The Federal Reserve is caught between a rock and a hard place—and it only has itself to blame.
Specifically, the U.S. is still plagued with elevated inflation (though it has cooled somewhat), and high interest rate hikes have wreaked havoc on the banking industry (the industry that the Fed regulates). In other words, the Fed has a tough choice to make: Continue to raise interest rates to squelch inflation and risk further harm to the banking industry or pause rate hikes and risk inflation remaining elevated.
To better understand how the Fed put itself in such a tight position, let’s rewind back a few years and consider the role of inflation, as it’s been the Fed’s “boogeyman” in recent years.
At the end of 2020, the Fed’s favorite inflation indicator, the Personal Consumption Expenditures (PCE) price index was sitting at 1.3% and core PCE (excludes food and energy) was at 1.5%, well below the Fed’s target of 2%. By the end of 2021, though, the PCE surged to 5.8% year-over-year, with core PCE up 4.9% year-over-year—and it showed no signs of slowing down.
Yet, the Fed claimed inflation was “transitory” throughout 2021.
We all know how that turned out. Inflation wasn’t transitory; it was persistent. By the end of the first quarter in 2022, PCE jumped to a 6.6% annual pace and core PCE stood at a 5.2% annual pace. And it was at this point that the Fed finally pulled its head out of the sand, admitted inflation was elevated and took action.
Our central bank started to aggressively raise key interest rates in March 2022, lifting the Fed funds rate from around 0% to a range between 4.75% and 5% today. That’s the fastest pace of rate hikes on record!
The Fed’s aggressive tightening policy was aimed primarily at curbing inflation, and it has been slightly successful in achieving this goal. The February PCE rose 5% year-over-year, and core PCE was up 4.6% year-over-year, which is down from 5.4% and 4.7% in January.
However, the Fed’s rate increases have impacted more than just inflation, as we’ve seen firsthand with the recent banking crisis, the ailing real estate industry, commodity price fluctuations, slowing economic growth, stock and bond market volatility, and even earnings growth.
Unfortunately, all of the repercussions from the Fed’s actions over the past few years have yet to be realized, but we have started to see some of the impact—and can predict how the fallout could continue this year. Let’s consider seven of the biggest impacts that we’ve already witnessed and could continue to see in the coming months (and even years).
Impact #1: Banking Crisis
Jason Bodner (who writes Sector Spotlight in the Navellier & Associates weekly Marketmail) detailed on March 21, 2023 how bank’s poor decisions added to the financial industry’s woes, but the Fed’s quick and aggressive rate hikes over the past year is one of the main reasons why the banking industry is in chaos.
“Consider the chart of the Fed funds rate… notice the parabolic spike in rates:
I took the liberty of adding an orange line depicting a slower, steadier hypothetical hiking cycle. Should that have taken place, perhaps the ailing banks would have had more time to adjust. So, was it the fault of banks for poor choices in collateral? Yes. Was it the fault of abolishing of the fractional reserve system in favor of a zero-reserve system? Yes. Was it the Fed’s fault for zapping us with aggressive chemo style rate hikes? Yes.
Does it ultimately matter who’s fault it is?
Will it change where we are?
So, panic rocked depositors who made a run on the bank (SVB) faster than they could liquidate collateral. The Fed came out and guaranteed deposits for SVB and Silvergate. First Republic got a $30 billion injection from JP Morgan and Bank of America. Credit Suisse came under fire for liquidity and accounting concerns. The Swiss National Bank intervened and failure thus far, is averted.”
Clearly, there’s a banking crisis—and here in the U.S., a lot of that crisis was spurred on by an overzealous central bank. The fact is that the Fed is in charge of protecting the integrity of the U.S. banking system, and it has failed at its job.
