Tonight, President Biden will present to Congress and the nation his first official State of the Union address (SOTU). In terms of timing, this will be the latest into a new year that a SOTU has been held in at least 50 years.  Therefore, when looking at market performance leading up to and after the address, we’ll be dealing with different than normal seasonal factors for this SOTU. Still, the S&P 500’s performance in the month leading up to the current SOTU address ranks as the fourth worst since 1945, outperforming only 2016, 2008, and 1982. Whereas the average performance in the month prior to the SOTU is a gain of 2.2%, this year, the S&P 500 is down by about 6.6% in the month leading up to Biden’s first SOTU address (chart below).

In the last 50 years, there have only been four other years where the S&P 500 traded down 5%+ in the month leading up to a SOTU address. In those four other years, the S&P 500’s performance in the month after the SOTU was a loss of 1.5%, but the median was a gain of 0.7%, indicating that results varied widely.  For perspective, the average one-month return for all periods in the last 50 years is a gain of 1.1% (median: 1.8%). Regarding treasuries, in the four years where the S&P 500 was down 5%+ leading up to the SOTU, the 10-year yield’s performance was all over the map both before and after the address.

Below is a table that summarizes the performance of the S&P 500 and the 10-year yield in the month before and after the SOTU address. For the S&P 500, performance in the week after the SOTU has generally been positive, but one major exception was 2020 when the S&P 500 declined more than 27% as COVID crashed the markets and economy.  Regarding the 10-year, it’s performance is relatively trendless, although its yield tends to rise modestly the day after the address as investors ponder how all the ‘goodies’ that the President mentions in the speech will be paid for.

Although the past month’s performance has been weak relative to the other periods, there is little correlation between performance the month before and after the SOTU address. Although there is a slight positive relationship, only 3% of the variance in the y-variable is explained by movements in the x-variable. Essentially, this is not a tradeable event.

Ukraine and the pandemic will likely be the main focusses of tonight’s address, and investors will eye the President’s comments about each situation for a read on the President’s view on each situation. Positive comments about these situations may not necessarily be positive for the market, as easing in these areas would imply an increased probability of more aggressive Fed rate hikes. In any event, though, investors should not be making trading decisions based on previous market movements leading up to and after the SOTU, as every year bears unique political circumstances. Click here to view Bespoke’s premium membership options.

The receding of COVID case counts and higher oil prices had a beneficial impact on manufacturers in the eleventh district in February.  The Dallas Fed’s Manufacturing Outlook Survey was forecast to see Business Activity rise only slightly from 2 in January to 2.8 after three straight months of declines.  Instead, the index surged 12 points to 14 which is the biggest one-month gain since June 2020 and the highest reading since October.

As we have seen with other regional Fed manufacturing surveys this month, breadth across components has been somewhat mixed in spite of the move in the headline index.  While there are a handful of categories in the upper end of their historical ranges, others like Company Outlook and Inventories have been more middling. Additionally, six categories decelerated month over month.

One area that experienced a decline was in regards to output.  Production and Capacity Utilization both fell in February.  For the former, that was the third decline in a row leaving it at the lowest level since January of last year. Capacity Utilization is also at the lowest level in a year and a month, but this month’s decline was far smaller than the prior month’s 9.4 point drop.

While production has pulled back, Order Growth Rate held firm as New Orders hit the highest level since July.  Meanwhile, order backlogs continue to fall from historic levels with this month marking the lowest reading since last January as shipments recovered some of the declines from the past few months.

Employment was perhaps the most interesting area of the report.  While the region’s firms continue to report net hiring, the Employment index plummeted 9.3 points for the largest single-month decline since March 2020. That deceleration in new employees happened alongside a deceleration in Hours Worked and Wages & Benefits as well. While current conditions for the Wages and Benefits index was lower, expectations have been blown out of the water.  That index not only set a new record high, but it did so on the largest one-month gain to date.  In other words, hiring slowed slightly in February, but there are widespread plans to increase wages in the future. While it is hard to pinpoint the exact reason for that increase, one potential explanation can be firms trying to raise wages to entice new workers.  Click here to view Bespoke’s premium membership options.

Welcome to Bespoke Brunch Reads — a linkfest of the favorite things we read over the past week. The links are mostly market related, but there are some other interesting subjects covered as well. We hope you enjoy the food for thought as a supplement to the research we provide you during the week.

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Inflation

After Long Covid, U.S. Businesses Get Ready for Long Inflation by Shawn Donnan and Emma Kinery (Bloomberg)

Amidst extremely stressed supply chains, high commodity prices, and extremely tight labor markets, US businesses are getting more comfortable and used to the idea of raising prices to solve profitability challenges. [Link; soft paywall, auto-playing video]

Why This Economic Boom Can’t Lift America’s Spirits by Josh Mitchell (WSJ)

While the unemployment rate has plunged, consumer spending is booming, and wage gains are rapid, Americans are feeling much less optimistic about the economy compared to recent periods of weaker growth. [Link; soft paywall]

Crime

Miami Street Gangs See No Hope In Dope. They’ve Switched To Identity Fraud Fueled By Russian Hackers by Thomas Brewster (Forbes)

With stiff penalties and lots of competition (not to mention physical danger) in drugs, semi-organized criminals are turning to white collar crimes as lower hanging fruit. [Link; soft paywall]

Three men plead guilty to planning U.S. power grid attack, driven by white supremacy by Kanishka Singh and Sarah N. Lynch (Reuters)

A small terrorist conspiracy to violently attack the American power grid has led to guilty pleas from conspirators per plea agreements recorded this week. [Link; soft paywall]

China

Beijing Olympic Ratings Were the Worst of Any Winter Games by Tiffany Hsu (NYT)

