Stock market participants can act irrationally for quite a long time
The January rally went much higher than I thought possible. The Fed was still moving toward higher interest rates and was not going to “spend” in any way. The word game has been transformed several times, from lowering rates this year to stopping rate hikes, to the joy of 0.25% just a few more times this year. All of these stories have been far too optimistic. While I can be accused of absorbing some of this Kool-Aid as well, my conceit was that the economy can handle higher rates. That ZIRP was not only unnecessary, but that keeping interest rates at zero was actually detrimental to the economy, causing several assets, such as Bitcoin, to become “fizzy.” I thought that as long as interest rate hikes are slowed down for the economy to adjust, a soft landing or even avoiding a recession altogether while beating inflation is possible. I thought – it now seems erroneously that the Fed used only 2% inflation as an ambitious target. Once we hit the 3% grip, the urgency of tightening would diminish. Instead, two things have become clear: 1) inflation is nowhere near 3%, and 2) it is “sticky” and may not get there with a sluggish 0.25% increase. Loretta Meister has already cut 0.50% for March, we’ll see later this week when no fewer than 5 Fed officials will make statements on Thursday and Friday. Will we then get more restrictive commentary to set the stage for faster tightening? Will the Fed come out with guidelines that the rate will increase even 0.25% and will continue through the end of the year and stay in place until 2025? Can any economy handle that kind of pressure? What I mean is that if rates are expected to rise at every FOMC meeting, that in itself is a barrier to economic growth. How does a bank price a loan that they know could potentially be 75 basis points higher in less than a year? Can the borrower handle such a business climate? Lending will only slow down and be given only to the companies that need it least.
Higher and some say much higher, and for longer
Greg Branch, founder and managing partner of Veritas Financial, said on CNBC last week that he expects 6.25% as the final Fed Funds Rate (FFR). Who is Greg Branch and why should we care what he thinks? Because way back when I believed he was predicting the end of 2021 that the Fed would get super aggressive. I presented him as one of those permanent bears you always hear me whining about. I wish I had listened to him then. He has been right every step of the way and now I am going to listen to him carefully. I don’t believe anyone else projects such a high level. Suppose he’s wrong? He and others who are clearly more adept at watching the Fed and rate hikes will push the range of the terminal FFR to at least that level. No doubt stocks have not discounted that level.
PCE is coming and could rock the market
Previous Core PCE — December ’22: 4.4 November ’22: 4.7 October ’22: 5.1 September ’22: 5.2
Below you will find the BEAs (Bureau of Economic Analysis) own definition of the report Core personal consumption expenditures.
“The PCE Price Index Excluding Food and Energy, also known as the Core PCE Price Index, is released as part of the monthly Personal Income and Expense Report. The core index makes it easier to see the underlying inflation trend by excluding two categories – food and energy – where prices tend to move up and down more dramatically and more frequently than other prices. The core PCE price index is closely monitored by the Federal Reserve in conducting monetary policy.”
What interests Jay Powell in particular is the spending on services. This accurately reflects the labor costs, wages and benefits that Powell is very focused on. He believes that high employment is a driver of inflation. The old wage-price spiral of the 1970s is back. I think this is nonsense, but Powell maintains that the number of open jobs relative to the number of available employees drives up demand for consumption and that drives up inflation. It may just be a convenient excuse to just keep increasing until inflation breaks or the economy breaks. At the moment, the latter alternative is not a priority.
Interest rates in the 2-Y and 10-Y have stalled until last week
The real mover of the market was the tag team of the 2-Y and 10-Y. In my eyes it was the 10-Y that flew. However, the 10-year pulled back from a multi-month high of 3.90%. The 2-Y continued to rise rapidly and came within a whisper of a 15-year high — It reached 4.718% and settled at 4.617% yield, that’s a full 9 basis points for the week! The dollar played an equally important supporting role. The dollar rose to a 6-week high by the end of the week. Recall that, like last week, it was at a multi-month low of 100.09. This week it almost went to 105. Is it any wonder Thursday fell hard then followed Friday before recovering some for the close? The SPX and NDX were still moderately in the red at -.28% and -.58% respectively.
