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.