In what is becoming a common occurrence for markets, the Fed meeting was met with a substantial move higher in stocks during their Wednesday afternoon press conference, only to be reversed the following day. Chairman Powell’s timely leak to reporters on Monday opened the door for a 75bps hike, to which all but one voting Fed Board member agreed. Following another strong CPI report last Friday, it is clear that inflation is not going anywhere anytime soon. The Fed risks losing whatever credibility they may still have and being backed into a corner.
Forward dot-plots now point to a 3.8% Fed Funds rate in 2023, which would be the highest level since 2008, and which preceded the Great Financial Crisis and housing implosion. July’s meeting is now a coin flip between 50 or 75bps which would equate to a range of 2.0% – 2.5%, and by year-end Fed Funds are projected to be 3.25% – 3.5%. The 10-year Treasury closed yesterday at 3.30%. Either that rate keeps trekking higher or an inverted yield curve will be upon us. Recall, an inversion has been 100% correct in predicting a recession since WWII.
Front-loading rate hikes should halt growth quicker and bring about the bearish scenario I outlined last week: an overly aggressive Fed playing catch up, an inverted yield curve, lower P/E’s, slowing consumer spending, rising layoffs, minimal wage gains, declining home values and a stagflationary market. The depth of each of these will determine if stocks decline 5% or worse after already correcting over 20%. It doesn’t guarantee a recession, but odds are certainly much higher today than a few months ago.
Not helping matters, the Swiss National Bank shocked markets by raising rates by 50bps yesterday, helping push stocks down 3%+ around the globe. This was their first rate hike in 15 years, but is still a negative 25bps. More rate hikes are now expected, which no one predicted prior to the meeting. They also noted a probability that they would sell off assets on their balance sheet. Their top 5 holdings are the usual suspects, Apple#, Microsoft#, Amazon#, Google# and Tesla.
Just about every developed nation is now raising rates in a globally coordinated effort to bring down inflation by muting growth. As we are all aware, central banks cannot dig for oil, create new refineries or increase food production. Their blunt, possibly obsolete, tools can only potentially impact demand, not supplies. With consumer pocket books still flush with cash, normal rate increases may not be enough to break inflation while growth goes negative. As Chairman Powell has noted, the Fed could certainly use some help from the Government too. Trillions of dollars were created out of thin air, and reversing this will not happen overnight, even with an aggressive Fed. Patience and time are necessary ingredients, likely more than many hoped for even a few weeks ago. However, the market is doing the Fed’s work with respect to a lot of inflation ingredients.
Metal prices are dropping with palladium, nickel, steel and iron ore all down over 40% from recent highs. Lumber is down 60%. Corn is starting to roll over. Even wheat, which is directly impacted by the Ukraine invasion, is down 22%. Natural gas is down 20% in a week and oil is showing some semblance of reversing course with oil stocks down 15% in the past two weeks. None of this helps the year-over-year CPI comparisons today, but it will certainly help down the road. Again, this is a waiting game. Fed rate hikes, declining money supply growth and quantitative tightening take upwards of a year to fully impact economies. The risk now is that the Fed does too much.
I noted last week that the U.S. has the worst inflation rate globally, being some 60% higher than peers. However, it is still a real issue in the world’s other large economies: UK has a 7.8% inflation rate, Germany 7.4%, Canada 6.8%, India 6.3%, Italy 6.0%, France 4.8%, South Korea 4.8% and China is benefitting from purchasing Russian oil at a steep discount, along with locking down their economy, to only print a 2.1% inflation rate, if one believes data out of their officials. They are one of the few holdouts from a monetary easing standpoint, but they were also tightening conditions while we were sending checks to everyone in 2021. The Bank of Japan actually kept their pedal to the metal with unlimited purchases of 10-year bonds at a 0.25% cap. They also offered to do more if necessary this morning!
This inflation is bringing us into a tit-for-tat global policy environment, bringing about the term “reverse currency war”. Normally, central banks try to avoid deflation by boosting growth of their economies via low interest rates, which spurs demand but also leads to a weaker currency relative to the world. Now in an inflationary environment the opposite is true. Raising interest rates creates more demand for local currency and makes exports more expensive. This helps slow growth (objective #1 right now) which should bring down inflation.
The Swiss National Bank knows this and has finally switched to a multi-decade policy of fighting against a strong currency, surprising and spooking markets alike. Now that we are raising rates by 75bps instead of smaller increments, other central banks must respond or risk a weaker currency and higher inflation. A self-reinforcing policy action that makes a recession much more likely.
As I try to put a more positive spin into this market commentary, a lot of recession risks have been priced in. Could there be more? Certainly, but there are a lot more opportunities for investors than before the year started, even if we have a minor recession.
I’ll cherry pick some large cap names (NOT a recommendation) to give a flavor for what is out there today for long-term investors. One can now create a diversified, fairly valued portfolio that provides a lot of income in the form of dividends by taking an equal-weight position in the following to create a diversified portfolio: Simon Property Group#, Pioneer Natural Resources#, ONEOK#, AT&T#, Gilead, Best Buy#, Franklin Templeton, IBM#, Walgreens, Whirlpool, KeyCorp#, Novartis#, Southern Company, Exxon Mobil#, Dominion Energy, Broadcom#, Newmont Mining, Cisco# and UPS. They will give you a growing 4.7% dividend yield and only trade at 11x next year’s estimates. Even if (when) those earnings estimates come down by 10%, you are looking at a 12P/E, well below the S&P and historic norms. You can take out some of the more economically sensitive names and replace them with your favored “safety” stocks, but the point remains. Stocks are getting cheaper. Opportunities are arising. Negative forward news is getting priced in. Even fixed income investors are able to find 5%+ corporate or 4%+ in tax-free Muni bonds. All that is left for investors to do is utilize time and patience and let cash build up in portfolios until we get clarification on the above negative scenarios.
Venus Williams is 42 today and Barry Manilow turns 79.
James Vogt, 610-260-2214