Where do we go from here?
I don’t make predictions about the schedule. If PCE Core spending, especially services spending is bad, and Fedspeak is having hawkish talk about going back to a 0.50% rate hike towards the end of this holiday-shortened week, then I can totally see a drop to 3800. generally bearish, i’m not a super bull. I currently see no evidence for 2023 to reach the old high of last year, let alone make new highs. Also keep in mind that we have about 3 weeks after this to worry about what the Fed is doing and saying before their next FOMC meeting on March 21-22. If a more aggressive schedule of tightening is proposed leading up to and during the meeting, we could go lower.
As it stands with the data I have to project forward, I wouldn’t say we are entering another bear market. I just think expectations of the recovery will be adjusted and indices could start rising again. Maybe they’ll break even higher if we actually see inflation break out of the 5%-7% range and move into 3%. I put the spread at 7% for a reason and it’s not a typo. Larry Summers stated on Bloomberg TV this weekend that if you take some numbers out of the calculation, he comes out with a median inflation of 7%. He feels the Fed is between a rock and a hard place and is likely to plunge us into a recession and rightly so.
I don’t have that view, the consumer is still strong, and there’s a chance we’re keeping people employed, but if the number of additional vacancies per worker drops, maybe Powell could call it a win before we go into a recession . I don’t blame market participants for taking the opportunity to celebrate the resilience of the economy and raise prices, but let’s face it, the average P/E of a Nasdaq stock is 18. We are way overvalued. 3 weeks ago Tesla (TSLA) was $100, this week it was inches below 220, and had a PE of over 55. There are a lot of names like that, I’m not choosing TSLA. Stocks must discount higher interest rates. I know that if I go through the litany of hedging and short positions that our community at Dual Mind Research once again maintains, I think you’ll be bored. I’ll be bored if I tell them. Check out my last two articles that go into detail about preparing for this recession. Yes, I’m about 3 weeks early again. I think from now on, if I’m brave (or stupid) enough to make a time-based prediction, 3 weeks should be added to the goal. I will try to remember such a caveat. The market can remain irrational much longer than we think!
Okay, so what trades can I talk about?
I have gone through my entire long term account and my trading account and I have not opened any new long positions. So let me talk about one sector that I’m going to add to both my long-term and trading accounts, which is energy. I’m going to add to my Devon (DVN) holdings, they had a bad quarter due to temporary circumstances. If you are a long-term investor, these are opportunities. I will definitely add to my EOG Resources (EOG), and I have my eye on Apache (APA). If it comes in a bit more, I’ll add that position as well. I want to collect more Eli Lilly (LLY), for a split second it dropped to $320 on Friday, but I wasn’t fast enough. Ideally I’d like to get more under $320. I guess the software hasn’t broken out yet so I still haven’t picked up Palo Alto Networks (PANW) not because they excite me but because they offer a comprehensive bundle and I think they will increase their market share because some CFO is more interested in checking boxes than getting the best in each category. I added my Confluent (CFLT) through a call option. I really like the price action there. I’m waiting for my “Tech Titans” names to fall back to Earth, but that may take a little longer by mid-March. However, if the indices start falling hard this week and Amazon (AMZN) drops to $89, I’d start adding stocks, same with Alphabet (GOOGL) but a bit lower, like $83. I haven’t set buy prices for ServiceNow (NOW), Intuit (INTU), and Adobe (ADBE), but I’d like to see them down 30 to 50 points. Maybe next month I’ll be lucky. I feel the same way about chips and chip device makers. I think they’ll come out of the glut of chips this year and if they get knocked down enough I’d love to own that sector. Sorry, I have no concrete desires. I’m holding on to my shorts for next month, which means I’ll have to roll out some of my Puts into April to capture what happens at the next FOMC meeting.
I hope you all had a meaningful, if not enjoyable, President’s Day.
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