Navellier & Associates Inc. does not own Silicon Valley Bank (SVB), Silvergate Bank, JpMorgan Chase & Co. (JPM), Bank of America (BAC), Credit Suisse Group (CS), or First Republic Bank (FRC) in managed accounts. Jason Bodner does not personally own Silicon Valley Bank (SVB), Silvergate Bank, JpMorgan Chase & Co. (JPM), Bank of America (BAC), Credit Suisse Group (CS), or First Republic Bank (FRC).
Impact #2: Housing & Auto Industry Woes
If the Fed continues to raise key interest rates, it could further hurt other industries besides banking, like the housing and autos industries. I actually recently voiced these concerns, asking “how many industries does the Fed need to destroy” before it backs off its aggressive rate hike policy in an interview with Fox Business.
In my opinion, the Fed has already done a good job of destroying the housing and auto industries, as higher interest rates equate to higher mortgage rates (more than 7% at the end of 2022) and auto loan rates (up to 11%)—and that deters many consumers from purchasing homes and vehicles.
Take new homes sales, as an example. New homes sales dropped 19% year-over-year in February. The one positive is that new home sales have actually risen on a month-to-month basis, up 1.1% to a 640,000 annual pace in February. The increase in new homes sales comes on the heels of mortgage rates starting to dip. According to Freddie Mac, mortgage rates have now fallen for four-straight weeks, with the average 30-year fixed mortgage dropping to 6.32%.
Now, even though new homes sales are still down substantially year-over-year, the spring is the seasonally strong time of year for home sales. So, if mortgage rates continue to decline (and the Fed sticks with its plan to halt key interest rates hikes), new and existing home sales could accelerate in the coming months.
Impact #3: Slowing Economic Growth
With the Fed doing its best to destroy select corners of the U.S. economy, I’ve been inclined to agree with my favorite economist Ed Yardeni, who has called the current economic environment a “rolling recession.” In other words, we’re not in a full-blown recession, but there are parts of the U.S. economy that are struggling (like the aforementioned housing and auto industries).
Goldman Sachs, though, has a more pessimistic outlook, predicting a “hard landing” for the U.S. economy. Its analysts now forecast that there’s a 35% chance of a recession in the U.S. in the next 12 months. Full-year GDP growth is only expected to be 1.2%, down from 1.5%.
The firm recently expressed concerns about the banking industry, specifically the decline in lending at small- and medium-sized banks in the U.S. Tighter lending restrictions, especially in the wake of the recent banking crisis, could hinder consumers’ ability to secure loans, which would ultimately impact GDP growth.
The fact is that consumer spending accounts for nearly three-quarters of total U.S. GDP growth—and if Americans don’t have the funds to spend due to inflation or lack of loans, the U.S. economy suffers. We saw that firsthand in the fourth quarter of 2022 when consumer spending only rose at 1% pace, or the weakest quarterly gain since the pandemic.
Impact #4: Gold Prices Soar Higher
Clearly, there’s been a lot of fear on Wall Street and Main Street recently, especially about slowing economic growth and the potential for more banking failures. And these fears subsequently hurt the U.S. dollar, banking stocks and a lot of stocks globally, as well as drove gold prices higher.
Senior Writer Gary Alexander recently pointed out on January 4, 2023 that the U.S. dollar and gold prices tend to have an inverse relationship, in that when one is up, the other is down. Interestingly, gold prices still ended 2022 slightly higher even though the U.S. dollar was incredibly strong last year—and Alexander expects the yellow metal to continue to rise in 2023.
“Gold and silver actually ended 2022 up a bit, due to the dollar’s decline since October. In the last two months of the calendar year, gold shot up over $200 per ounce, from $1,627 to $1,830 (+12.5%), while silver rocketed from $18.01 on October 13 to $24.13 at year’s end, up 34%. A couple of respected analysts are predicting $3,000 to $4,000 gold this year. I won’t go near those figures, but a new high at $2,100 gold and a 10-year high of $30 silver seem reasonable, as well as $110 oil sometime in the spring.”
