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Charts for the Week

May 29, 2023

AI | Blowing bubbles?

Since the artificial intelligence (AI) chatbot ChatGPT was released last November, interest in AI has exploded, offering growth technology stocks another shot of adrenaline. The AI story is largely holding up the broader market indexes so far this year with some valuations starting to look rather bubblish again after briefly retreating from such levels in 2022. But can the run in AI stocks continue in the current economic environment?

Speculative bubbles typically thrive on two things: a narrative about a glorious future that goes viral and easy credit. AI has the first part in spades as the technology has the potential to be truly revolutionary and has clearly caught the public's imagination. However, the AI bubble will have to overcome a tightening credit cycle if it is to continue to inflate. That said, there may still be enough juice left in the system from all the pandemic stimulus to let the AI stocks run for a while. 

From a long-term perspective, bubbles generally look ridiculously irrational, but in the moment it can be perfectly rational to buy a stock that the herd seems determined to push higher. The challenge is getting out of the herd’s way when it changes direction. 

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Sources: YCharts,, AOWM calculations

Debt Ceiling | Fiscal fig leaf

May 22, 2023

The cash reserves of the federal government are running low as the powers-that-be continue to negotiate an increase to the statutory debt limit. It is generally viewed as unimaginable that the historically meaningless debt ceiling won’t be raised as it has been 78 times since 1960. Accordingly, financial markets have largely shrugged off the drama. Nevertheless, the nation’s growing fiscal imbalances will ultimately require more than a fig leaf of attention, potentially sooner rather than later since the pandemic increased the federal debt held by the public to around 100% of GDP. 

Even with the pandemic in the rearview mirror, the government is still running a nearly $2 trillion deficit which equates to more than 7% of GDP. That is half of what the deficit was at its pandemic peak, but it remains historically elevated especially considering that the unemployment rate is at its lowest level in 70 years. If there is a recession in the next year, the deficit will naturally widen even more and further exacerbate the long-run fiscal challenges facing the country. 

Some combination of lower discretionary spending by Congress, higher taxes and higher inflation seems a likely result of the growing gap between federal receipts and outlays -- barring a technological miracle that dramatically lowers health care costs or accelerates economic growth, which the political class may hold out hope for as long as possible until events force them to do otherwise. 

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Small Caps | Not feeling very bullish

May 15, 2023

The stock market continues to trend sideways, held up primarily by the stocks with the largest market valuations. While seemingly going nowhere fast, the S&P 500 Index still remains more than 15% above the low reached last October. Small cap stocks, on the other hand, have traded back toward the lows with the Russell 2000 Index down nearly 29% from its all-time high.

Small cap stocks typically lead the market coming out of a downturn (or at least keep pace). They are clearly not doing that now. Thus if last October was the low, the market is defying its historical pattern, which it has frequently done over the past three years.  

On the positive side for small cap stocks is their relative valuation. The Russell 2000 is trading at less than 13 times expected earnings while the S&P 500 is over 19. Even if estimates for future earnings remain too optimistic and have further to fall, investors seem to have built some margin of safety into small cap valuations. 

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Peak Fed Funds | Wait and see

May 8, 2023

Policymakers at the Federal Reserve increased their target overnight interest rate to over 5% last week and indicated they will take a wait-and-see approach from here to evaluate whether they have done enough to bring inflation under control. The fed funds rate is now above most measures of inflation for the first time since 2019; however, in real, inflation-adjusted terms, the Fed’s target rate remains historically low unless inflation continues to fall relatively swiftly in the coming months. 

The Fed is looking for financial conditions to tighten further naturally from here with policymakers expecting the fed funds rate to be about 1.5% above falling core PCE inflation by the end of the year (which would still be well below where the real fed funds rate peaked in 2000 or 2007).  If inflation does not fall as forecasted, nominal rates will likely not have peaked after all. 

The strong labor market may complicate the Fed's contemplative pause. The unemployment rate fell back to the multi-decade low of 3.4% in April and has been below 4% for more than a year which has added to inflationary pressures. Unemployment often does not start to increase until several months after the Fed has stopped raising rates. But for policymakers hoping to be done with rate increases, it would be helpful for the imbalances in the labor market to start moderating sooner rather than later (ideally via a glorious soft landing of more folks joining the workforce than a big decline in employment). 

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Sources:  YCharts,, AOWM calculations

May 1, 2023

The Consumer | Still spending

Economic growth in the first quarter was weaker than forecasters had expected with the economy growing just 1.1% during the quarter at a seasonally adjusted annual rate. Quarter-over-quarter growth has been choppy over the past eighteen months, but the economy does seem to be trending towards slower growth, if not a recession.

