Positive Stock Market Observations For The Week Ahead

Friday’s (Jan. 6) stock market improvements were nice turnabouts. So, now what? More of the same? Could be, but not because of that December employment report. We’ve seen that report lose its punch in the following days. It is other observations that could continue the happy environment – for a while, at least.

Unemployment, not employment, is the key indicator, and it is favorable

Last Friday’s employment numbers and analysis are fine, but it’s the ongoing low unemployment numbers that are especially important. The continuing low weekly unemployment claims (next report on Thursday) and last Friday’s low monthly unemployment numbers provide the best proof that there is no economy downturn or recession ahead.

Contra-note: Employment growth has been slowing and layoff announcements have been increasing. Open questions: Are these just a sign of growth being trimmed back and a focus on productivity returning, or are they a prelude to more serious cutbacks?

Coming inflation report should be favorable

The Econoday.com consensus outlook for Thursday’s December 2022 CPI report is for further improvement. The rates foreseen are a monthly 0% (for CPI-all items) and 0.3% (for CPI-all items less food and energy). Because those forecast numbers replace the higher December 2021 rates of 0.6% for both, the trailing 12-month rates should decline again.

Contra-note: Some earlier price rises were due to temporary factors (e.g., vehicle pricing), and they now are declining. Just as they gave a temporary increase to the inflation numbers before, they are giving them a temporary reduction recently. Eventually, that down impact will vanish.

Consumer sentiment could have unexpected positive rise

The advance January University of Michigan consumer sentiment measure will be reported on the next day – Friday. Sentiment has been a continuing drag, but the typical analysis has stopped at the top line measure, rather than examining the four survey areas: income, assets, debts and prices. Those four follow very different paths, particularly when the overall number declines. This time around, prices (inflation) has been the primary drag on the overall number.

Therefore, with inflation now starting its seventh month of lower price rises and media reports turning positive, that sentiment area should be improving. The Econoday.com consensus outlook is only for a small rise – from December’s 59.7 to 60. (The range of forecasts is from 57.4 to 62.) An actual reading of 62 or higher could be the surprise.

Contra-note: While price worries should abate, there has been some slight decrease in income and asset sentiment. Because the monthly survey results are volatile, we’ll have to wait and see if these decreases are precursors or just survey blips?

Federal Reserve’s tough words have yet to match actions

Not enough is written about what the Federal Reserve is not doing.

First is the miniscule reduction of their enormous bond holdings that were bought with created demand deposits (that is, newly printed money – a primary cause of “fiat” money inflation). Until they reverse those purchases, that surplus cash continues to slosh about, aiding the inflationary environment.

Second is their self-labeled “large” interest rate increases. Unlike any other time, they started their “tightening” in the 0% basement. That’s why the increases (not the actual rate levels) look historically high. The most accurate measure of tightness is how the short-term U.S. Treasury bill rates compare to the inflation rate – in other words, the “real” (inflation-adjusted) interest rate. Except in very high inflationary periods, a tight money situation occurs when short-term rates exceed the inflation rate. The Federal Reserve’s 15-year low-rate control has still not allowed the short-term rate to reach the inflation rate, much less exceed it. So, we are still in a negative real interest rate environment, and that means conditions are still “loose” or “easy” – not tight.

Therefore, the good news is that there is no need to worry that the Fed is driving us into a terrible recession. They aren’t even close yet.

Contra-note: The latest Fed minutes reported discussion about growing investor optimism that the Fed’s interest rate increases could slow down, stop or even reverse because of the inflation rate’s recent declines. The worry is that the optimism would undermine the Fed’s inflation-fighting actions. If so, the Fed could decide to take stronger actions to squelch the optimism.

The 2021-2022 stock market fads look like they are officially dead

The death of fads is an important signal that the stock market has shaken out weak investors and ill-conceived investment strategies. The last couple of weeks saw the remaining fad leaders finally hit ground zero (that is, back to the point at which they started). With no fad investor having a gain, likely all fad participants are gone:

• Meme stocks
• Special purpose acquisition companies (SPACs)
• Biotech IPOs
• Non-earning growth story stocks

So, now can a new bull market start?

No. Shaking out weak investors does put those fad prices back down. However, it does not mean new fads are primed and ready to go. First off, similar fads don’t repeat right after they’ve been killed off. Second, just as witnessing a car crash makes drivers cautious for some time after, seeing fads die makes investors cautious.

So, what’s the good news? Finally, the media can stop reporting about those old, has-been investments. Now, it’s time to focus anew, and this is when investing regains fundamental interest that creates a strong following.

Contra-note: There are so many uncertainties and risks that exist beyond the former fads, that the happy shift could take a while. Chances are, even if inflation recedes as a worry, some or many of those other issues will come to the forefront.

The rest of the stock market has done some shaking out, too

Look through any screening of stocks, and many attractive issues will reveal themselves. Great! Time to buy! – Wait! How to decide? There are so many.

Exactly. There are at least five major issues at work, only one of which is taken care of.

1. Overpriced growth stocks from overoptimistic investors – Looks like the shakeout has taken care of that
2. Growth is slowing – Question: How low will it go?
3. Interest rates are up, reducing the present value (the stock price) based on prospects – Question: How much higher will the interest rates go?
4. Fed continues to raise interest rates and will eventually liquidate bond holdings – Question: When and by how much?
5. As interest rates rise, economy growth will likely slow, helping reduce inflationary pressures – Question: Will economy finally fall into a recession, the agreed-upon cure for persistently too-high inflation?

The bottom line: Don’t be in a hurry to get bullish

It’s nice to see the fad shakeout along with silver linings and reasons to cheer. However, many other issues need to be dealt with and their outcomes revealed. Moreover, we need to see how this Fed-vs-inflation conflict plays out – especially because the Fed has not truly begun to tighten.

Finally, the current stock market’s state (as of Jan. 6):

• NYSE has 1,673 listings – Nasdaq has 2,863
• Percent below $1B market capitalization – NYSE = 32% – Nasdaq = 69%
• Percent without earnings – NYSE = 25% – Nasdaq = 56%
• Percent with stock price below $5 – NYSE = 10% – Nasdaq =36%
• Percent with stock price 50% or more below 52-week high – NYSE = 17% – Nasdaq = 42% (And remember: A 100% rise is needed to offset a 50% drop)