by Bryan Perry
February 7, 2023
Bond and equity markets are in a much better place than how they ended 2022, with further evidence of slowing inflation providing a bullish catalyst. Aside from an impressive labor market that is adding more jobs than forecast, data on manufacturing, factory orders, housing, retail, and productivity are all trending lower – which is in line with the Fed’s directive to soften economic growth without inciting a recession.
Last week, the Fed raised the overnight Fed Funds Rate by 25 basis points to 4.50%-4.75% and there is currently a better than 82% probability for another quarter-point hike to 4.75%-5.00% at the next Federal Open Market Committee meeting on March 22, and a 48% chance of a similar hike at the May 3 FOMC meeting, taking Fed Funds up to 5.00-5.25%. Given the strong job market and overall economy, I think there is a good chance the Fed will take the Fed Funds Rate up to even 5.25%-5.50% before they cease.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It is pretty clear that the Fed is fixated on the tight labor market, and Friday’s stunning non-farm payrolls data showing an increase 517,000 workers added to payrolls and the unemployment rate falling to 3.4% solidified the notion that the Fed will keep hiking and keep rates higher longer than bond traders thought.
Specifically, Powell said: “I continue to think that it is very difficult to manage the risk of doing too little and finding out in six or 12 months that we actually were close but didn’t get the job done, inflation springs back, and we have to go back in and now you really do have to worry about expectations getting unanchored and that kind of thing. This is a very difficult risk to manage. Whereas … of course, we have no incentive and no desire to overtighten, but if we feel that we’ve gone too far, and inflation is coming down faster than we expect we have tools that would work on that.”
The Fed also continues to shrink its balance sheet to the tune of $95 billion per month, but it still stands at $8.5 trillion, with a goal of reducing it to $5.9 trillion by the end of 2025. This is a key metric that doesn’t get much mention, but the M-2 money supply is showing negative growth, which means less money for banks to lend out. It’s not having a negative impact on the market, but M2 bears watching.
The reopening of China is viewed as a huge offset to the orchestrated slowing taking place in the U.S. and Europe. Their revival will help Europe, the U.S., and other countries that trade heavily with China to avert recessions. At least, this is how the market currently reads it. What is not priced in the market, I think, is any upcoming major offensive by Russia on Ukraine in the months ahead. This and fresh tensions over the spy balloon launched by China and the future of Taiwan are persistent geopolitical risks to the market.
And then there is “FOMO” (Fear of Missing Out) back at work. The economy appears strong enough to handle a 5%+ Fed Funds Rate, which is triggering a sudden shift in sentiment and pulling money off the sidelines, afraid the train has left the station. When stocks trade higher after companies miss their sales and earnings estimates, it generates that “uh oh” moment, where investors sense the market has priced in the trough in earnings, to be followed by a resumption in revenue and profit growth by the third quarter.
There are some serious disconnects in the market landscape. The yield curve remains highly inverted with the 2-year/10-year spread at -77 bps, and near the -84 bps spread seen on December 7 when it felt like the economy was sliding into a recession and stocks were cratering. Clearly, the bond market isn’t biting on the current rally, and in fact is signaling the Fed will pivot hard later this year and embark on lower rates.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
On the other hand, the Dow Jones Transportation Average (DJTA) is breaking out, hitting a 6-month high last Wednesday. According to Dow Theory, leadership by the transports is bullish for the broader industrial sector – hardly the stuff of recessions.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The chip and chip equipment sector is also moving higher, trading up and through its 200-day moving average like a hot knife through butter, which historically is a strong indicator that further gains in the NASDAQ are in store. This upside breakout also coincides with some leading companies posting underwhelming Q4 results and issuing cautionary guidance. And yet, semis as a whole ripped higher.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Wall Street’s most prominent bears now would be Morgan Stanley’s Mike Wilson, Bank of America’s Michael Hartnett, and JPMorgan Chase’s Marko Kolanovic. All have been rated 5-star analysts for calling last year’s bear market. In their most recent comments of the past week or so, they are all still bearish:
(1) Wilson states that, “the rally is a trap and the bear market’s final leg looms;” (2) Harnett claims, “investors are sleepwalking into a selloff,” and (3) Kolanovic warns that, “stocks have a 10% plus drop ahead: things have to get worse before they get better.” They all claim the fundamentals (earnings) are going to crumble, but halfway through earnings season the numbers are coming in better than forecast.
The bottom line is that global equity funds had $44.7 billion of inflows in the past four weeks, according to the note, citing EPFR Global data. Stocks have rallied since the start of 2023 on signs of cooling inflation, optimism over China’s reopening, and hopes that slower economies will force global central banks to pause hiking rates. As time progresses, the balance of earnings season and forward economic data will begin to determine whether these “three bears” are right, or the those getting long on equities.
After such a powerful rally, I look for the market to consolidate for a good period of time to relieve the very overbought technical condition of most leading stocks, to see some fluff come out of the high-beta stocks, and for the market to reconsider further rate hikes and other factors. Some backing-and-filling is constructive and sets up the market for further gains if the fundamentals hold up.
The early money is betting they will.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
The Global Fallout of the Fed’s Decision
Income Mail by Bryan Perry
The Market Will Likely Pause Until Some Obvious Questions Are Answered
Growth Mail by Gary Alexander
We’re in the “Sweet Spot” of the 4-Year Presidential Cycle
Global Mail by Ivan Martchev
A Big Euro Sell-off (Dollar Rebound) is Coming
Sector Spotlight by Jason Bodner
Emotions Drive the Market – But We Are Just Observant Passengers
View Full Archive
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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