Markets Update

Let’s update our markets outlook in light of yesterday’s Fed announcement. The policy was exactly as expected.  Even the forward guidance brought no surprises. But there was a notable shift in Powell’s framing of its reaction function. Put simply, in 2022 “financial conditions” mattered; in 2023 they don’t. This so far has been taken by the markets as an all-clear to dump the dollar and buy everything else. I believed Powell was serious about quelling inflation when FC mattered; now that it doesn’t I don’t. If yesterday’s performance is any indication, consumer inflation will dog the economy and markets for most of this decade.

A word about SS. It has been right about bonds, right about gold, but wrong about stocks. It’s missed something, not likely unrelated to the above. This merits taking its outlook with extra grain of salt until it adapts to the new reality.

There remains a solid bear case for stocks, but it has been deferred. This turns on the aforementioned “financial conditions” factor. The Fed was correct in 2022; FC certainly do matter.

Unless promptly reversed, the FC easing seen over the past few weeks will filter through the pricing chain into consumer prices over the coming months and the goods and services disinflation Powell cited yesterday will stall. If it continues long enough, it will reverse.

This is not part of the current market narrative. Given the Fed’s shifting sands thinking on the matter, how it reacts can’t be thoughtfully anticipated. It seems likely to last until this resurgent inflation becomes obvious in consumer price data. Meanwhile other more exogenous issues are in play as well; potential escalation of the Ukraine war, a rancorous debt ceiling battle, possibly even a war over Taiwan. More foreseeable developments include continued supply chain “shocks” upon which inflation now obvious in financial markets will be blamed.

Other ticks in the bearish column include the absence thus far of a compelling capitulation low and valuations that never reached historic bear market territory.

While being optimistic that the Fed would resist a bit longer, we’ve openly acknowledged the intense pressure Wall Street has put on Powell and Co to wave the white flag on inflation. Now that it has the upper hand, it’s difficult to predict how much inflation to expect, and though a leg down over the next few weeks seems likely, when the bear market in stocks may resume … next month or next year. I continue to like quality and value stocks long term, but even they could for a while underperform the junkier and growthier assets that surged during the last easy money run. Foreign stocks remain relatively attractive, if not so much as they were when we highlighted them last fall. Gold and treasuries continue to look more attractive than cash. Commodities too. 

As always, reader thoughts are welcome.

6 thoughts on “Markets Update

  1. jk says:

    kb homes reported 68% cancellations on its home sales contracts; people walked away from their deposits to avoid the higher rate mortgages. and either 16 or 18% [i forget] of the labor force is housing related. hard to believe we’ll avoid a recession [however defined].

    1. Bill Terrell says:

      Thanks, JK. It’s pretty widespread; far from limited to KB … and the soft housing data are far from limited to cancellations. Wolf Street has been covering this extensively:

      We haven’t talked about it here partly because it’s so well covered there. I mostly try to focus on things other media are missing. Also because it’s no surprise. We just had an insane housing bubble. Even here in bucolic Smallville, western Pennsylvania, where the 2004-2008 bubble and 2008-2012 bust barely registered, we just went through a phase where listings were drawing competing offers. Many never even made it to listing. This is the kind of thing I’ve only ever seen before in the bubble era DC suburbs.

      Bubbles burst.

      It’s less than meets the eye … more like a return to normal. It’s like when stock prices soar 50% over the space of a few months, then return to where they were. Financial media cry Armageddon, but only by selectively choosing the peak as the baseline. The whole thing was just a round trip to nowhere.

      No obvious actionable policy implications … gotta get that bubble feeling back? The damage was done in 2020-2021. Or you could look at it the other. glass-half-full way … we may finally be stumbling our way into solving that unaffordable housing problem.

      1. Bill Terrell says:

        BTW for the benefit of readers that might be unfamiliar with our congenital disdain for the term “recession” … aside from the semantic problem of defining one, you also have the more fundamental problem of reducing a rich, continuous range of states or processes to a simplistic binary variable (recession present or absent), a loss of information that would be unacceptable in any field aspiring to the status of science. The impulse to label as opposed to quantify is degenerate.

