Previous Fed Chair Alan Greenspan was nicknamed the “maestro”, not because he resembled a Seinfeld character, rather, he oversaw the Fed during a steady economic growth period from 1987 – 2006. The Dow quadrupled during his tenure resulting in the greatest cumulative return for any Chairperson. His easy money policies eventually led to the Great Financial Crisis that was resolved with massive money printing. Bernanke, Yellen and now Powell followed up with even more money printing, eventually leading us to where we are at today; massive inflation everywhere and a still overly accommodative Fed.
Powell tried his best maestro impersonation Wednesday afternoon, following the Fed Board’s unanimous decision to raise Fed Funds by 50bps to an upper limit of 1%. They also followed a well telegraphed script where balance sheet holdings will be reduced starting in June. For the first three months, the cap will be set at $30B/month in Treasuries and $17.5B/month in mortgage-backed securities. After that, it will increase to $60B and $35B, respectively. It was only 6 months ago they were purchasing $120B/month. Quite the mistake….I mean, reversal.
The real music started during his press conference. Fears for an overly aggressive tightening cycle were met with comments that 75bps increases are NOT on the table and 50bps was all but guaranteed for meetings in June and July. August is an off month where they can reassess incoming data and meet again in September where it could be another 50bps or smaller. Rate hike futures dropped, creating a sense that this Fed is fearful of creating an inverted yield curve. The Fed put was alive and well but there are reasons to believe this is the way to go. A lot of tightening is already priced in but won’t immediately hit the economy.
Corporate profit margins are peaking. Numerous commodities are declining. Mortgage rates have more than doubled to 5.5%. Loans are more expensive. Stocks are down double digits. Eventually, this works its way through the system but it does take time. Inflation doesn’t have to get to 2% by September for the Fed to slow down this tightening phase. It just has to show a positive trend downwards.
Investors cheered the somewhat dovish shift as stocks bounced ~3% across the board equal to nearly 1,000 Dow Jones points. Bonds advanced as well, causing yields to drop everywhere along the curve, especially on the short end. Every equity sector gained ground, led by Energy following an EU decision to phase in a Russian oil embargo. Russian oil is still flowing to other Asian economies at a huge discount but this move is expected to take off at least 1mm barrels from an already tight market. As Jim and I have noted on numerous occasions, it will be very difficult to get inflation back towards 2% – 3% if oil prices keep rising.
Not even a day later and those market gains were wiped away, and then some. Knee-jerk reactions to Fed meetings almost always get flipped the following day, but this was excessive on both ends. A decision to slow tapering and take 75bps increases off the table creates fear that inflation is not going away as fast as we need it to. The 30, 10 and 5 year Treasury yields spiked by 16bps, 15bps and 13bps to 3.16%, 3.07% and 3.02%, respectively, yesterday. That is a massive move in just one trading session and approaches four year highs.
Usual suspects responded in kind with the Nasdaq getting crushed, dropping 5% after its 3% rally on Wednesday. High beta, Covid-shutdown, money printing winners again proved to not find a floor, led by Shopify. You may notice a Shopify logo when purchasing something online as they help facilitate small business purchases among many other related functions. The stock was a darling, advancing from $300 to $1,750 during the pandemic. After a 72% collapse since November, one may think downside was limited. After their earnings update, the stock dropped another 15% yesterday and still sports a 125x P/E. Although many stocks today are great long-term values, the short-term is still quite uncertain. Buyers beware across the board, especially for those sky high P/E companies.
In total, all sectors ended in the red with safety areas like Utilities and Consumer Staples holding up better than most. This was a clear risk-off day, where everything got sold and hard. It’s highly probably some hedge funds were caught off guard and had to liquidate with margin calls hitting their trading desks.
We often talk of signs for bottoms in the stocks. One common theme is mass liquidations where 90%+ of stocks are down in one trading session. Even with a 25% drop in the Nasdaq from last year’s highs already past us, this looks to be the first 90% down day since the correction started. Painful to see, but washouts help find a floor from where bases or reversals can begin. By no means is that an all-clear signal but good to see for those with cash sitting on the sidelines awaiting favorable entry points.
No amount of Fed tightening will re-open China or end its zero Covid policy. It will not increase oil, grain or many underinvested commodities. They can’t pull back consumer handouts still sitting in savings accounts from the past few years. It won’t bring more people into the labor market. Supply chains need to repair on their own. Russia doesn’t care about interest rates either. The only thing that will help all of the above is time. That is what Chair Powell is attempting to “conduct” here. While opening their playbook over the next four months, investors have one less item to worry about over the slower summer months. Economists alike will offer a multitude of reasons why this is a good or bad thing. Only in hindsight will we know if this plan of action worked.
Who knows if the Fed’s plan is the right one, but cautious movements are preferred as opposed to a straight line to 3% or 4%. Many auto, business, credit and home equity loans are tied to the Prime Rate. Just about every Fed rate increase result in banks raising their Prime lending rate. Boost it too fast and consumers and businesses could collapse. They need time to prepare their finances. Even with the slowness, it is quite uncommon for this aggression to not lead to unintended consequences. That being said, I’m hard pressed to see any reason for baby steps with respect to the Fed’s bloated balance sheet. Rip off the band-aid and start reducing it. Showing a real sense of concern over inflation may give credence back to the Fed.
Investors should not get more bearish after days like yesterday. 10% – 20% corrections are more common than what we’ve experienced over the past decade of loose monetary conditions. They act as a cleansing of financial markets. That being said, it is hardly time to be aggressive either. Some purchases today will look great in five years but could see another 20% drawdown in five months. 90% down days happen in groups and are usually followed by consolidations, not a straight line to new highs. P/E ratios are coming down. Consumers are still flush with cash. Supply chains will keep improving, especially after China fully opens back up. All is not lost, but it could take at least until the Fall to see if this plan works.
Today, we get April employment numbers. Markets would prefer 3 things: solid jobs added, slowing wage growth and an increase in labor force participation rates. The report could dictate the next 1,000 points, positive or negative. The next critical update is the CPI report on Wednesday. Anything showing inflation peaking could bring relief to this volatility.
George Clooney turns 61 today. Here’s hoping Meek Mill, 35 years old today, can watch Joel Embiid play in tonight’s playoff game.
James Vogt, 610-260-2214