Following the Federal Reserve’s statement, stocks initially soared. The door is open to get away from 75bps increases and slowly get back to a 25bps pace. December is now a 50/50 shot at 50bps or 75bps. The Fed also noted the need to focus not just on lagging data (like CPI and employment) but also on forward-looking projections. The Fed’s press release specifically mentioned “the lags with which monetary policy affects economic activity and inflation.” Investors took this as a shift from data dependent to forward-thinking dependent, a positive.
Expectations for a slight pivot to end this easing cycle were met with Powell’s question and answer session where more fireworks came. He was explicit in the Fed’s position that inflation is Enemy #1. Though the pace of rate hikes may slow, the result is projected to be higher and for longer than markets think. Simply put, 50bps is on the table next month and 25bps could keep being implemented into the Summer. Stocks reversed course and closed down 2.5%, dragged down again by the mega-caps. The S&P is down 22% this year and the mega-cap, technology heavy Nasdaq is down 34%.
The positive spin, at least as I see it, relates to the shift in pace. It is much better for a Fed to “think” they are going to get Fed Funds to a preferred level than to rush there immediately. The chance of a policy error drops if they take more time and let economic data adjust. The Fed can only accurately project what the next month’s rate outlook will be. For Powell to think that they can predict where Fed Funds will be by March or June is misplaced. Recall, a little over a year ago the Fed was predicting zero rate increases for 2022 and inflation was not an issue. Now we will get the benefit of tougher CPI comparisons, added time for interest rate increases to impact spending, and for hiring to slow. Once that happens, the real pivot will occur. It is not the biggest positive, but could mark an inflection point somewhere down the road and prevent the Fed from going too far, too fast…assuming they have not already done so.
So far, stock futures are up strongly, led by China reopening hopes, but the real action will come following the employment report due out this morning. Again, good news (more jobs, higher wages) is bad for stocks and vice versa.
With the craziness that is 2022, we have hardly mentioned the upcoming elections and the significant changes they will bring to DC and the economy relative to the past two years. Votes are already being tallied, betting markets are rapidly adjusting, and many of us will head to our local polling locations just like the good old days this Tuesday. With inflation at multi-decade highs, geopolitical tension getting worse, ongoing border issues and another rather unimpressive President, it is clear that Democrats are facing an uphill battle to maintain control of all three chambers. On top of this, citizens almost always vote with their wallets (James Carville: “It’s the economy, stupid”). With stocks and bonds suffering from one of the worst years on record, it would be a surprise if the Republicans did not take back the House and possibly the Senate. This mess of an economy is not entirely any one person’s or party’s fault, but that matters little to the average voter.
Polls and prognostications on elections have not been very accurate lately, starting with Brexit in 2016. However, it is extremely rare for any incumbent President to not lose seats in the House or Senate during the midterms. Of the past 19 midterms since World War II, only once did the incumbent’s party manage to gain seats in both the House and Senate. This was following 9/11. Throw in the slowing economy and projections are for 20 – 70 seats in the House of Representatives shifting to Republicans. This would mark the end of Nancy Pelosi’s multi-term run as Speaker at the age of 82. The speakership is assumed to remain with a California representative in Kevin McCarthy.
The Senate races are more of a coin flip with recent polling showing a late push for Republicans. Locally, most of us have been bombarded with John Fetterman and Mehmet Oz ads as the State of Pennsylvania is one of the tighter races. Arizona, Georgia and Nevada will also go down to the wire. Quite a few other battles are within the margin of error, meaning we likely will not even know who controls the Senate come Wednesday morning.
From a legislation perspective, this equates to gridlock. A Republican House will do little to help any bill introduced by a Democratic Senate (and vice versa). Being forced to compromise, meeting in the middle and working on bipartisan issues is possible, however unlikely, in this day and age of tit-for-tat fighting between parties. All eyes will be on the 2024 Presidential election and making sure nothing gets done that will help the other side of the aisle accomplish anything to shift votes in their favor. Our forefathers set the Government up specifically so no one had full control, the fringes were a small voice and people met in the middle; thus, helping out the majority of Americans. Here is hoping we can get back to that notion.
From a market perspective, historically stocks do quite well after midterms. Adding in an end to Fed tightening over the coming months, a peaking of inflation, peaking interest rates, fair valuations and a still healthy consumer…things are starting to look up for 2023. By no means is that an all-clear signal, but after such a disastrous nine months any relief is welcome news for investors, especially if they find a way to compromise on major issues and get this country back on the right track. A tradable rally is quite possible. As Jim Meyer has noted though, upside is limited while earnings readjust lower. A reprieve from oversold conditions is not a reason to get overly aggressive.
That being said, a GOP sweep would eliminate any tax hike regulations, thus helping stocks. Republicans would likely propose more drilling and energy tax credits. Any bill from that side of the aisle has minimal chance of being signed into law by the President. At a minimum, it would lessen the regulatory fears for the industry. Debt ceiling increase battles, which are becoming a tradition in DC, would be much more problematic assuming a GOP sweep. Recall, we have seen numerous instances of both parties holding an increase in the debt ceiling for ransom. Each party will attempt to get their own policy concessions in place during debt increase agreements. Following a liquidity event in UK government bond markets, future debt ceiling debates could bring forth more volatility in 2023.
Wednesday is the start of the next Presidential election cycle. Rhetoric, positioning, and partisan fighting are sure to be as messy as ever. Rest assured; a mixed DC is better than either party being in complete control. Here is hoping, but not expecting, that calmer heads prevail and our elected officials do what was promised; work together for the majority and put us back on the right path forward.
The Karate Kid, Ralph Macchio, is 61 today. Sean Combs, aka P. Diddy, aka Puff Daddy turns 53, as does Matthew McConaughey. Rising 76ers star Tyrese Maxey turns 22 today. Lastly, former First Lady Laura Bush is now 76.
James Vogt, 610-260-2214