The old market adage says that investors should never fight the Federal Reserve. But stories like Freeman’s and the broader rally seen since the market bottomed in mid-June: the S&The P500 is up 15.3%, the Nasdaq Composite is up 19.3% and the ASX 200 is up 10.7%: Says investors are not only fighting the Fed, they’re also giving it the middle finger to the central bank.
That’s little trouble for Fed Chairman Jerome Powell, whose speech at the annual Jackson Hole symposium this week in the US now takes on extra importance.
The rally is bad news for Powell, given that it means financial conditions have loosened despite the Fed’s huge rate hikes and non-stop wondering, so expect it to once again send the message that fighting Fed inflation is far from over.
And expect the market to listen, shrug and mutter ‘well, he would say that’.
The fight between the Fed and the market may well continue for a while, and investors need to think about the ramifications of a win (or loss) for either side.
One of the reasons the market is willing to fight the Federal Reserve is the communications mix-up. Even when the Fed tries to sound aggressive, there is always something for the doves to cling to.
After raising rates by 0.75 percent in late July and making it clear he wasn’t spooked by signs the economy was slowing, Powell blurted out that “it’s probably appropriate to slow the pace of increases.” later in the year.
The release last week of the minutes of the Fed’s open market committee where that decision was made offered something similar for everyone.
Inflation, the Fed said, remained “unacceptably high” and recent declines in oil and other commodities could be reversed quickly. Supply chain disruptions would take a long time to resolve. And overall, “there was little evidence to date that inflationary pressures were abating,” and inflation was “likely to remain uncomfortably high for some time.”
Pretty clear, right? Well, not quite. The minutes also noted that low- and middle-income households were having a tough time and that there would be a need to rein in rate hikes “at some point.” And more moderately, the minutes said “there was also a risk that the Committee could tighten the policy stance more than necessary to restore price stability.”
Are investors wrong to bet that the Fed is hyping its war on inflation and that the peak of US inflation and interest rates may not be far off?
Certainly, there are signs that goods inflation is slowing as commodity prices fall. Supply chain disruptions are easing. And the higher rates seem to be starting to do their job, with consumers spending in lower socioeconomic groups.
But investors may also be hearing what they want to hear, says Philip Marey, senior US strategist at Rabobank.
“Inflation is not likely to drop back to 2 percent very soon,” says Marey. “The subjacent inflation is located at 5.9 percent. Nominal wage growth has risen to 6.7 percent in a wage-price spiral the Fed is unwilling to see. Accommodation inflation (41% of core CPI) reached 5.7%, continues to rise and is likely to remain elevated in 2023.
“The same crowd that thought inflation was transitory are now celebrating peak inflation and the arrival of an early pivot from the Fed. What they don’t seem to understand, however, is that bringing inflation back to 2 percent will take patience. , by the Federal Reserve and the markets”.
Rally of only four actions
Perhaps the attitude of investors is not surprising. As Bank of America chief strategist Michael Hartnett points out, for every $100 investors poured into US stocks since January 2021, there were outflows of just $2. “Everyone is bearish, but no one has sold stocks,” says Hartnett.
Hartnett timed the past 12 months as accurately as anyone on Wall Street, predicting the bear market and the latest rally. But he remains bearish, for various reasons.
First, Wall Street’s rally is very limited, with just four stocks (Apple, Microsoft, Amazon, and Tesla) accounting for 30 percent of S.&Earnings of P500.
Second, he sees the pain coming from corporate profits as interest rates rise, the US housing market continues to lose steam, consumer spending returns and eventually unemployment rises.
Third, Hartnett wonders if the bear market rally will soon run out of steam; since 1929, the average bull market with a gain of 10 percent or more generated a return of 17.2 percent over 39 days; this has delivered 17.4 percent in 41 days.
Finally, he agrees with the view that the market is underestimating how much work the Fed needs to do. Not only does Hartnett think inflation could still hit 6 percent next fall, but he says the Fed’s quantitative tightening program Fed has barely started; For every $100 of bonds the Fed bought during COVID, Hartnett says he sold only $2.
“Whether the Fed knows it or not, they are nowhere near done,” he says.
Hartnett is smart enough to consider the bull case, which is essentially centered on two things: that stocks were hit brutally in the first half of the year, and that a recession could be averted if governments bail out citizens with stimulus versus the cost of living. pressures
As this column has been saying for a few weeks now, market momentum is a rare thing that needs to be respected. This rally, whether it’s a bear market tear or a genuine bottom, could well continue if investors decide they’re happy to continue to take on the Fed.
But for investors thinking about how much exposure they want to risk right now, it might be worth considering the five things Bank of America says this rally implies: that rates and inflation matter “less than ever for stocks”; that “fighting the Fed now works”; that “rate markets are farsighted, despite record economic uncertainty”; that “although QE inflated assets, QT will not deflate them”; and that “global geopolitical risks do not present a material threat.”
To Jackson Hole, and then to you, Mr. Powell.