Market Update

The S&P 500 lost 2.67% last week to end at 3,970.04. The index bounced off its 200-day moving average Friday at 3,940. The 50-day prevented the S&P from moving higher though. The short-term trend is down. First support is the 200-day. The 100-day is at 3,910. Next support is 3,800. To the upside, first resistance is the 50-day followed by 4,100 and then 4,200. We wrote last week that, “It’s a toss-up whether the S&P will move higher … or try the downside again.” Pencil in the same for the coming week. Although the bounce off the 200-day Friday gives a slight edge to the upside on Monday.

We also wrote, “Regardless of direction next week, the odds favor more downside testing in the coming month. Earnings estimates continue to fall. The Fed continues to talk tough. The Fed funds futures market continues to move higher. Leading economic indicators continue to point toward recession later this year or early next. And liquidity is drying up.” Nothing has changed.

Last week saw more evidence that interest rates are going higher for longer. The purchasing managers’ index came in stronger than expected. Likewise, personal income and spending surged in January. As well, consumer sentiment hit its highest level in over a year. Finally, we got a higher-than-expected January core inflation number. Core PCE rose 0.6% and is up 4.7% year over year, showing no slowing. Making it worse was the upward revision to the December number. The market sold off Friday on the inflation news.

Rising interest rates will continue to create headwinds for stocks, limiting their upside. The 10-year yield is at 3.96%, up sharply since the big January jobs number. The two-year yield ended Friday at 4.90%. It normally peaks above the final Fed funds rate in a tightening cycle, according to James Bianco of Bianco Research. The expectation is for the Fed to now hike rates three more times by 0.25% for a total of 0.75%. That would put the terminal fed funds rate at 5.25% to 5.50%. The fed-funds futures market has rates rising to a peak of 5.40% sometime in September or October of this year. The two-year Treasury will need to rise another 0.50% just to match the expected terminal funds rate. The 10-year will likely rise as well. Bianco is expecting a parallel shift in the yield curve. That would take the 10-year yield to 4.60%, above its previous cyclical high of 4.25% hit in October. The 10-year yield most influences the 30-year mortgage rate. The housing market will continue to struggle if the 10-year continues to rise.

The sharp and continuing rise in interest rates should keep a lid on the S&P 500. The index is still weighted to a handful of big tech names. Meta, Apple, Amazon, Netflix, Alphabet, Microsoft, Nvidia, and Tesla accounted for 3.05% of the 3.81% gain in the S&P 500 through February 22, according to Bianco. The other 492 stocks have broken even. It is those same big tech stocks that are most affected by rising interest rates. Expect the S&P 500 to struggle as interest rates move higher. Risk is still to the downside.

Economic Indicators

Economic data was strong last week. The S&P flash services PMI showed expansion, rising to 50.5 from 46.8. The U.S. manufacturing PMI continued to show contraction but did rise from 46.9 to 47.8. Initial jobless claims were below 200,000 again. They came in at 192,000 down from 195,000 the prior week. Jobs are a lagging indicator, but weekly jobless claims are a leading indicator. The jobs market is strong.

Consumer spending was strong, showing an increase of 1.8% following a decline in December of 0.1%. Personal income rose 0.6% up from 0.3%. New home sales in January were 670,000, well above expectations of 620,000. Unfortunately, inflation also was stronger than expected. Core PCE rose 0.6% in January above expectations of 0.5%. Core PCE year-over-year rose 4.7% up from 4.6%. Rising core inflation is not something investors were expecting. The Fed-is-about-to-pivot narrative is on its deathbed.

Bear markets don’t end before the Fed stops tightening. Bear markets don’t end before the public starts panic selling. The Fed has not stopped tightening. There was no panic selling by the public in October. It is unlikely that the bear market is over.

What is the Purpose of Insurance?

Insurance is primarily needed to replace income for a dependent. It also has its uses for estate planning purposes, but most people don’t need it for estate planning. Term life insurance is the best solution in most cases. It is the lowest-cost insurance. The level term period locks in the premium for the duration of the policy. All other types of insurance have an investment component. The investment features of life insurance policies are expensive. You will earn a higher rate of return with a low-cost diversified portfolio.

You only need insurance if you have a dependent who will need income replacement should you die. Six to ten years of income is a common rule of thumb. Better to look at spending goals though. Enough insurance to get the kids through college for example. Enough to pay off the mortgage for a spouse who can’t afford the mortgage on their own. Enough to get a stay-at-home spouse to social security age. Or at least long enough to give them a chance to gain the necessary skills to re-enter the workforce.

I had two conversations last week with people that have insurance they don’t need. It is money wasted. Money that could go into investments to grow wealth for retirement. One policy was written on a 37-year-old. It is a variable life policy. The cash value is growing but slowly. It is growing slowly because of the mortality and expenses associated with the insurance policy. The expenses are a drag on return. It is growing more slowly than if she was investing the premium in a low-cost diversified portfolio. As well, she won’t need the policy after her children are out of the house and on their own. Her youngest is 9 years old. She needs coverage for another 13 years or so. She won’t need insurance anymore at that point. The variable life policy is an expensive solution for a temporary insurance need. She should have gotten a level-term life policy. It would have covered her much more cheaply for the time she needed insurance. She would have more wealth at the end of the coverage period.

The second conversation was with a couple in their sixties. They bought universal life policies at age 60. Four years in and still no cash value. They don’t have children, so no dependents relying on their income. They will both retire in another five years or so. Even less need for insurance at that point.

The insurance agent told them they could always draw on the policies’ cash values. They could use the cash value for long-term care if needed for instance. They would be better off investing the premiums in a low-cost diversified portfolio of stocks and bonds. They would have more wealth to meet spending goals. More wealth to pay for long-term care if needed in their 80s. They certainly don’t need life insurance in their 70s and 80s.

I frequently come across situations where people have bought insurance policies they don’t need or that won’t do what the insurance agent claims it will do. It’s a shame. People are left worse off as a result.

Buy pure life insurance for the period needed to protect income for dependents. Put the rest of your hard-earned dollars into a low-cost diversified portfolio. You will end up with a better retirement as a result.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist