Chairman Powell’s final speech before a blackout window starts was one for the bulls. Prior to the next Fed meeting in a couple of weeks, he made sure to lock in a 50bps rate hike as the time has come for moderation in the size of increases down from 75bps. This was (or should have been) fully expected. Fed fund futures barely budged, meaning those investors were well ahead of this speech. However, stocks breathed a sigh of relief, as some likely feared a repeat of Powell’s prior surprisingly hawkish Jackson Hole speech which drove a 20% drop in stocks in just two months.
Another key clue was given during Powell’s breakdown of inflationary pressures where housing is in a bucket by itself. He clearly noted a recognition that implied rents (a 30% CPI weighting) have a major lag effect. The rest of the inflationary groups are trending in the right direction he stated. That is a significant change from his commentary a few weeks ago. This is part of the off-ramp and a great sign that we are in the final innings of this rate-hiking schedule. As we have been noting, the quicker they stop, the greater chance of avoiding another Fed policy mistake, if they have not already made one.
Below is what Powell may be looking at. Outside of homes being built from yesteryear’s orders, the housing market is signaling a severe crunch. Normally, this would precede rate cuts, not hikes. Granted, a lot of the pressure is stemming from home owners not willing to move today, as their replacement property is overvalued and a new mortgage would be double the interest rate. Still, the supply of homes for sale today is double that of the past few years.
About the only negative I could see is Powell’s belief that he must still keep raising rates, even if they are smaller increments, and pulling liquidity via quantitative tightening in order to raise unemployment and slow wage gains. Again, these things take time and we have already seen serious labor issues with tens of thousands of layoffs announced. Holiday season hiring is well below trend. Wage growth is dropping. Wednesday’s ADP employment report showed a massive drop in hiring.
Here is the wage growth trend, showing that wage growth is dropping towards historic trend lines. Why press harder?
Source: RBC Capital Markets
Again, not everything was rosy, but stocks and bonds love to see an end in sight for this tightening schedule. You cannot get back to easing rates without stopping raising them first!
To see what the Fed thinks, it is always a good idea to check with their Wall Street Journal mouthpiece, Nick Timiraos. Timiraos immediately tweeted the following: “Powell may not have intended to ease financial conditions, but his comments about avoiding unnecessary weakness overshadowed his concerns about labor-market imbalances.” Sounds to me like they do not want stocks and bonds to rally too much, as this builds consumer confidence, grows personal assets and increases overall wealth. More confidence = more spending = more inflation. I would expect Fed officials to keep preaching the higher for longer mantra and try to talk tough, even though incoming economic data is likely to align with their desired intent.
Yesterday morning a few more reports showed positive momentum on negative data (bad news is good news in this inflationary battle). Unemployment claims rose to 1.61 million people from 1.55 million the week before. It is very rare to see more people unemployed during the critical holiday season. Even more important, the Fed’s preferred inflation measure, the PCE which takes out food and energy prices, was below consensus and further confirms inflation is coming down. Today, we get the all-important November payrolls update.
Beaten down growth stocks took Powell’s cue that the end of this tightening cycle is just around the corner. Interest rates dropped, along the most critical 10-year portion of the yield curve. Rates down means growthy P/E’s can go up again. Netflix#, Square, Meta#, Nvidia, Qualcomm# and even Peloton posted 5% – 9% gains in Wednesday’s session, and moved even higher yesterday. The Nasdaq advanced over 4%, driven by semiconductor stocks which were up 6% in just one session. Every sector finished in the green with prior leaders like Energy and Industrials lagging behind their growth brethren. The Dow Jones, and its 600-point rally, was a laggard, “only” being up 1.7%. Yesterday, the index dropped fractionally from a negative earnings report out of Salesforce#.
Further optimism is shown in market breadth. 95% of S&P 500 stocks closed positive on Wednesday, which is becoming more frequent as we end 2022. Currently, 92% of the S&P constituents are above their 50-day moving averages. For much of this year, the battle between the market-cap-weighted index and individual stocks showed money flowing out of mega-cap FANGMAN group and into other areas. While the S&P 500 is down ~14% this year, the equal-weight S&P is only down ~8%. The less growthy Dow Jones closed at a seven-month high and now sits just 6% from its all-time record.
If there is any one data point to look at with respect to inflation, it is probably the 10-year Treasury yield. More progress is happening in bond land as well, with the yield on the 10-year down ~80bps since October to 3.53% today. The bond market is pricing in a significant slowdown, lower inflation and a likelihood of lower Fed Funds rates down the road. Currently, markets are pricing in one rate cut in 2023. Take that with a grain of salt though. At this time last year, many did not expect any rate hikes for 2022!
The Most Anticipated Recession Ever?
Markets are forward looking. What happens in the Summer of 2023 is supposed to be priced into stocks and bonds today. Below is a survey from our own Philadelphia Federal Reserve. Each gray column is a recession. The blue lines represent the percentage of professional forecasters who expect a recession in the coming year. Each recession was preceded by a rising number of “pros” who forecasted a drop in GDP. No recession has ever been more expected than today. Frankly, it is not even close. So, the question remains: Has the Fed overdone this rate hiking cycle? Are earnings going to collapse like in every other recession? Is the most anticipated recession ever already priced in to stocks? There is a big difference from a slight slowdown in GDP for a garden variety recession and one that crushes the economy like 2008/2000…etc.
While we do not have all the answers just yet, what we do believe is that earnings estimates will have another leg lower, implying the current 17X market multiple is overstated. While the Fed slowing down their pace is welcome news, sky-high debt levels and multi-decade interest rates are a bad combination. Bad news was priced in during 2022, but the Dow Jones is already almost back to all-time highs. Some bubble areas have been popped, but upside from here will be much more selective than before. The S&P range of 3600 – 4300 remains our base case. Momentum exists for this rally to at least approach the upper end of that bracket, but one has to be pretty bullish to be a buyer today based on earnings and a successful soft landing from a Fed which continually makes mistakes.
Singers Britney Spears and Nelly Furtado turn 41 and 44 today. Aaron Rodgers is now 39. Lucy Liu turns 54. GO TEAM USA!!!!
James Vogt, 610-260-2214