Stock prices recovered from a key support area last week and rose by 2 percent on Friday, in spite of bad news showing the economy and inflation remain strong. Although these are encouraging developments, there are potential problems ahead.
The Week That Was
Economic reports show the economy in February was similar to what it was in January. Business surveys for manufacturing were consistent in showing a slight decline in overall activity and new orders, but they also point to greater inflationary pressures.
The February ISM survey for service-sector businesses shows booming activity, surging new orders, significant job gains, and high inflation. This survey provides no hint of a slowdown.
The only other economic news this past week was for January new orders for durable goods. Both total orders and orders other than defense and aircraft have been essentially unchanged since the middle of last year. After allowing for the likelihood of higher prices, new orders appear to have declined slightly over the past eight months.
Things to Come
The key economic news this week will be about the job market. ADP reports its numbers on Wednesday and the government on Friday. It’s difficult to explain the recent conflicts in job data.
ADP’s seasonally unadjusted data show a significant weakening in jobs over the past four months compared with a year ago. A decline of 1.4 million jobs from October to January of this year compares to a gain of 367,000 in the same period a year ago.
Government job data (also unadjusted) show a decline of 1.8 million in the four months ending in January, compared to a decline of 2.2 million in the year-ago period. Hence, a slight improvement from a year ago but still significantly down.
Both February weekly unemployment data and business surveys continue to point to a strong job market, However, large differences between two key sources of data make it difficult to determine the strength or lack of strength in jobs.
Amid all the confusing data, we look for February payroll jobs to be below the consensus estimate of 250,000.
Money, Money, Money
My monetary analysis focuses primarily on the amount of money coming into the economy. Fed data through February show a decline of $400 billion since the peak in June. For the past six months the percentage decline is 1 percent, but the year-over-year change is an increase of 4 percent.
The latest data on spending and inflation suggest the massive increases in money in 2020 and 2021 continue to boost spending and inflation. As a result, the Fed will continue to take money out of the economy in the months ahead. The CME’s calculation for the peak in the fed funds rate is currently 5½ percent.
Market Forces
The combination of monetary restraint and higher interest rates has never been a positive environment for stocks.
In an encouraging development, the bellwether S&P500 index found support right at its 50-day moving average. Even more encouraging is that the index weathered the bad news of rising interest rates and ended the week up 2 percent.
Speculating on upcoming data for jobs and inflation holds the potential for negative surprises. Both the S&P and ISM business surveys for February reported accelerating price increases. This is the logical consequence of the sharp increase in earnings in January. Businesses have to raise prices to recoup the cost of higher wages.
It is seldom wise to base investment decisions on speculation about upcoming numbers. However, with the Fed likely to continue monetary restraint through the remainder of 2023, stocks remain vulnerable.
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Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 17 percent
Monetary Policy: restrictive