To the extent the economy is growing, the consumer is primarily to thank. Businesses drew down inventories in the first quarter, which weighed on growth, but the consumption of goods and services continued to head higher. The economy has leaned heavily on personal consumption over the past few years as it has grown to represent nearly 71% of real GDP. 

The enormous stimulus doled out during the pandemic has fueled consumer spending. Consumers are likely still sitting on over $1 trillion more in savings than they otherwise would have had. That stockpile is being slowly whittled down but should continue to support the economy for the remainder of the year. Once it is gone, the economy will be more vulnerable to the Fed’s tightening monetary policy which is expected to go another rung higher this week. 

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The Markets | Unsettled quiet

April 24, 2023

The stock market has had a quiet start to the earnings season during which companies report their first quarter profits. Over the past two weeks, the realized and expected future volatility of the S&P 500 Index has fallen back to where it was at the market peak in January 2022. The seas have calmed quickly after the recent rattling storm of two large bank failures. 

It is unusual for the market’s daily swings to be this subdued during a bear market -- or the early stages of a new bull market if that is where we are. But the stock market has been anything but normal over the past three years. 

Adding to the eerie stillness of the stock market is the strange activity in the Treasury market where the yield on the one-month Treasury bill has cratered to 3.36% over the past few weeks even while expectations have increased for the Fed to raise its target overnight rate above 5% next week. It is unclear why the most liquid market in the world is behaving so oddly, though it may have something to do with concerns about the looming debt ceiling battle in Congress. 


Even without the potential for a brewing debacle in the nation's capital, the next two weeks are likely to make all financial markets livelier as two-thirds of the companies in the S&P 500 Index are scheduled to report their first quarter earnings and the Fed will announce its next interest rate decision. If the stock market sleeps through all that without at least a few characteristically erratic swings, something peculiar is afoot.

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April 17, 2023

After Rate Hikes End | Flip a coin?

Inflation continued to improve in March with the headline number falling to 5%. The Fed may still hike rates one more time next month as core inflation excluding food and energy is showing less progress, but the end of Fed rate increases seems imminent. 

What happens after the Fed stops raising rates? History tells us the stock market may go up – or it may go down. At the end of the past ten Fed tightening cycles, the market reacted positively six times over the subsequent six months. Half the time, however, significant market declines were still to come, including the false dawn in 2006 when the market sailed to new all-time highs in 2007 before the financial crisis struck. 

When policymakers finally do indicate that they think they’ve done enough, the decreased uncertainty around how high the Fed will raise rates may very well generate a momentary rally in the stock market. How long such a rally lasts will likely depend on corporate profits and investors’ risk appetites remaining robust. Stubborn inflation and/or a deep recession would dent both. 

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Sources:  YCharts,, AOWM calculations

Jobs Report | Bad good news?

April 10, 2023

The labor market remained strong in March with an estimated 236,000 jobs added and the unemployment rate ticking lower to 3.5%. The good jobs report has increased the odds that the Fed will raise rates at least one more time; however, the news was not all bad for policymakers striving to bring down inflation. 

The size of the labor force continued to grow at a healthy pace for the fourth month in a row as the labor force participation rate increased to its highest level since March 2020. The possibility of a soft landing always depended in part on drawing back into the workforce the individuals who left during the pandemic. 

Policymakers could also look past the good headline numbers and see signs of weakening in the labor market if they wanted a reason to pause their rate hikes. Private payrolls increased by the lowest level since 2020, and the number of temporary workers continued to decline compared to last year. 

Fixed income investors certainly seem to think the labor market is about to weaken substantially as the negative spread between the 10-year Treasury yield and 3-month Treasury yield reached a historic level of inversion last week. 

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Fed Remittances | No longer supporting Uncle Sam

April 3, 2023

During the era of Quantitative Easing, the Federal Reserve greatly expanded its balance sheet and made a lot of money. Last week the Fed released its audited financial statements for 2022 and reported net income of $60.7 billion. Over the past decade, the Fed’s annual earnings have averaged over $80 billion. This has been a wonderful free lunch for the federal government as the benefactor of the Fed’s earnings, but that free lunch has come to an end. 

The Fed started losing money in September as it began to pay out more in interest than it was earning on its portfolio of fixed income securities. It is now losing about $2 billion each week and has accumulated losses of $44.2 billion over the past seven months. Unlike some of the banks which have also been squeezed by low yields on long-term assets and rising rates on short-term liabilities, the Fed doesn’t have to worry about its solvency. It can effectively print money to meet its commitments and nicely gets to book its losses as a deferred asset because the losses reduce what it must remit to the Treasury in the future.

