Market Super Bowl

At last look, the spread between the Eagles and Chiefs for this weekend’s Super Bowl is just three points. A narrow spread suggests this could be a more competitive game than most. Both teams have young quarterbacks. With Tom Brady’s retirement and Aaron Rodgers going dark for four days as he decides whether he’ll play again, this Super Bowl seems like a key moment in NFL leadership changing from one generation to the next.

Much like the tight spread for this weekend’s big game, markets seem to be rallying for now, but the economy looks like it could go either way. We’ll be watching for what forces are the true leaders.

We came into this year discussing higher interest rates, high inflation and the possibility of a recession. Yet asset prices have rallied. Stock prices are up, and the most risky parts of the market have done best. Despite the layoff announcements from big technology companies, the NASDAQ (which is a technology-laden stock index) is up over 12% since the first of the year. Furthermore, Bitcoin, one of the riskiest of risk assets, has risen over 30%.

At the same time, interest rates have continued higher, in fact, the Federal Reserve raised rates again last week by another quarter-percentage point. The current target for Fed Funds is 4.5 to 4.75%. Economic data is generally sluggish, though in some places like housing, numbers are improving. Let’s have a closer look at key data and its implication for portfolio positioning.

Labor Markets

Last week’s jobs number showed over half a million jobs created, and an unemployment rate at 3.4%, a decades-low figure. There’s no doubt those are strong numbers. However, the context is important, too. During the State of the Union address, the President noted that over 12 million jobs have been created in the last two years. Unfortunately, unless the President wants to take credit for the pandemic, it isn’t reasonable for any administration to say its’s created these jobs. The reality is, the jobs being created are mostly the ones lost during the economic downturn that resulted from policies made in reaction to the pandemic.

Still, the jobs market presents a conundrum. While last week’s report was very strong, you can see that the general trend for job growth is down. Makes sense, when you think about the number of companies that are announcing layoffs. The chart below, from the Bureau of Labor Statistics, shows the monthly growth number, which can be volatile and is often revised. You can see the downward trend. Employment is usually the last thing to weaken when headed into a recession, and that may be more the case today because of how tight the labor market is (as evidenced by the 3.4% unemployment rate!).

Interest Rates

Despite rising interest rates, the bond market has seen a big rally since late last year. In fact, the Bloomberg Barclays Aggregate bond index return is up 2% since the beginning of the year. The yield on the 10-year Treasury note has declined from a high last October of 4.25% to 3.64% (remember yields down, bond prices up). So if the Fed is raising rates, why are these rates coming down?

Markets’ job is to anticipate the future and price it. That’s why, when the future is less certain, such as at a point like this, prices can be more volatile. The Fed is saying it’ll continue to raise rates to fight inflation, while the market believes the Fed won’t get as far as it’s indicated. So bond buyers are in the market taking advantage of yields not seen in a very long time, driving yields lower.

Inflation has certainly weakened, making the case for bond bulls that future interest-rate increases may not be needed. However, the future path for inflation is not clear. Yes, it has come down from over 10% to just above 4%. That is still more than twice the level of desired inflation by the Fed. Energy prices have weakened; however, the war in Ukraine rages on and may continue to put upward pressure on energy prices. The lagged effect of supply chain issues and companies raising prices may not dissipate that quickly.

Portfolio Positioning

Our view is that it is too early to agree entirely with markets’ view that the Fed will ease up soon. We think investors as a whole may be ahead of themselves, taking on more risk than warranted. As a result, we remain conservative with our average maturity level for bond portfolios. We’ve taken a more careful perspective on adding credit risk.

We have been fully invested in the stock market, though we have emphasized strategies that focus more on companies with free cash flow and sustainable growth through an economic slowdown. This has allowed us opportunities to participate in the rally while tilting a bit toward more defensive positions.

Enjoy the game this weekend. Stay tuned here for how the markets and the economy will roll through this year.