The Fed Is Increasingly Hawkish – Week in Review

The Fed is Increasingly Hawkish

The market had another bad week making it the third one in a row. Despite generally positive earnings from companies reporting in the second quarter, stocks remain under pressure. There are two items impacting the stock markets right now. First, The Fed is increasingly hawkish. Second, the War in Ukraine is affecting energy prices, although the recent COVID-19 closures in China may dampen demand and thus prices.

Stock Market Had Another Rough Week

According to StockRover*, every index was down in the US this past week. In addition, nine of the 11 sectors were down. Only Real Estate and Consumer Defensive were up this past week.

The Nasdaq is nearing bear market territory at roughly (-18%) year-to-date (YTD). The Communication Services sector is already in bear market territory, while Technology is close to one.

Will the trends continue down? This question is a difficult one to answer. Earnings are relatively good for many companies despite margin pressures. However, the fear of rising interest rates and future hikes by the US Federal Reserve is pressuring stocks, especially struggling growth stocks.

The Fed is Increasingly Hawkish

The US Federal Reserve is increasingly hawkish due to inflation. In a recent panel discussion, Chairman Jerome Powell indicated that a ½-point increase is on the table. An increase of this size would be the largest since 2000, and it would be the first time rates were increased at two meetings in a row in 2006.

Quoting Mr. Powell,

It is appropriate in my view to be moving a little more quickly…I also think there’s something in the idea of front-end loading I would say 50 basis points will be on the table for the May meeting.

Furthermore, shrinking the Fed’s $9 trillion balance sheet will likely move forward.

Stock markets have reacted poorly to the Fed’s increasingly hawkish stance. On Thursday, the Dow Jones was down more than 400 points, and the Nasdaq was down 2%. Friday was even worse, with the Dow down nearly 1,000 points, the worst day since October 2020. The Nasdaq was down 2.6%, and the S&P 500 Index was down 2.8%.

Consequences of the Fed’s Increasingly Hawkish Stance

Higher Interest Rates

Higher interest rates will hurt some companies but benefit others. For instance, real estate sales should slow as mortgage rates rise and buyers cannot afford larger homes. There is even a risk of a housing market crash. Growth stocks will be punished as borrowing money for acquisitions, share buybacks, and expansion becomes more expensive. Growth companies tend to take on more short-term debt, which will become more expensive.

However, banks, insurance companies, and brokerages benefit as the marketable securities they keep on their balance sheet earn more interest. Most of these financial companies hold billions of dollars on their balance sheet, so a 0.25% uptick can mean millions of dollars in more income. For instance, Chubb’s (CB) investment income is at a record and will likely go higher in 2022. In addition, higher interest rates mean greater net interest margins and more profit for banks.

Investors can also benefit as short-term investments, like CDs, MMDAs, high-yield savings accounts, and I-Bonds will pay higher interest rates.

Stronger Dollar

Another little talked about aspect of rising interest rates is the USD is getting stronger. The US Federal Reserve is raising interest rates faster than its counterparts in the rest of the world. This fact means US Treasuries are more attractive to global investors. The table below shows the 10-year bond yield by country. Why invest in bonds at low rates when the US 10-year bond pays almost 3%?

Furthermore, global investors are fleeing risk, which means they are leaving emerging markets and buying US Treasuries. The result is a stronger dollar. The charts below show the USD versus the GBP, Euro, Yen, and Yuan.

The net result will be US exports are more expensive while imports are cheaper. This point should help reduce inflation in the US. It will also mean foreign investment in the US should rise.

Final Thoughts on the Fed is Increasingly Hawkish

The Fed will likely increase the Federal Funds rate by 0.50% in early May after a 0.25% increase in March. Some analysts and traders are pricing in a 0.75% increase, but that seems unlikely. In addition, the Fed will start reducing its balance sheet. Both actions will place upward pressure on interest rates. Countering that upward pressure will be increased buying for the US and international investors of US Treasuries. However, the Fed will remain increasingly hawkish until inflation comes down. As a result, investors should expect more volatility and the possibility of a recession.

