QUOTE OF THE WEEK
“The secret of contentment is knowing how to enjoy what you have and to be able to lose all desire for things beyond your reach.” – Lin Yutang
As we expected the Fed has decided to pause raising interest rates. Chairman Powell said that they were going to follow the data, however he put the possibility of raising rates another 1/2 of a percent in the future. No guarantee, but I think they are done raising rates because the economy is continuing to slow. As stated before, when the Fed stops raising rates, long term interest rates will start to decline. As stated in the last letter we have allocated the managed portfolios in U.S. Treasuries over multiple durations from 1-3 year up to 30 year bonds.
Last week the markets were up substantially with what I would call a “relief rally” due to the Fed pausing on their rate increases. Even with this rally, under normal conditions, stock prices will rise when earnings go up. Last quarter the S&P 500 earnings were flat. We don’t yet know what earnings will be for the second quarter, but the projections are that they will be negative so this may not be a sustainable rally.
Everyone is excited by the year to date increase in the S&P 500 of 15.19%. Many are assuming that the bear market is over but no one is talking about the underlying statistic that is driving the performance of the S&P 500 this year. The performance of the “magnificent seven” stocks in the S&P 500 are up 78% year to date. In other words, the performance is being driven by only seven stocks. If you go back to the beginning of 2022, five of the seven are down, with some substantially down. One stock is up slightly, and one is up over 20%.
Don’t be complacent as there are strong headwinds to the economy and the stock market going forward. The Purchasing Managers Index (PMI), the index that measures month over month economic activity in the manufacturing sector, is at 42. Anything below 50 is a contraction in manufacturing and every time the index has fallen below 46, a recession has followed.
Due to the Debt Ceiling Debate the Fed has had to drain the Treasury General Account. This is the checking account of the Treasury. It was depleted down to approximately $50 billion to finance the government during the period when we were waiting for the resolution on the Debt Ceiling debate. The normal balance is around $1 trillion so this means they are selling Treasury bonds to get the account back up to the $1 trillion balance which will be taken out of the economy from people buying those bonds.
One of the issues that will probably affect the economy going forward, is the fact that credit card balances have risen 17% over the last 12 months. Consumer spending is 70% of the U.S. economy but people are paying for living expenses using their credit cards. Add to that the interest rates have risen 5% over the last year leaving the consumer stretched and running out of money.
Another component of the pandemic era relief for households is coming to an end. The debt limit deal struck by the White House and congressional Republicans requires that the pause of student loan payments will end by August 30th so student debtors will have to start making their payments again. This will also slow consumer consumption.
The recession is right around the corner but how deep and how long is yet to be determined and keep in mind that the stock market declines with every recession.
We are currently positioned in U.S. Treasuries of different durations with managed accounts and intermediate term bonds in the annuities.
Sources: NY Times,. Time Magazine 576701.1