Nothing seems to be getting in the way of rate cuts as the Fed maintains its dovish stance.
Hotter inflation in January and February. Nope.
Strong payroll growth. Nope.
An economy that usually surprises to the upside. Nope.
A core CPI stuck at about 4 percent—double the Fed’s 2 percent target? Nope.
The Fed’s creed
Neither snow nor rain nor heat nor gloom of night…nor a high core CPI nor upbeat job growth nor hot inflation numbers at the top of the year stays the Fed from a June rate cut.
That was the general message from the March Fed meeting, and Dow, S&P 500, and Nasdaq closed at new highs on Wednesday and Thursday.
Investors are chomping at the bit for the Fed to slash interest rates. Just a couple of weeks ago, March was to mark the first rate cut of the cycle, according to the CME’s FedWatch Tool.
And, going forward, the most likely path wasn’t simply a gradualist approach. The CME’s tool reflected (and still reflects) an aggressive series of rate cuts, up to seven 25 bp rate cuts at one point.
Yet, it’s not the first time investors have bet on a dovish Fed. It’s not the first time they jumped the gun on a Fed pivot or pause.
Honestly, I’m not sure why investors are so optimistic that the Fed will cave to their demands.
You’re thinking, “But hasn’t inflation slowed down?” It has. The core PCE Index is just below 3%. That would give the Fed cover to ease. The six-month annualized core PCE is just under 2%. That would also give the Fed cover to ease.
The core CPI has slowed but is near 4%, and progress has stalled. That’s far from the definition of price stability.
More importantly, GDP in the second half of 2023 expanded at an annual pace of over 4%. Nonfarm payrolls shocked just about everyone in January, rising by 335,000. Notably, the same thing happened last year when payrolls surged by about 500,000 in January.
The consumer isn’t backing down, fiscal stimulus is in the pipeline, and companies are adding to payrolls. If the Fed is truly data-dependent, I’m unsure what would justify the five rate cuts that investors currently expect, let alone the six or seven projected in January.
Put another way, there are few signs the economy needs that much monetary stimulus.
For starters, the Fed has never embarked on an aggressive easing without a recession. Do investors expect the ever-elusive recession to materialize this year?
Well, based on the recent series of highs in the market, the answer seems to be a resounding no. Recessions and bear markets go hand in hand; at least, that’s what 60+ years of market history tells us. If investors were fretting over a recession today, we wouldn’t be seeing major indices near highs.
Final thoughts
Mostly upbeat data are not conducive to an aggressive cycle. Besides, the Fed has openly opined on the lessons of the 1960s and 1970s. Inflation has slowed down, but we’ve been on this merry-go-round before.
So, why are investors so optimistic the Fed will aggressively backpedal on rates this year?
Wall Street analysts were unusually pessimistic as the year began. Should we have been surprised? Probably not. Recession forecasts were all the rage as the year began.
A recent story in Bloomberg News points this out. In fact, since 2000, analysts had not forecast a down year until 2023.
Despite earlier concerns, the economy has held up well this year, and major indices such as the S&P 500 Index are heading into yearend in positive territory.
Notably, analysts failed to call down years, including 2000, 2001, 2002, 2008, 2018, and 2022.
Partly cloudy with a big chance of uncertainty
Predicting the economy and the stock market can be challenging. It is not a straightforward process. Models rely on many variables. Get some of the variables wrong and the forecast can go awry.
We can learn plenty of lessons from this year’s missteps by the pros. But let’s keep it simple.
“Inflation remains well above our longer-run goal of 2 percent.”
“Inflation pressures continue to run high, and the process of getting inflation back down to 2 percent has a long way to go.”
“The labor market remains very tight.”
“We remain committed to bringing inflation back down to our 2 percent goal.”
The rhetoric is strong, but is the bark worse than the bite?
We just had another blowout jobs report, and core inflation is stuck above 5%.
But the Fed passed on hiking rates in June, and the Fed is penciling in just 2 more 25 bp rate hikes this year—that’s two of four meetings. That sounds like the very gradual pace of rate hikes we saw in the 2010s when inflation was hovering just below 2%.
Is the Fed really committed to getting inflation back down?
Last year, they talked a big game, and they followed through, much to the chagrin of investors. This year, I’m not so sure. Maybe it’s simply the fear that anything more than a mild recession could be lurking.