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The Stock of the Week

Today we highlight a screener in StockRover*. Specifically, we are looking at stocks within 10% of their 52-week low, a dividend yield of more than 3%, a dividend payout ratio less than 65%, a dividend-to-free cash flow (FCF) ratio less than 70%, and a price-to-earnings (P/E) ratio less than 15X. The screenshot is below; 82 stocks pass this screen.

We then rank order the stocks using the StockRover* quality score, accounting for profitability and balance sheet metrics. The No. 2 stock on the list is Intel (INTC). Other dividend growth stocks in the top 10 are Gilead Science (GILD), 3M (MMM), T. Rowe Price (TROW), and Franklin Resources (BEN).

The screenshot below is from Stock Rover*.

• 3 Pharma Dividend Growth Stocks Yielding 4.5%
• Intel (INTC) – A Dividend Stock to Own
• T. Rowe Price (TROW) – An Undervalued Dividend Aristocrat
• 3M Company (MMM): Dividend Safety Analysis
• Franklin Resources (BEN): Dividend Safety Analysis

Dividend Increases and Reinstatements

Search for a stock in the list of dividend increases and reinstatements. This list is updated weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

The dividend cuts and suspensions list was most recently updated at the end of March 2022. As a result, the number of companies on the list has risen to 548. Thus, well over 10% of companies that pay dividends have cut or suspended them since the start of the COVID-19 pandemic. The list is updated monthly.

Four new additions indicate companies are experiencing solid profits and cash flow in March.

The new addition was Orchid Capital (ORC), Lument Financial Trust (LFT), 360 Digit Tech (QFIN), and James River Group Holdings (JRVR).

Market Indices

04/23/22

Dow Jones Industrial Averages (DJIA): 33,813 (-1.85%)

NASDAQ: 12,839 (-3.83%)

S&P 500: 4,272 (-2.75%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 21.6X, and the Schiller P/E Ratio is about 33.6X. Note that the long-term means of these two ratios are 16.0X and 16.9X, respectively. 

The market is still overvalued despite the recent market correction and rebound. Earnings multiples more than 30X are overvalued based on historical data.

S&P 500 PE Ratio History

Shiller PE Ratio History

Stock Market Volatility – CBOE VIX

This past week, the CBOE VIX measuring volatility was up about 5.5 points to 28.21. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.

Yield Curve

The two yield curves shown here are the 10-year US Treasury Bond minus the 3-month US Treasury Bill from the NY York Fed and the 10-year US Treasury Bond minus the 2-year US Treasury Bond from the St. Louis Fed.

Inversion of the yield curve has been increasingly viewed as a leading indicator of recessions about two to six quarters ahead, according to the NY Fed. The higher the spread between the two interest rates, the higher the probability of a recession.

Economic News

The US Census Bureau reported new residential building permits were up 0.4% in March to a seasonally adjusted 1.873M. New residential building permits are running 6.7% above the March 2021 level. However, single-family permits were down 4.8% from a revised February figure of 1.205M. Building permits increased in both the Northeast (+11.1%) and Midwest (+2.8%), while the South (-0.1%) and West (-3.5%) both saw decreases.

The National Association of Realtors reported that sales of existing homes fell 2.7% in March to a seasonally-adjusted annual rate of 5.77M, down 4.5% compared to March 2021. Home sales have now dropped for two consecutive months. Sales of single-family homes fell to a 5.13M annual rate (-3.8% Y/Y), and existing condo sales dropped to a 640K annual rate (-9.9% Y/Y). Total housing inventory was reported at 950K, up 11.8% over February’s inventory (-9.5% Y/Y). Properties typically remained on the market for 17 days, down from February 18th. 

The US Energy Information Administration reported that US commercial crude oil stockpiles decreased by 8.0M barrels to 413.7M barrels (15% above the five-year average) for the week ending April 15th. Crude oil refinery inputs averaged 15.7M barrels per day, an increase of 194K barrels per day compared to the previous week’s average. Gasoline inventories decreased by 0.8M barrels (3% below the five-year average), and distillate inventories fell by 2.7M (20% below the five-year average). Refineries operated at 91.0% of their operable capacity as gasoline production increased, averaging 9.8M barrels per day. 

Thanks for reading The Fed Is Increasingly Hawkish – Week in Review!

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