It wasn’t just your imagination: this Olympics wasn’t good. China’s winter games drew only a little better than half of the viewership the prior games in Korea reported. [Link; soft paywall]

China Is About to Regulate AI—and the World Is Watching by Jennifer Conrad and Will Knight (Wired)

New rules introduced by Chinese regulators will change how algorithms that dictate pricing, determine search results, and power a galaxy of different consumer tech are managed, a first in the world. [Link; soft paywall]

Renewables

U.S. offshore wind auction bids top $1.5 billion, with more to come by Nichola Groom (Yahoo!/Reuters)

The largest-ever sale of offshore wind development rights in the US got major interest from 14 different companies despite efforts by homeowners to restrict development based on protection of views from summer homes. [Link]

Million-Dollar Home Listings Dry Up for Wealthy Suburban Buyers by Prashant Gopal (Bloomberg)

Large footprint suburban homes have evaporated off the market as dual-income Millennials seek breathing space with big budgets. The result is a massive price boom for the McMansion. [Link; soft paywall, auto-playing video]

Markets

Heavily Hedged Traders Have Been Awaiting a Stock-Market Storm by Vildana Hajric and Katie Greifeld (Yahoo!/Bloomberg)

Short interest has risen and put options have flown into the hands of speculators nervous about a market decline, making the drop in equities this week less painful than it might otherwise have been. [Link; auto-playing video]

Ukraine Swaps Signal 90% Chance of Default as Russia Attacks by Laura Benitez (Bloomberg)

Financial markets are pricing high odds of a default for Ukraine, but the aggressor is also being punished thanks to sanctions and fears over political disruption. [Link; soft paywall]

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Have a great weekend!

The Kansas City Fed’s February reading on manufacturing activity was expected to grow at an accelerated rate with forecasts calling for the headline number to rise from 24 to 25. Instead, the actual reading came in even higher at 29.  That is the strongest reading on the region’s manufacturing economy since last May. Similar to the Richmond Fed report on Tuesday, expectations saw a similarly impressive reading rising to 38 which is tied with last April for the highest reading on record.

Relative to other regional Fed reports released this month, the Kansas City Fed’s survey has generally seen stronger results.  As shown below, nearly every category across current conditions and future expectations sit in the top decile of their respective historical ranges and breadth was generally positive. The only indices that declined month over month were not outright negatives with declines in things like prices, order backlogs, and delivery times.

Of the indices that were higher, the biggest gains came from New Orders, Shipments, and Production. Each of these categories rose double digits month over month. While those increases bring these readings into the top decile of their historical ranges, they have not fully recovered the peaks from earlier in the pandemic. Expectations indices are in a similar situation with significant increases (except for order backlogs) this month. Production has seen the most notable increase of these as this month’s reading on expectations hit the second-highest level on record behind the October 2003 reading.

The report showed supply chains remain stressed but improved as delivery times fell another 2 points marking the third decline in a row.

The report’s readings on prices showed a wide divergence between current conditions and expectations.  Both indices had generally been on the decline from extremely high levels in the past year, but over the past two reports, expectations have surged with both prices paid and received hitting new record highs. Meanwhile, current conditions have only flattened out after reversing lower in the second half of 2021. Click here to view Bespoke’s premium membership options.

As the S&P 500 enters correction territory, sentiment has further degraded.  Once again this week, less than a quarter of respondents to the weekly AAII sentiment survey reported as bullish. Although it was an improvement from 19.2% last week, the current reading of 23.4% remains in the 6th percentile of readings going back to the start of the survey in 1987. We would also note that while there are a range of potential factors that have likely played a role in the recent drop in sentiment ranging from price action to forecasted paths of interest rates to geopolitical tensions, this week’s survey likely did not fully capture changes to sentiment from the news surrounding the situation in Ukraine. More specifically, the collection period would not have captured today’s news of escalation.

Bearish sentiment crossed above 50% as recently as the last week of January, and after falling all the way back down to 35.5% earlier this month, it is now back above 50%. In fact, bearish sentiment surpassed the January high of 52.9% by 0.8 percentage points this week to reach the highest level since April 2013.  Back then it was only slightly higher at 54.48%. The two-week increase since the low on February 10th now ranks in the top 3% of all two-week changes on record.  As for other sentiment surveys, the bearish results are being echoed with the Investors Intelligence survey seeing the highest bearish reading since April 2020.

With the huge pickup in bearish sentiment, the bull-bear spread has fallen below -30.  Similar to bearish sentiment, that is the most pessimistic reading on sentiment since April 2013.

With both bullish and bearish sentiment rising, each reading’s gains have borrowed heavily from neutral sentiment. Neutral sentiment has gone from a multi-year high of more than 40% only two weeks ago down to the lowest level since last April this week.  The bulk of that decline occurred since last week’s survey as neutral sentiment plummeted 14.7 percentage points week over week. There has not been as large of a decline in neutral sentiment since February 2003.

Given how severe of a decline neutral sentiment experienced this week, in the table below we look back at all other times that this reading has experienced a double-digit percentage point decline for the first time in at least six months.  Of the baker’s dozen of prior occurrences, the current instance ranks as the second-largest decline in neutral sentiment behind the August 1994 instance when it fell 15 percentage points. There were also three other times—March 2005, July 2010, and April 2013—when, similar to now, bearish sentiment was above 50%.  Overall across these past occurrences, the S&P 500 has tended to outperform in the short term but longer-run performance (3 months to one year out) has been smaller than the norm for all periods.  In the three periods most similar to the present period, though, where nearish sentiment was also above 50%, forward returns three, six, and twelve months later were higher each time    Click here to view Bespoke’s premium membership options.