February 26, 2023
Weekly Market Outlook
By Keith Schneider and Donn Goodman
Hello Gaugers, hope you are having a productive week and have been able to take advantage of some of the wild swings we are witnessing in the market.
We thought we might recap for you what we have been sharing since the beginning of the year:
We also suggested investors be prepared for a hotter release on forthcoming PCE inflation numbers. All of these, we cautioned, would be negative for the stock market. We were spot on.
The Fed’s Preferred Inflation Gauge - the PCE
On Friday, the much anticipated report came out at 8:30, and like we said in last week’s Market Outlook… SURPRISE!!!
The PCE (Personal Consumption Expenditures) rose at the fastest pace since last June. This was an alarming sign that price pressures remain high in the U.S. economy and could lead the Federal Reserve to keep raising rates well into later this year.
This was not helped in the past two weeks by several Fed Governors indicating that they wished the committee had raised rates by 50 basis points instead of 25 basis points at the early February Fed meeting.
Friday’s report from the Commerce Department showed that consumer prices rose 0.6% from December to January, up sharply from a 0.2% increase from November to December. On a year-over-year basis, prices rose 5.4%, up from a 5.3% annual increase in December.
Excluding volatile food and energy prices, so-called core inflation rose 0.6% from December. This unexpected move was up from a 0.4% rise the previous month. And compared with a year earlier, core inflation was up 4.7% in January versus a 4.6% year-over-year uptick in December.
This was not what the Fed was hoping to see.
And it was certainly not what the stock and bond market expected. Friday, the S&P 500 sold off over 1%, and the tech heavy NASDAQ was down over 1.7%.
Last week, both Mish and I commented (in our respective outlooks) that inflation can take a long time to decline. We are far from the Fed’s target of 2%.
We have had a consistent mantra since the end of 2021: that inflation can often take years to dissipate. What typically occurs is a lengthy period of stagflation.
Mish has repeatedly said to watch global food prices to identify the major shortages driving global inflation higher. You can see last week’s Market Outlook for a graph of the rising food costs.
Since last March, the Federal Reserve has attacked inflation by raising rates 8 times. 4 of these times were at an unprecedented 75 basis point level.
We believe the Fed is not done. In fact, it would not surprise us to see a 50 basis point rise at the next Fed meeting in March and possibly another 75-100 basis points before they stop raising rates. Effectively that would put Fed overnight rates at 5.5%-or even greater.
After Friday’s PCE came in “hotter” than expected, estimates for the next increase (and subsequent Fed potential rate hikes) were ratcheted up considerably. See the chart below:
This week, Jamie Dimon (CEO of JP Morgan) appeared on Mad Money with Jim Cramer. He suggested that we might see rates above 6%. Like us, Jamie described the insidious effect inflation has on all Americans. And, as we reported last week, 64% of Americans live paycheck to paycheck. If food and energy prices edge up even slightly more, many Americans will not be able to make ends meet.
The Effect Rising Rates Have On The Stock Market
For over a year now, we have harped on the notion that investors should “not fight the Fed.” As I have recanted numerous times, I learned this in my first economics class in college back in the 70s. It still holds true today.
Recently, a subscriber asked me, “What are the biggest causes of market corrections or bear markets?”
In many of our Market Outlooks, we have discussed everything from appropriately valuing the markets to the negative impact higher interest rates and slower growth rates can have on market values.
Understand that short-term rallies and sell-offs often occur because of an “overbought or oversold” market where deviations are worked off. We want to spend some time describing the major causes for intermediate to long-term market pullbacks:
When the Federal Reserve is rapidly raising rates as they have during 2022-2023, there is a much higher chance of a “hard landing” or recession (two consecutive quarters of negative GDP). We seem to be headed that way, but folks are hoping we get a soft landing as a result of the continuing robust employment market. We are not sure this is possible. Chances of a recession increase with every subsequent Fed rate hike.
Raising prices (change at the margin) is healthy for companies. However, at some point, consumers either stop purchasing as much of the product, downgrade their quality to a less expensive product, or simply cannot afford it. This has a detrimental effect on stock prices as companies’ revenues begin to slide. We started seeing this in our current earnings season. Several big retailers report this week, and it will be interesting to see how their earnings fare. So far, consumers have held up this market.
During Covid, many of these products were unavailable or became scarce (semiconductors as an example) and disrupted our markets to the point that many manufacturers were not able to deliver enough goods. Thus, their growth rates slowed dramatically.
Wars in other parts of the world are sometimes enough to cause shortages in the U.S. An investor only needs to look to the current Russia-Ukraine incursion to see the negative effect a war might have on world food prices. There has been a disruption of food staples, including wheat, soybean oil, and other products produced in that part of the world. We do not yet know what effect Russia’s planned pullback in oil production might mean for all important energy prices in the near future.
Currently, we are acutely aware that some or all of the above factors are negatively affecting our economy. It is a real possibility that the stock market is in for a range-bound sideways path while rates are still rising (both by the Fed and the bond market). This is something that Mish has written and spoken consistently on national T.V. See a range-bound chart and comic below:
Estimates on future earnings (and the market multiples analysts use) for market pricing are still coming down. It may be hard to get a “real” bull market until interest rates, input prices (food), and other pressures on our economy subside. This may be the only way inflation cools and gets closer to the Fed’s target rate
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