by Bryan Perry

September 7, 2022

Inflation is still around, so the Fed is promising to raise rates and draw down their balance sheet rather aggressively “until the job is done,” meaning they want to bring inflation down to their target level of 2%.

Their monetary tool kit is powerful, but it’s a big stretch to see how they can accomplish their objective when the commodity markets, supply chain disruptions, war in Ukraine, crumbling global currencies and geopolitical risks contribute mightily to global inflation factors that remain out of their control.

Friday’s jobs report showed an unemployment rate that ticked up to 3.7% from 3.5%, while July factory orders fell by a bigger-than-forecast 1.0%, adding to the market’s selling pressure, so the technicians that called the move off the June lows a “bear market rally” are getting congratulated by the financial media, as all the major averages turned down when meeting their downward-sloping 200-day moving averages.

Standard and Poor's 500 Exchange Traded Fund Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The uncomfortable logic of today’s market landscape calls for investors to root for bad economic news to cross the tape, since good news implies more Fed tightening. The Fed is set to raise the Fed funds rate by 75 basis points at the next FOMC meeting on September 21. In order for the market to be convinced they may pause after that, we must see a steady stream of disappointing data, evidence of a slowing economy.

Current odds reflect a 57% probability the Fed will raise short-term rates 0.75%, per the FedWatch Tool.

Target Rate Probabilities Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

When inflation gets embedded in the economy, it doesn’t surrender easily. Back in 1981, when inflation was roaring, Fed Chairman Paul Volker oversaw the task of fighting inflation with the prime rate peaking at 20.5% in August 1981, when annual inflation was running at 13.5%. At that time, 30-year mortgages were pegged at 18.4% and money markets were the greatest investment of the time, paying 18.9%. The cause of inflation then was rising oil prices, government overspending and rising wages. Sound familiar?

A repeat of 1980-82 is what terrifies the current Fed, hence Powell’s tough talk in Jackson Hole a little over a week ago. Far from being “transitory,” inflation is like a force of nature, once released. With the Fed’s balance sheet at nearly $9 trillion and our national debt at nearly $31 trillion, higher rates would put massive stress on the ability to service what would be soaring interest costs on $31 trillion of federal debt.

When investors are in this uncomfortable “bad news is good news” environment, where stocks tend to rally when the economy is slowing, that is not a good long-term situation. Ultimately, sales and earnings growth will slow, and stock valuations will contract. The market dislikes recessionary forces that call for a “hard landing.” A soft landing, also called a “growth recession,” is what the current Fed is aiming for.

This “threading a monetary needle” is delicate work, and only time will tell how it plays out. The value of the U.S. dollar is trading at levels not seen since the dot-com bubble days, which ended in 2002 with the S&P 500 losing nearly 50% of its value. The dollar is currently the most crowded trade in the world – as global macro events and inflation imply very high levels of uncertainty. The Fed had a chance to stave off inflation in early 2021 by stopping QE much earlier, but instead they embraced the “transitory” message that put them squarely behind the curve, and now they’re in a much more challenging position.

With the bad news now out front – all of which the market knows and is probably fully discounting at this point – the good news has yet to make its mark or be fully appreciated. Let’s turn it into a checklist:

  • Last Friday, hourly wages and factory orders were tame, coming in below forecast. Check one.
  • WTI oil closed at $86.87 per barrel, matching a multi-month low. Check two.
  • The 10-year Treasury rallied to close at 3.19% with an inverted yield curve, implying economic slowing. Check three.
  • European funds have seen net outflows for the past 29 weeks. The euro, yen and yuan are all taking out their multi-year lows against King Dollar, and the U.S. bond and stock market remain the most trusted place in the world to allocate capital. Check four.

Hourly Earnings Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

From the 20-year chart below, the U.S. stock market is consolidating a monster move higher following a firehose of Covid-19 stimulus spending both here and abroad, as capital flows charged into U.S. stocks.

Standard and Poor's 500 Exchange Traded Fund Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Most of the 2022 correction is likely complete. While there is a lot of wood still to chop, the long-term bull trend is very much intact. The market just got way ahead of itself. That will be resolved, probably by year-end, if not sooner. Why? The inflation data will likely cool faster than the current consensus expects. The CPI and PPI data for August come out next week, right in front of the next FOMC meeting.

If there was ever a time for the market to pivot higher, it would be on the thrust of these two critical reports being softer-than-expected. That would be check five. The bigger question is when the market will regain its primary uptrend. Investors, by nature, are impatient, and it may be past the mid-term elections before the bull market makes its big move. While that is only two months away, it will feel like a lifetime.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

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EU Natural Gas Saga Hits Dramatic Escalation

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It’s Human to Worry, But It’s Not Very Profitable

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About The Author

Bryan Perry

Bryan Perry

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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