Over the past six to twelve months, there has been significant coverage and talk regarding a looming recession.
This level of attention from analysts, economists, and the financial media is unusual, as recessions typically catch us off guard. It’s only in hindsight that we recognize the signs that were hidden in broad daylight.
This time, however, it’s hurry up and wait… and wait and wait. Last week’s payroll report highlights that we’re still waiting.
Yet, the Fed is on board with a mild recession. It sees one developing later in the year.
The job market is flourishing, and inflation is more than double the Fed’s annual 2% target. However, central bankers are considering forgoing a rate hike next week in order to assess the impact of 10 straight rate hikes, which have raised the fed funds rate from zero to 5%.
The current series of rate increases is the sharpest since 1980. But even with a 5% fed funds rate, it’s not at a historically high level, particularly with inflation hovering around 5%.
Essentially, this means that the real fed funds rate is zero, and it doesn’t appear to be restrictive, given today’s still-high rate of inflation.
Once again, investors in some corners of the market were bracing for an earnings Apocalypse. Once again, fears were exaggerated.
Why? I think I can point to a couple of reasons.
First, analysts have historically been too conservative with their forecasts for corporate earnings. Q1 was no exception.
Second, we’re not in a recession… at least not yet. Fortune 500 companies are huge. Sure, they can execute well and expand their reach. But they aren’t immune to missteps. If they fail to execute, it can be reflected in sales and profits.
But because they are so big, most aren’t immune to the tailwinds and headwinds that an economic expansion or recession will bring. If folks are spending, they benefit. If folks are stingy, they feel the pain.
Earnings for S&P 500 firms will likely end up falling less than 1%. On an absolute basis, it’s not impressive. But analysts had been expecting profits to decline by over 5%.
In other words, it’s a beat, and on average, most companies are beating by a wider-than-historical margin.
It boils down to modest overall economic growth and an easy-to-clear hurdle.
“Markets can remain irrational longer than you can remain solvent.”
That observation came from the late economist John Maynard Keynes. Today, it’s fear, not the fundamentals, that are driving short-term sentiment.
Silicon Valley Bank and Signature failed, and the government stepped in to guarantee all deposits of the two banks. And, the Fed implemented a new lending program. Crisis solved.
Advance to late April.
First Republic says it lost a substantial number of deposits since the beginning of the year. The FDIC steps in and sells the deposits and most assets to JPMorgan. “This part of the crisis is over,” JPMorgan CEO says.
Well, not so fast.
Analysts are now warning that regional bank stocks are stuck in a negative feedback loop. The fundamentals don’t seem to matter. Fear and sentiment do. Following First Republic’s demise, short sellers and the market eye their next target, which right now is California-based PacWest Bancorp.
“Markets can remain irrational longer than you can remain solvent.” It’s just one more reason why a well-crafted diversified investment portfolio tailored to your long-term goals can help you manage short-term volatility.
Got volatility? You bet. The DJIA can rise or fall by 800 points in a day. What’s going on? Millions of large and small investors are buying and selling, attempting to discount, or price in, future events. This occurs in ‘normal’ and ‘not-so-normal’ times.
But even in normal times, uncertainty is always present. No one knows the future with certainty. Do you have a crystal ball? I didn’t think so.
What might happen to bond yields, corporate profits, economic growth, inflation, and more?
Today, the economy is on solid footing. Consumer balance sheets are strong, jobs are being created, and the economy is expanding. However, the markets are facing huge headwinds: rising inflation, a more hawkish sounding Fed, and the Russian invasion of Ukraine.
Russia’s invasion has injected an enormous amount of short-term uncertainty into markets.
For example, how do investors price oil? Well, what’s going to happen to Russian oil exports?
The U.S. is looking to ban Russian oil imports, but Europe has been reluctant. Yet, banks don’t want to finance shipments, and dock workers aren’t unloading the crude.
How long might this last? How do investors price oil in such an unstable environment? It’s why we are seeing huge swings in crude.
Eventually, we might expect investors to gather around some version of a new normal. I guess in some respects, a roughly 10% drop in the S&P 500 suggests an incredible amount of resilience. Think about it: inflation is soaring, uncertainty is the rule, the Fed will be raising rates, and markets are down modestly.