That through-the-looking-glass accounting unfortunately does not eliminate the reality that the federal government is losing what amounted to nearly $1 trillion in revenue over the past twelve years. Whether it was ever wise for the Fed to create that income stream will be long debated, but its loss will clearly add to the burgeoning federal debt which seems headed towards a day of reckoning that will force the powers-that-be to raise taxes and/or lower spending. 

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Interest Rates | Future path increasingly uncertain

March 27, 2023

Fed policymakers once again raised the fed funds rate by 0.25% last week while once again increasing their projections for inflation and lowering their outlook for economic growth; however, for the first time since they started tightening monetary policy, they did not raise their forecast for the peak fed funds rate. 

Policymakers still expect to raise the fed funds rate one more time by 0.25% to over 5% and then keep it at that level through at least the end of the year. Fixed income investors, on the other hand, think rates have peaked and that the Fed will be cutting interest rates by July. 

Everyone anticipates the recent turmoil in the banking industry will tighten the availability of credit and slow the economy. The disconnect between policymakers and investors is that market participants think more things are likely to break causing the Fed to reverse course to maintain financial stability. 

If fixed income investors are right, the economy will soon be in a recession, which has not been priced into the equity markets. If the Fed is right, interest rates will be higher for longer than either the fixed income or equity markets are currently expecting. In either case, markets will remain volatile given the heightened level of uncertainty.  

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The Fed | Stuck between a rock and a hard place 

March 20, 2023

Policymakers at the Federal Reserve meet this week to decide their next step in their battle against inflation, which is declining but remains well above the Fed’s 2% inflation target. The Fed’s next step was highly anticipated to be another rate increase of 0.25% or 0.50%, but the recent turmoil in the banking industry has complicated things. 

Based on the market for fed fund futures, investors still view it as more probable than not that the Fed will raise its target fed funds rate to between 4.75% and 5%. Last week the European Central Bank raised its target interest rate by 0.50% despite the banking issues rattling the Old World. Given regulators’ reassurances about the soundness of the US banking industry and the persistence of high inflation, it will be hard for policymakers to pause their rate hikes now. 

If the Fed does raise rates this week, we will enter a strange world in which the Fed is increasing interest rates while simultaneously loaning hundreds of billions of dollars directly to banks to calm nervous depositors concerned about rising interest rates. But we live in strange times, and policymakers may be stuck with no better options. 

Sources:  YCharts

Bank Failures | Changing investors' outlook for rates 

March 13, 2023

The past week has been eventful. The Fed Chair, Jay Powell, first led investors to believe that the central bank would push interest rates higher for longer to combat inflation. Then the 16th and 29th largest banks in the US quickly failed leading investors to wonder if the Fed is about to pivot in dramatic fashion towards lowering rates and once again injecting large sums of money into the system.

The two banks that failed, Silicon Valley Bank and Signature Bank, rode the large wave of monetary stimulus during the pandemic with their market capitalizations surging to over $43 billion and $22 billion, respectively, just 14 short months ago. However, they both fell victim to an old fashion bank run over the past week. 

Banking by its very nature depends on the confidence of depositors – only about half of all bank deposits are insured by the FDIC, and banks on average only keep about 10% of the deposits they hold in cash. Thus if there is a loss of faith in an institution, it can quickly get into trouble even in the best of situations, and a rising rate environment is less than an ideal environment to be forced to sell off fixed income investments. 

During the pandemic, banks were flooded with deposits as a result of the unprecedented government stimulus, and they invested a lot of those deposits into fixed income securities when interest rates were pegged to the floor by the Fed. As interest rates have risen, that has pushed down the value of those securities. Much like with an investor who buys a bond with the intention to hold it to maturity, the day-to-day change in value shouldn’t matter as long as the security can be held to maturity – which for banks depends on avoiding having a wave of depositors ask for their money back all at once. 

Policymakers at the Fed and the Treasury have hopefully forestalled further panic about the safety of deposits with their response to the recent bank failures. Nevertheless, the events of the past week are still likely to dampen the animal spirits of investors with a renewed appreciation for the risks they are taking.  

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Federal Debt | Snowballing 

March 6, 2023

As Congress marches towards a showdown this summer over raising the federal debt limit, the Congressional Budget Office (CBO) has highlighted the long-term fiscal challenges facing the federal government with its latest 10-year budget projection. 

