Amidst the cacophony, COVID may still be calling all the shots

Stocks fell yesterday with losses accelerating into the close as rising crude oil prices reminded investors of the inflation forces yet to come.  Bonds got a reprieve from their epic route despite heightened hawk talk from the Fed.

Signal or noise?  It is a more common concept these days, but it is one that has been with me throughout my career. I first learned it in my days as a technology-focused finance bro many years ago. In telecommunications, engineers are always trying to push the limits of how much data they can send through the air, a wire, or a piece of fiber.  The more data, the faster the communication. In the case of data, as one would suspect, more and fast are good things. One of the biggest obstacles for the engineer is the noise which gets injected into the transmission from a number of different factors such as temperature changes, attenuation due to distance, or the physical properties of the medium. There are many more, but let’s keep it simple and just say that when a transmission reaches its destination it must be decoded and turned into something useful. Before that can happen, the receiver must determine what part of the received transmission is the actual transmitted signal and what part of it is noise picked up along the way. In essence, engineers had to come up with all sorts of innovative ways to filter the noise out of the transmission. You know, get to the meat of things.

Ok, enough of my overly simplified engineering lecture on data communication. Let’s move the clock forward and bring this into the world of finance. In the markets, like telecom engineers, we are also eternally attempting to separate a signal from noise. Just take a look at a price chart of your favorite stock. There are ups, downs, spikes up, spikes down, gaps, etc. What we want to know as investors is whether or not there is a trend. Is it going higher? Yes, then buy. If it is going lower, you would want to take profits…or limit your losses by selling. Stocks 101, and it seems so simple, right? You don’t have to answer, the chuckle you just gave was enough. Finding those signals within all of the noise is not always so simple. We have actually borrowed quite a bit of math from the technology world to filter the noise out of market movement, and while it certainly gives us a leg up, it in no way guarantees success on every outing.

Taking a step back from individual stocks, in that past 2 years, entire markets have been moved from macro-level events, dragging all stocks, good and bad, in all sorts of directions. Of course, there were the big market movers such as major global events, but there were also many little, let’s call them, diversions along the way that also seemed to have a big impact on the on-edge market. This person said this - markets up; that person said that - markets down…repeat, repeat, repeat. If you are a longer-term investor, you must sit on the sideline and take in all of those market moving events and determine which ones will affect not only your holdings, but your overall portfolio. You must constantly determine what is just noise, eliciting a temporary market reaction, and what is a signal, causing lasting changes.

At current, we are faced with many different bits of information. We have inflation, the pandemic, earnings, interest rates, a war, politics, environmental challenges, public health issues, etc. You can turn your TV to your favorite financial news station and hope to hear what experts say.  If you do, you will notice that 50% of the experts will say one thing and the other 50% will say the exact opposite thing…so, good luck. Let’s take a step back and attempt to separate the signals from the noise. The Fed is raising key interest rates and getting increasingly hawkish. More and more FOMC members are hinting to a +50 basis hike in the next meeting. If the Fed raises too aggressively, it can cause a recession, which is bearish for the economy and stocks. Markets are reacting, as is evidenced by a flattening of the yield curve and an increase in equity market volatility. Then, there is the Russian invasion of Ukraine. That can be filed under geopolitical risk, which also has led to volatility. But what is really moving the markets? Yesterday, you could have watched crude oil prices tic higher as world powers were considering further curbs on Russian energy exports. Indeed, energy prices impact almost every stage of every type of production.  Higher costs to producers mean higher prices to consumers…inflation. We are getting there, bear with me. 

Inflation is bad and the rate hikes they bring make things even more difficult for consumers. That has been a common theme as of late. I wake up, I check crude oil prices, if they are up, with almost certainty, energy companies are all trading higher in the pre-market while growth companies are all down. The opposite occurs when crude is down. It is all inflation expectations driven. In the big picture, those back-and-forth movements are near-term noise. So, lets back out further to see if there is a bigger signal. What caused all of this inflation in the first place? Yes, there is more demand for goods as the economy emerges from the pandemic lockdowns. Interest rate hikes can curtail demand and ultimately be throttled with policy. But what of the supply chain problems?  What controls them? I saw a map this morning that showed a significant number of container ships piled up on the China coast…more than normal. The cause? COVID related lockdowns and quarantines. Lest we forget here in the US which has had a recent reprieve, COVID is still surging elsewhere, and new variants are being closely watched. A recent surge in China has caused plant shutdowns. Remember, that it was those semiconductor plant shutdowns that caused supply constrains to shut down auto manufacturing assembly lines. Stalled assembly lines caused diminished supply which caused auto prices to skyrocket…inflation. I can go on and on with similar examples across all industries, and all paths are likely to lead back to COVID, which is still, very, very much, a signal amidst much noise.

YESTERDAY’S MARKETS

Stocks traded lower yesterday as fresh jumps in crude oil heralded fears of further inflation. The S&P500 fell by -1.23%, the Dow Jones Industrial Average gave up -1.29%, the Nasdaq Composite Index lost -1.32%, the Russell 2000 Index declined by -1.72%, and the S&P500 ESG Index traded lower by -1.16%. Bonds gained ground and 10-year Treasury Note yields lowered by -9 basis points to 2.29%. Cryptos were slightly higher by +0.28% and Bitcoin was lower by -0.56%.

NXT UP

• Initial Jobless Claims (March 12) is expected to come in at 210k compared to last week’s 214k claims.
• Preliminary Durable Goods Orders (Feb) may have fallen by -0.6% after gaining +1.6% in the prior period.
• S&P Global Flash Manufacturing PMI (March) is expected to have fallen to 56.6 from 57.3 while the Services component may have moved to 56.0 from 56.5.
• Fed speakers:  Kashkari, Waller, Evans, and Bostic will all speak today.