Well, in the wake of the banking crisis and economic growth fears, gold prices soared above $2,000 in March—and have remained above the $2,000 level in April. So, Alexander’s prediction for $2,100 is certainly on the table for this year.
Impact #5: Inverted Yield Curve
Now, the Fed’s aggressive tightening policy to curb inflation hasn’t just hurt corners of the U.S. economy, slowed overall GDP growth and drove folks to safe havens like gold; it has also inverted the yield curve. What this means is that the two-year Treasury yields more than the 10-year Treasury. Now, I’m an ex-banking analyst, and I can tell you that an inverted yield curve is very bad for any bank.
Back in the late 1970s and early 1980s, the yield curve was severely inverted, and I worked in the banking industry. Specifically, I would spend my days merging losing financial institutions together to make them qualify for FSLIC of FDIC insurance. Essentially, I would take the largest financial institution and merge it into the smaller, but would re-amortize its assets (e.g., loan portfolio) to make the combined financial institution look better.
Unfortunately, we’re in a similar situation to the late 1970s and early 1980s, in that the yield curve has been inverted since July 2022. So, it’s no surprise that banks ran into problems.
Interestingly, given the recent chaos in the banking industry, Treasury yields have plunged from their recent highs. The 10-year Treasury yield sank from a recent high of 4.06% on March 2 to a recent low of 3.38% on March 26. I should also add that the two-year Treasury yield dropped from a recent high of 5.07% on March 8 to a recent low of 3.78% on March 27. Both yields have since moderated, with the 10-year Treasury sitting at 3.56% and the two-year Treasury at 4.2%.
So, while yields have tumbled from their recent highs, the yield curve still remains inverted, albeit not as severely. Unfortunately, as long as the yield curve remains inverted, we’ll have more banking issues, and there is a risk that other banks may fail the Fed’s capital requirements.
The good news is that the Fed never fights market rates. As market rates decline, the Fed has to follow market rates longer term. So, the big, big declines in Treasury yields recently basically ensures that the Fed will not increase rates going forward.
Impact #6: Fed Set to Pause Key Interest Rate Hikes
Just as everyone expected, the Federal Open Market Committee (FOMC) voted unanimously to raise key interest rates by 0.25% on March 22. The Fed funds rate now stands at a range between 4.75% and 5%, which is the highest level since 2007.
Since we all knew that the Fed was going to raise rates again, I was more interested in the Fed’s “dot plot,” as well as the FOMC statement and Fed Chairman Jerome Powell’s comments in the wake of the latest key interest rate hike. And I wasn’t disappointed.
The survey of Federal Open Market Committee (FOMC) members “dot plot” showed a median high-end range of only 5.1%. In other words, the Fed funds rate is close to its projected peak and only another 0.25% increase could be necessary.
I should also add that the FOMC statement was well received and viewed as dovish, since it excluded the previous phrase of “ongoing” rate increases and added “some additional policy firming may be needed.” Fed Chairman Jerome Powell even noted that FOMC members considered standing pat given the recent banking chaos and implied the March increase could be the last one for a bit.
So, the Fed may be nearing the end of their current hiking cycle—and that’s good news for stocks.
Impact #7: Growth Stocks Back in Favor
With the rate hike cycle nearing an end, growth stocks have returned to favor, and we need to look no further than action in technology stocks in the first quarter. The NASDAQ was up a whopping 16.8% in the first three months of the year, versus the S&P 500’s 7% gain.
Interestingly, despite the strength in tech stocks so far this year, a lot of the so-called FAANG stocks flamed out. Apple (AAPL) was the exception, and The Wall Street Journal recently pointed out that Apple and Microsoft (MSFT) now have their highest-ever weightings in the S&P 500, with a combined 13.3% weighting. The fact is Apple and Microsoft have been deemed an oasis by many investors.
