Stocks fell yesterday after enthusiasm for Nvidia’s spectacular earnings report faded. What investors learned once again is that when a stock is priced to perfection, you can’t beat perfection. Yes, Nvidia beat all published forecasts and issued forward guidance beyond previous predictions. But the message of the market is that, at least on a short-term basis, beating and raising expectations had already been priced in. Thus, despite the fact that dozens of analysts raised earnings estimates and price targets, Nvidia’s stock finished virtually unchanged for the session.
Now market attention turns to Jackson Hole and Fed Chair Jerome Powell’s speech this morning at 10:05 Eastern time. Just as traders placed bets on Nvidia’s earnings, they are doing so again, predicting market reaction to what Powell is going to say. While I obviously don’t know what he is going to say, here is the backdrop for his comments.
1. Economic growth to date is too fast for the Fed’s liking. However, there have been recent hints, including several earnings reports this week from retailers, that the consumer spending binge is running its course.
2. Inflation is slowing, but the level of inflation is still too high for comfort.
3. Future rate decisions will be data dependent as always. Between 10:05 this morning and the next FOMC meeting in late September, there will be lots of additional data including another employment and CPI report.
4. Therefore, Powell is not going to predict what the FOMC will do in September. Beyond September, it will be a fool’s game to guess. With that said, he will reiterate the Fed’s goal to bring inflation back toward its 2% target over time. If that requires more rate increases in the future, so be it.
5. With that said, Powell watches markets. The recent rise in the 10-year rate and weakness in the stock market might be helpful to his cause. But freefall and panic are not.
Thus, Powell’s task today is to make clear that the battle against inflation isn’t over. But given significant progress over the past several months, the pace of any changes in monetary policy going forward can be gradual, reflecting changes in future incoming data. In other words, firm and resolute without being harsh and impetuous. It’s a tightrope he has navigated before.
Just as markets tend to have spasms immediately after FOMC meetings as traders unwind both successful and unsuccessful short-term bets, look for such gyrations shortly after 10 this morning. Given the lack of other news, stocks are likely to move in lockstep with the bond market over the next few weeks. Lately, the 10-year moved to cycle highs but backed off a bit waiting for Powell to speak. In recent notes, I have made the case that the 10-year yield today is about where it should be in an era of 2% growth and 2% inflation. That doesn’t preclude spikes in either direction over the short-term. Treasury is going to issue lots of debt over the next few months. It’s also noteworthy that the duration of Federal debt has reached an average of 75 months, the highest in over 20 years. Generally, longer duration means higher debt service cost. Add in a few $1.5+ trillion deficits, and you see a massive problem. Are markets just beginning to realize this or am I just late discussing the idea? Time will tell.
After today, the news quiets down. The August employment and CPI reports will evoke some reaction, but the real issue is likely to be the state of the U.S. consumer. U.S. consumer spending has been uniquely strong. From China to Germany to South America, growth has been notably weaker. There are a lot of unique aspects of our economy that can explain part of the difference, but massively expansive fiscal and monetary policy are key factors. Federal outlays are still growing but they are shifting. Rather than being direct handouts to consumers, money is shifting toward infrastructure and investments. That will help in the future, but consumer spending is more than two-thirds of GDP. If the consumer is tapped out, that’s bad news.
Is he tapped out? Probably not yet, but some consumers are. You see it in a rise in default of lower grade auto loans. You see it in rising credit card delinquencies. You see it in a 2+ decade low in mortgage purchase applications. You heard it all week as retailers temper their outlooks heading toward the all-important Christmas season.
In summary, I have no idea how markets might react to what Powell will say this morning. But the reality is that the Fed is going to be reactive, not proactive at this point in time. It can wait, watch, assess incoming data, and react. It doesn’t have to get in front; it already did that. Now, as the excess cash handouts of the pandemic era are largely used up, is consumer behavior changing? There are signs that it is. If so, businesses will need to react. Hiring will decline, layoffs might follow. For months, investors have shelved the idea of a recession coming. A soft-landing became the consensus. No landing became a real possibility. Is that right? In the fourth quarter of 2007, real GDP rose by 2.5%. By the first quarter of 2008, the recession was underway. Given unemployment is still around 3.5%, this coming Christmas season isn’t likely to be poor, but it could be lackluster, setting the stage for a recession to start early next year. Just like Powell always says, the future outlook will be data dependent.
With that said, there are lots of reasons to expect the economy to slow. Employment growth rates are down, and so is the savings rate. The cost of money is up. Inflation may be slowing but the impact of higher prices the past two years is still with us. Credit card balances can cost 20%+ in interest. That alone is reason for caution. As I have noted before, the next 6-8 weeks could be a volatile time for stocks. Economic data and trends in bond rates are likely to be the most important determinants of near-term performance.
Today, Tim Burton turns 65. Elvis Costello is 69. At a time when Russia and Putin again make front page news, it may be worth noting that the man often noted as Russia’s first czar, Ivan the Terrible, was born on this date in 1530.
James M. Meyer, CFA 610-260-2220