The CBO makes these forecasts each year assuming current laws remain in place and smooth sailing for the US economy. Not surprisingly these estimates have significantly underestimated how much debt the federal government would accumulate over the coming decade.

In the past fifteen years, the US has experienced a financial crisis and a pandemic – rough seas that led to significant outlays by the federal government. The federal debt held by the public has already topped 100% of GDP, and the CBO projects it is headed towards 200% over the next thirty years. Market-imposed fiscal limits may prevent that forecast from being another underestimate.

The powers-that-be have been able to increase the federal debt with no apparent downside as the Federal Reserve has pegged interest rates at abnormally low levels for most of the past two decades. With interest rates returning to more normal levels, Congress likely won't be able to kick the hard decisions down the road for much longer.       

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Corporate Profits | Normalizing as stimulus wanes

February 27, 2023

With most of the companies in the S&P 500 having reported earnings for the fourth quarter of last year, “only” 68% have exceeded the well-managed earnings expectations of analysts. Over the past few of years, that number has often been greater than 80%. 

During 2022, corporate profitability began to normalize after benefiting greatly from the sizable government stimulus injected into the economy to counteract the effects of the pandemic. Even after retreating slightly, profit margins remain high by historical standards; and yet the consensus expectation is they will rebound higher again this year despite the Fed’s efforts to slow the economy with higher interest rates.

Those higher interest rates in themselves cast doubt on expectations for higher margins. Over the past couple of decades profit margins and corporate bond yields have often moved together with interest rates leading the inverse change in margins by a few months. The most direct link between the two is the fact that lower interest rates ultimately reduce companies’ borrowing costs and vice versa. Indirectly, corporate bond yields are also an indicator of investors’ general confidence in future corporate profitability. 

Current corporate bond yields, which still reflect tight credit spreads to US Treasury debt and thus a high confidence in future corporate profitability, nevertheless suggest that profit margins may continue to decline back towards a more historical level even without a recession. 

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Sources:, Ycharts, Federal Reserve, Moody's Seasoned Baa Corporate Bond Yield,, AOWM calculations

Rising Rates | How high and how long?

February 20, 2023

Recent economic data has suggested inflation may be more stubborn than hoped.   As a result, investors have once again shifted their expectations for how high the Fed will raise interest rates.


Over the past two weeks, expectations for the peak fed funds rate have moved from below 5% towards 5.5%. Long-term interest rates have increased by a similar amount but remain below the levels they reached last fall.


Is it time to shift from fixed income securities with short-term maturities and lock in long-term interest rates? History suggests investors can be patient as long-term rates, especially for corporate debt, haven’t typically begun to decline significantly until the Fed is done raising rates. And if the markets are in the process of slowly adjusting to a new normal of higher interest rates, short-term debt may continue to offer better returns for a while as it did in the 1960s and 1970s.


How much higher and longer the Fed will raise rates is hard to predict, but investors are likely still best served by tilting their fixed income investments towards high quality, short-term debt.

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Banks | Beginning to batten down the hatches

February 13, 2023

Bank lending has remained strong despite the slowing economy, but the number of banks tightening lending standards continues to grow which does not bode well for future loan growth. The demand for loans is also declining as the Fed continues to raise interest rates. 

A retrenchment in available credit could be one of the things that helps to tip the economy into a recession later in the year. And in turn a recession would also likely lead to a de-leveraging of corporate balance sheets. Corporate debt outstanding has grown to a historically high level relative to GDP (~50%). After the recessions in 2001 and 2007-2009, corporate debt as a percent of GDP fell to around 40%.   

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Labor Market | Still beating expectations

February 6, 2023

The jobs report last week was once again better than expected as the labor market continues to hold up well in the face of rising interest rates and a slowing economy. The unemployment rate fell to its lowest level over the past 69 years, and employers were estimated to have add 517,000 new jobs. 

January’s employment numbers took a little steam out of the stock market which has charged higher through its 200-day moving average and last year’s downtrend line. Investors took a breath from their recent bullish run as the strong jobs report makes it more likely that the Fed actually will take interest rates higher for longer. 

The strong labor market unfortunately cannot be taken as a sign that the Fed will succeed in pulling off a soft landing of taming inflation without a recession – which would be the best news for investors. There have been a lot of historical outliers over the past few years; however, it would be the historical norm for employment to remain strong past when the Fed plans to finish raising rates in a few months and then turn south with the economy a few months thereafter. 

