachs have received considerable attention for their forecast that the Fed will begin monetary easing in the second quarter of next year. This view has generally been well received by the market as indicative of a relatively quick transition from tightening to easing, thereby supporting a ‘soft landing’ narrative for the US economy. Our view continues to be that this scenario is unlikely given the resilience of core inflation and its historical tendency to spike up sharply unless it reaches a sustained low baseline for an extended period. Moreover, several recent data points—including Tuesday’s release of July retail sales numbers—suggest parts of the economy remain overheated, and that additional rate hikes may be on the horizon.

- Over the next week, the market’s attention will be focused on retail sector profits – earnings season wraps up with several major consumer retailers reporting later this week – and forthcoming economic data, notably building permits and durable goods orders. This information will provide increasing fodder for the Fed’s interest rate decision at its upcoming mid-September meeting.

08/08/2023

After surfeit of optimism, markets take a step back...

· US stocks have traded lower over the past week as disappointing earnings results, mixed economic data, and renewed worries about regional banks weighed on markets. Moreover, a pronounced bearish trade has driven the 10-year Treasury yield to its highest level in more than a decade, suggesting that interest rates may remain higher for longer. The 10-year yield nearly reached 4.20% last Friday before falling back to 4.02% on Tuesday.

· Late Monday, Moody’s announced ratings downgrades on ten regional banks, while putting several other lenders on review for downgrade. Among the risks cited were rising funding costs, lower regulatory capital on hand, the chance of commercial real estate defaults, and the possibility of a recession. “We continue to expect a mild recession in early 2024 and given the funding strains on the U.S. banking sector, there will likely be a tightening of credit conditions and rising loan losses for U.S. banks,” per the Moody’s statement. While these are all valid concerns, the timing of the downgrades is somewhat surprising, given that the banking crisis reached an apex in early spring with the collapse of Silicon Valley Bank and First Republic. Since then, there has been considerable stabilization in the sector, and we believe the Moody’s downgrades could present some selective buying opportunities.

· Over the last several weeks, we’ve consistently pointed to weakness in China as a material consideration for global markets, and the concern is now further magnified by new data. July exports fell by the largest degree since February 2020, while imports also dropped more than economists had expected. The softness in imports weakens the hope that domestic demand will help China’s economy recover.

08/01/2023

Markets priced for perfection…but are they prepared for potential downside?

· US stocks have traded flat over the past week as investors digest the Fed’s July rate hike as well as a host of earnings and economic data. Earnings season is now in full gear with highly variable revenue and earnings results thus far. While it is true that the stock market rally appears to have broadened with a wider swath of sectors participating in the upside, we continue to have concerns related to both equity valuations and the potential for core inflation to remain stubbornly high.

· One particularly concerning measure of valuation is the equity risk premium, or the difference between the earnings yield of stocks and the yield on government bonds. This premium – effectively the reward one receives for bearing the additional risk associated with an equity investment – has fallen to its lowest level in 20 years, now at roughly 1.1 percentage points. So, on the one hand, we have seen a market rally that has been driven largely by speculation and a runup in prices that has not been matched by rising earnings as earnings in fact have declined for the last three quarters. On the other hand, profit margins are still near all-time highs, and there is little reason to expect a meaningful runup in earnings in the near future. While we recognize there are some signs that the economy could be headed for a ‘soft landing’ – or at least softer than originally anticipated – we remain strongly concerned about stock valuations.

· Another factor that cannot be ignored is the growing risk in China and other AsiaPac markets. China is showing signs of a significant economic slowdown after decades of supercharged growth. A much-anticipated post-pandemic recovery appears to have subsided, with data showing warning signs across the economy. There is concern that the government’s traditional tools for reversing course may not be viable options in this environment. And complicating the picture is the fact that there are major challenges across commercial and residential property sectors, sluggish consumer spending, and enormous levels of local debt.

· Over the next week, all eyes will be on company earnings and forthcoming economic data, notably non-farm payrolls and unemployment data on Friday, and inflation data next Thursday. We will have to see what the new data says, and how the market interprets it.

07/26/2023

Yet another Fed rate increase…what comes next?

- For the last week, the markets have continued a general path upward even as an inconsistent earnings season continues. Largely driving this move has been a breakout in optimism that a soft economic landing may yet be achieved. Whether the data will cooperate remains the multi trillion-dollar question.