The tech-heavy Nasdaq has set numerous records this year. The S&P 500 eclipsed its February high on August 18 and proceeded to set six more records before August ended.
An impressive stock market rally
And the better-known Dow crossed 29k today and is closing in on its previous all-time high.
Per Barron’s, the Dow had it’s best 100 day run since 1933 – up 50% from its March 23 bottom through mid-August. It’s stunning given the uncertainty regarding the economic backdrop.
It’s not that we remain mired in a recession. We’re not. The economy is in recovery mode, but there’s still plenty of ground to be made up. Yet, this story has been told before.
However, let’s remember that investors attempt to discount future events, usually between 6 to 9 months.
The major market indexes bottomed March 23, and major data points began to rebound in May.
Factors lifting stocks
My list begins with, “It’s the Fed, stupid.”
Federal Reserve stimulus and an open-ended commitment of additional support, which includes extraordinarily low interest rates and Fed guidance that low rates will continue for an extended period. Let’s not forget Powell’s late August speech, in which he stressed that the Fed will take a softer line on inflation and won’t be as quick to pull the trigger on raising rates.
But let’s not stop there.
2. An improving economy has also helped. Put another way, better economic numbers and Fed stimulus have combined to create a powerful cocktail for investors.
Wait, there’s more.
3. A smaller-than-expected drop in Q2 S&P 500 profits (Refinitiv),
4. A rollover in new daily Covid cases (Johns Hopkins) and talk of a vaccine, and finally, investors may simply be looking past the steep recession of 2020.
Yet, let’s not discount risks. When stocks surge, any unwanted surprises can create volatility and an excellent excuse to take profits. One has to wonder, even expect, that we may see some rocky days.
For now, the bulls stepped in front of an expanding economy when few saw the robust bounce that occurred in May and June. The collective view of investors on the economy remains optimistic, even if the month-to-month rate of growth is uncertain.
I never thought I’d EVER blog about getting a haircut. But then, these are unprecedented times we’re living in.
If you reside in one of the states or cities that has shuttered businesses, you probably haven’t been to a barber or hairstylist in over a month. If you’re like me, you snuck in just before businesses closed.
But for someone who gets a trim (I joke with the stylists that I call it maintenance) every 4 or so weeks, I was starting to push the limits. It makes you appreciate the simpler things such as getting a haircut, but I wonder what I might have looked like had I missed a late March trim?
It’s probably a good thing that I’ll never know!
Where should I start?
First of all, an appointment was required. No walk-ins. Not anymore. So, I called and was asked a number of questions… questions I’m grateful that were asked.
Did I have a persistent cough? Was I displaying any symptoms? Had I been around anyone in the last 2 weeks that had COVID-19? Was anyone in my household sick?
I answered honestly, and we made an appointment for later in the afternoon.
But wait, there’s more.
As I arrived, I was greeted by a large sign on the door that offered me additional guidance.
All customers must have a mask. Do not come in. Call and we’ll come outside and escort you through the door.
The new normal
OK, you won’t get any complaints from me.
I called, and shortly, a young lady exited the building with a sign that had my name on it. She too donned a mask.
We exchanged pleasantries and I politely asked her if we could keep conversation to a minimum. I missed the chatter that I’ve grown accustomed too, but I thought, “Masks aren’t perfect, she’s above me trimming my hair, and what about those droplets we’re all worried about?!”
Within 15 minutes, the beast had been tamed. What looked like the early stages of the Amazon jungle was now a neatly manicured lawn. Whew!
It’s not that I’m going anywhere anytime soon. It just felt good to experience a bit of normalcy and get my hair cut. I must admit that I feel better when I look in the mirror.
I assume my stylist hadn’t been working in over a month, but I didn’t ask. I assume she had been receiving unemployment, but again I didn’t ask. Benefits are generous today, but I was appreciative she came in, and I expressed those sentiments to her. I was happy to leave her a hefty tip.
Maybe, just maybe, as states slowly reopen their economies, the downward economic spiral will end, furloughed employees will return, and economic activity will begin to accelerate.
Still, I’m under no illusion that the economy will soon hit pre-crisis levels. But maybe the flicker of light in the sky is the dawn before the sunrise.