        The economy is a multidimensional entity too. Take for example the housing market and labor market. For house sellers, “the economy” is in dire straits. For labor sellers, “the economy” is brimming with opportunity. For buyers, it’s the mirror image. But never mind … let’s just stuff it all into one master variable, turn the crank, spill oceans of ink trying to decide whether it’s 1 or 0, and pretend we’ve enhanced our economic insight.

        It’s not a stretch to say that “recession” is not a phenomenon discovered by economists, but invented by economists.

        Compound that with the implicit value judgment, the negative connotation invoked by the term. Any resemblance to scientific objectivity is purely superficial. Undesirability is presumed without the burdensome business of producing a rational, fact based argument. The possibility that a “recession” might be a Good Thing is dispensed with summarily; no critical thought, analysis, or reflection required.

        It has negative practical value for investors. Fretting about it is a confusing distraction. The gist of much conventional commentary is to try to divine whether and when the economy is in a recession, then from that how it will affect financial markets. This provides two ways to get it wrong. Why not skip the middle man and go straight to the markets?

  2. jk says:

    reported jobs, seasonally adjusted +517,000 [how much of this was the infamous birth-death model? my google-fu has not been adequate to track this down]

    jobs, not seasonally adjusted -2,500,000.

    meanwhile treasury says it will need to borrow $932billion this QUARTER. with unemployment 3.4%. the fed isn’t buying, it’s – in effect- selling $95billion/mo of treasuries and mbs, foreign cb’s stopped buying some time ago. if i’m not mistaken, banks are already stuffed with treasury paper. who’s the buyer going to be?

    1. Bill Terrell says:

      Reason #9 I don’t talk much about the much ballyhooed non-farm payrolls. With hundreds of econ PhDs on staff, I doubt the Fed is unaware of the weaknesses either. As a whole the data support the general impression labor demand is strong relative to supply, such as the decline in unemployment claims, the employment cost index, strong services price inflation … the unemployment rate is again at new multi decade lows. It appears there may be a lot of jobs being created, but many are going to those who are already employed, as they find they need more than one paycheck to make ends meet.

      That Treasury and the Fed are both selling indeed does make one wonder who’s doing the buying. Just one more reason the Fed’s rigid, preprogrammed Treasury sales seem irrational. Why not adjust on the fly? In response to data? What a concept. Why, especially in light of its own stated distaste for holding MBS, does it still have a multi-trillion-dollar hoard of the stuff on its balance sheet? Why can Fed funds only move in long unidirectional trends?

      Amid the oceans of ink spilled over whether the Fed is too tight or too easy, it’s odd to see not a drop devoted to certain aspects of its policy conduct that have no apparent justification at all. The unasked questions are often the most important.

      The drivers of treasury prices might not be so straightforward though. There’s a competition between abundance of treasuries and abundance of dollars. More treasury supply, lower prices. More dollar supply, higher prices.

  3. Bill Terrell says:

    I haven’t been posting frequently lately partly because there haven’t been a lot of comments and frankly, not that much to comment about. For all the media sound and fury, markets strike me as having become exceptionally boring. So far this month for instance, in dollar terms, stocks have sold off, but so have gold and treasuries. Relative movement has been conspicuous for its weakness. So while our relative underweight of stocks versus overweight gold and bonds hasn’t hurt so far, it hasn’t helped either.

    Waiting for Godot is neither profitable nor fun, but I can’t get past the inversion of the yield curve. The 10-1 year spread inverted on July 12 of last year and hasn’t looked back since. The inversion is profound, not only deep but broad, affecting most of the curve, with three month yields well above thirty year yields. Yield curve inversions are some of the most certain predictors of the kind of stock underperformance we’ve been looking for, but can be a bit tricky on timing, with typically 6-24 months lag, and yield curves have often uninverted first anyway. For example by the time of the 2020 stock market crash, the inversion of 2019 had been all but forgotten in the media. In addition to many other factors, however, SS is well aware of this and nevertheless targeted a turning point last quarter.

    We’ve seen blips and stretches of this expected relative performance but so far they have generally been offset by blips and stretches of the opposite. Aside from the advance notice given by the YC & SS, such turning points typically come with little warning, can happen fast, and it can be hard to distinguish from minor, soon-to-be-reversed excursions before they’re well advanced. Not being fond of sitting on the edge of my seat, I prefer to maintain the stock:gold&treasuries under:over-weight. When its time to shine comes, it will be hard to miss.