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The Market | Fighting the tide

January 30, 2023

The markets have gotten off to a good start in the new year. The S&P 500 index is up over 6%, and the Bloomberg US Aggregate Bond Index is up 3%. To the extent these short-term price moves are indicative of a coherent outlook by investors, it would imply a growing view that inflation will quickly fall to 2%, the Fed will swiftly pivot to lowering rates, and the economy will avoid a recession.

That goldilocks chain of events would be a historical anomaly. It also may not be sufficient to push the stock market much higher. Improving expectations for corporate profits and growing risk appetites fuel strong bull markets; the tide for both is still going out at the moment.  

Even if the Fed was inclined to pivot towards lowering rates, it is far from guaranteed that would improve the short-term outlook for the market. But the potential effect of lower rates is likely moot as the Fed is poised to affirm yet again this week its plans to take short-term interest rates higher for longer. 

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Sources:, YCharts, BEA, PCE inflation, Wall Street Journal

January 23, 2023

Mortgage rates | Lower but still high

Last year mortgage rates spiked from around 3% to over 7%, significantly decreasing the affordability and sale of homes. The past few months have offered a slight reprieve as mortgage rates have retreated towards 6% and may have further to fall as they remain at a historically wide spread to the 10-year Treasury rate; however, high mortgage rates are likely to remain a headwind for the sector.   

The Federal Reserve is clearly being successful in slowing the economy when it comes to the housing market. In addition, data released last week on industrial production and retail sales in December showed other areas of the economy are weakening as well.

Given the growing signs that the economy and inflation are slowing, investors expect the Fed will increase its target fed funds rate by just 0.25% at its meeting next week and stop raising rates at its following meeting in March. 

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Inflation | Mission accomplished?

January 16, 2023

Annual inflation as measured by the Consumer Price Index (CPI) declined for the sixth straight month in December, down to 6.4%. Annual core inflation excluding energy and food also improved, declining to 5.7%.

Over the past three months, inflation has been running below 2% on an annualized basis, and core inflation has been close to 3%. As a result of declining inflation and the rapid increases in the fed funds rate by the Federal Reserve, real short-term interest rates based on core CPI eked backed into positive territory in the last quarter of 2022 after being deeply negative to start the year. 

Inflation is unlikely to take a straight elevator back down to 2%, but it is definitely moving in an encouraging direction which has alleviated a lot of investors’ concerns even if they remain overly optimistic about how quickly the Fed will stop raising rates and reverse course. 

The past few years have highlighted how little is understood about how inflation works, so policymakers are likely to stick to their plans for raising the fed funds rate above 5% for an extend period to ensure that the stake has been thoroughly run through the heart of inflation. If the markets and economy continue to motor along without any great unhappiness, there will be even less incentive for them to do otherwise. 

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Sources:, AOWM calculations

Labor Market | Strong employment, weak wages

January 9, 2023

The labor market remained generally strong in December with the unemployment rate falling to 3.5%. Instead of raising fears that the good jobs report might keep the Fed raising interest rates, investors seized on a slowdown in wage growth as a sign that inflation will continue to abate. While a potentially good sign for inflation, slowing wage growth is likely to add an additional headwind for the economy as wages fail to keep up with rising prices, hurting consumption.

There were also signs under the surface that the Fed is being successful in slowing the economy. The number of new jobs added continued to decline to the lowest level in two years. In addition, the number of employees in temporary help services fell further which has historically been a canary in the coal mine for the broader labor market. 

Investors are holding out hope that inflation will subside without a recession. However, state level data through November indicates that more than half the states are already experiencing negative labor market conditions which has historically implied a pending downturn for the national economy. Despite the positive market response to the jobs report on Friday, the odds of inflation retreating peacefully still don’t appear high. 

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January 2, 2023

2023 | The Outook

Financial markets are coming off their worst year since the great financial crisis in 2008. Last year, fixed income investments suffered their worst year on record as interest rates broke their four-decade downtrend, and stocks suffered their longest prolonged decline in thirteen years. Global financial markets have now shed nearly $40 trillion of their market value. 

Policymakers, professional forecasters, and investors remain generally cautious headed into the new year.  Nevertheless, the consensus outlook is also the best case scenario where inflation declines steadily, but the economy doesn’t slip into a recession (or at least only suffers a very mild one if it does). Inflation that failed to retreat as expected and/or a recession deep enough to weigh on corporate profits would likely make 2023 another tough year for investors. 

With margins still at historically high levels and earnings growth expected to remain strong despite the slowing economy, the potential for disappointing earnings appears to be the biggest risk for the market at the turn of the calendar year. 

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Sources:, Federal Reserve, Bloomberg, YCharts, AOWM calculations

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