- As expected, the Federal Reserve raised interest rates to 5.5% – the highest level in 22 years – as part of the sharpest series of rate increases in four decades. Notwithstanding Chair Powell’s commentary, the rate outlook moving forward is murky, although it retains a tightening bias that signals the strong possibility of an additional move later in the year. Many central bankers anticipate at least one more hike this year, but new (and softer) inflation data may reduce this conviction. There is mounting evidence that both inflation and the jobs market, though still hot, are cooling.

- A major economic concern appears to have been resolved on Tuesday as UPS and its 340,000-member union tentatively agreed to a new contract – thereby averting a strike that would have cost the economy billions of dollars. However, the agreement could act as a drag on both UPS and the US economy as the new contract’s substantial wage increases could further exacerbate inflation if other transportation employees seek similarly large salary gains.

- Consumer optimism remains robust as the recent job openings data combined with yesterday’s Conference Board Consumer Confidence Data ticked up in the latest readings – an indication that the public is feeling quite good about the job market in both sentiment and actions. However, another potential area of concern is that oil and gasoline prices are rising again. At least on a headline inflation basis, a big tumble in energy costs has been a huge disinflationary driver over the last year. Ongoing increases could appreciably affect consumer optimism and spending.

07/20/2023

Dumaine Investments Quarterly Newsletter | dumaineinvestments.com

In the aftermath of a first quarter marked by persistent inflation, unsettling economic data, narrowly generated market returns, and an abrupt and destabilizing banking crisis, the second quarter proved to be more positive, at least on the surface. While the banking system is by no means out of the woods – indeed many regional banks continued to struggle in the spring quarter – the backstops provided by the Fed and Treasury together with capital infusions from larger global banks appear to have steadied the financial sector. Meanwhile, consumer price inflation, after remaining almost unchanged in April, showed signs of improving as the quarter progressed, falling from 4.9% in April to 4.0% in May and then 3.0% in June...

Read more here: https://lnkd.in/grpeHMff

Explore the Fed's monetary policy, stock market gains, inflation concerns, and economic outlook in this wrap-up for the second quarter of 2023.

07/19/2023

Excessive exuberance? Market soars despite risks on the horizon...

· US stocks have rallied over the past week in response to lower headline inflation numbers and some surprisingly good early earnings results. While year-over-year earnings are expected to be down sharply in many sectors – estimates point to earnings-per-share for S&P 500 companies falling by 8.1% from a year ago, according to the Wall St Journal – several prominent companies have outperformed quarterly expectations, leading the market to new heights as of Tuesday’s close.

· As earnings season ramps up, financial companies are in the spotlight. The trio of big banks reporting last Friday – JPMorgan, Wells Fargo and Citi – all beat earnings expectations for the second quarter as the Fed tightening cycle helped more than it hurt, particularly for JPM, which was able to snap up First Republic at a bargain price. Although all three banks struck a positive tone about the health of the U.S. consumer, they acknowledged that the situation could change in coming months. Wells Fargo CEO Charles Scharf said that while the economy is performing better than expected, he sees it continuing to slow with uncertainty remaining.

· One of the major risks we see as the third quarter begins is a heightening in geopolitical tensions, with a ramp-up in the Ukraine War and the potential of further ruptures in US-China relations. Russia has decided to end the Ukraine grain-export deal roughly a year into the agreement, thereby increasing uncertainty over global food supplies and their prices. Meanwhile, Treasury Secretary Yellen’s trip to China did not allay fears of growing tensions. Moreover, she expressed concern about the likelihood of China’s economic slowdown having ripple effects through the global economy. After a batch of Chinese economic data came in weaker than expected on Monday, Yellen said that “many countries do depend on strong Chinese growth to promote growth in their own economies…and slow growth in China can have negative spillovers for the US.”

· Over the next week, analysts will be focused on both company earnings and forthcoming economic data (notably building permits, initial jobless claims, and home sales) ahead of the Fed’s interest rate decision next Wednesday.

07/12/2023

Inflation falls, as markets digest mixed economic data...

· After starting the quarter in a wait-and-see mode, US stocks dipped last week in the wake of a sharp spike in ADP’s reported employment data which was well ahead of expectations, presumably on the belief that this info would alarm the data-driven Fed and increase the probability of additional rate hikes. In a confusing twist, nonfarm payrolls data released a day after the ADP report were below market forecasts, leading the market to close the week on an uptick.

· This week has been marked by more mixed economic data. While the Institute of Supply Management’s services reading was ahead of forecasts, the Labor Department’s jobs opening report was below projections. Additionally, headline inflation came in at 3.0%, basically in-line with forecasts. Not surprisingly, the markets responded favorably, and were around 1% as of this writing. Nevertheless, the Fed remains committed to its 2% inflation target. As has been mentioned by several prominent analysts, the ‘last mile’ can be the hardest when taming inflation. Moreover, a large portion of the recent reduction in inflation has come from falling energy prices while core inflation has remained stubbornly high at 4.8%.

· At the industry level, energy stocks led gainers over the past week as crude oil hit a two-month high due to recent production cuts by Russia and Saudi Arabia. Industrials and financials also rallied after lagging the broader market in the year’s first half. After a torrid start to 2023, mega-cap tech stocks have been flat-to-down so far in July as investors appear to be taking a wait-and-see approach.

· In the days ahead, all eyes will be on Producer Price Index data, preliminary consumer sentiment numbers, and the now-starting corporate earnings season prior to the Fed’s July 25 rate setting meeting. As of today, consensus remains that the Fed will increase rates by 0.25 percentage points in July as the FedWatch tool shows a 95% probability of a rate hike.

06/27/2023

Market consolidates as second quarter comes to a close...

· US stocks traded lower over the last week, as the market appears to be in consolidation mode—after a sharp spring rally—with the end of the quarter looming. Indeed, the CBOE VIX index, which tracks stock market volatility and is typically referred to as the market's fear gauge, is nearing 3 1/2-year lows, suggesting market participants are taking a wait-and-see approach as they digest recent economic data and await second quarter earnings results.

· Tuesday’s batch of economic data—including durable goods orders, new home sales, and the Case-Shiller home price index—were broadly ahead of consensus estimates, confirming that the economy is heating up in certain sectors. New orders for US manufactured durable goods jumped 1.7% month-over-month in May, following an upwardly revised 1.2% rise in April and easily beating market expectations of a 1% decline. This report marks a third straight month of rising orders. Looking forward, all eyes will be on Friday’s reports for month-over-month Core PCE Price Index and personal spending data.

· Central bankers from around the world are gathering in Sintra, Portugal this week to discuss the state of the world economy. So far, they seem to agree that it’s not good. Federal Reserve Chairman Jerome Powell will speak on Wednesday, while European Central Bank (ECB) President Christine Lagarde reiterated on Tuesday that the battle with inflation isn’t over. According to Lagarde, the ECB, which has continued to move forward with interest rate hikes, cannot afford to waver.

· Notwithstanding today’s positive economic news, we continue to have significant concern about current market valuations and the potential for a protracted slump. The disparity between YTD market performance and the Fed’s resolute stance to bring inflation down to 2%—as communicated consistently by Chair Powell and other officials—is unsustainable in our view. We believe the sectors of the market that have buoyed this rally, notably technology and communications stocks levered to generative AI, are particularly overplayed and at risk of significant contraction. We’re accordingly maintaining a defensive stance within our equity allocations and in overall portfolio positioning.

06/21/2023

Wall Street and The Fed Remain Out of Sync…

· After a brief market rally in the wake of the central bank’s decision to pause rate hikes, US stocks have reversed course and traded down so far this week. In congressional testimony on Wednesday, Fed Chair Powell said policymakers expect interest rates will need to move yet higher to contain price pressures—echoing comments he made last week accompanying the FOMC’s decision to pause. He further indicated that the timing of additional hikes will be based on incoming economic data, a position thoroughly consistent with past communication from both Powell and other senior Fed officials.

· Given that the Fed’s interest rate ‘dot plot’ median currently points towards the likelihood of at least two additional rate hikes this year, we expect markets to be extremely focused on upcoming economic data. In the week to come, key data released will include both initial jobless claims and existing home sales (on Thursday), as well as durable goods orders (on next Tuesday). Several Fed officials will also be giving speeches over the next week, which could create additional volatility in markets depending on the substance of the remarks.

· At the global level, tensions between the US and China continue to grow, with Biden’s recent reference to Xi Jinping as a dictator causing sharp concern from China with state media construing the statement as ‘public political provocation’ by the US. The tensions re-emerged just days after the world’s two biggest economies held meetings to help stabilize relations as America’s Secretary of State, Antony Blinken, travelled to Beijing in an attempt to improve the nations’ dialogue. Along with uncertainty around the trajectory of the US economy and future Fed policy, diplomatic and economic relations with China will likely be a critical factor in determining the strength and durability of an extended market recovery.