However, Apple has negative forecasted sales and earnings growth, and Microsoft’s first-quarter earnings are only expected to rise 0.5%. Both Apple and Microsoft have also experienced negative analyst earnings revisions in the past three months, and that does not bode well for first-quarter earnings surprises for either company.
The reality is that back in January and February, we saw firsthand that earnings work—i.e., companies that announced positive earnings momentum and better-than-expected results were rewarded with higher share prices. Given that the S&P 500 is still expected to post negative earnings results for the first quarter, I expect stocks with accelerating earnings momentum and positive earnings surprises to re-emerge as the new market leaders.
The fact is that we remain in a fairly narrow stock market. I like to call this market a “15% market,” in that nearly all of the positive forecasted earnings and sales growth is only in 15% of all the stocks that I monitor. On the flip side, outside of the top 15% of stocks, there are lackluster earnings and sales.
Navellier & Associates Inc. owns Apple Computer (AAPL), and Microsoft (MSFT), in managed accounts. Louis Navellier and his family own Apple Computer (AAPL), via a Navellier managed account and in a personal account. He does not own Microsoft (MSFT) personally.
In other words, earnings are simply the best catalyst for success in 2023.
Your Best Defense Is a Strong Offense
Fed Chairman Jerome Powell recently stated, “There are costs to getting inflation under control.” As we’ve outlined in this Special Report today, we’ve already felt the repercussions of the Fed’s efforts to curb inflation—and will continue to feel the effects of its polices for many months to come.
The good news is that we can insulate our portfolios from the “Fed Fallout” by focusing on select growth stocks—those with superior earnings and sales growth, positive analyst estimates and persistent institutional buying pressure—as they should outperform in 2023.
Here’s the great news for you: I’m obsessed with fundamentally superior stocks.
My fascination with growth stocks started back in the late 1970s during my college years at Cal State Hayward. I wanted to uncover how to beat the market without taking on too much risk—and what I discovered was that a select group of stocks can consistently outperform the S&P 500: stocks with superior fundamentals.
Today, I’m a self-proclaimed “number guys” because the numbers do not lie—and right now, the numbers are telling me that stocks with accelerating earnings and sales momentum are the best protection from the Fed Fallout and the best way to prosper in 2023.
Our best defense is always a strong offense of fundamentally superior growth stocks.
Let me break it down for you…
Here at Navellier & Associates, we believe in the power of a well-balanced portfolio. It can literally neutralize the stock market’s uncertainty and take advantage of unique growth opportunities the market throws our way. That’s why we encourage our clients to take a diversified approach to managing their investments—one that can include growth, income, and capital preservation strategies.
These portfolios feature companies that are committed to growing their sales and earnings. Our growth portfolios are segmented by market capitalization, are actively managed, and seek inefficiently priced growth stocks with opportunities for long-term price appreciation. We screen for small- and large-cap companies that are consistently growing sales and earnings. Our team actively manages this portfolio to find undervalued growth stocks.
These offerings provide dividend growth and income opportunities with capital appreciation. At Navellier, our dividend and income portfolios strive for portfolio growth through securities with capital appreciation, strong dividend growth, and income opportunities. We seek out companies that have a history of growing and paying dividends. Most importantly, these dividend-paying companies have free cash flow to cover each dividend payment. This can make it much easier to have reliable income in retirement.
Capital Preservation/Defensive Portfolios
These portfolios aim to outperform in up markets and limit losses in declining markets by moving to cash or bonds. This asset allocation plan allows investors to play defense in a declining market. Our capital preservation strategies can help you mitigate steep market losses with defensive ETFs and covered calls. Defensive ETFs can serve this need as they shift to cash or bonds when conditions permit.
When you add up everything we have discussed today, you can quickly see the importance of having a diversified approach to managing your investments—one that can include growth, income, and capital preservation strategies. The power of a well-balanced portfolio cannot be overstated.
When you dive deeper into the details of our exclusive portfolios and strategies, you will see that many of them cross boundaries and can be combined to form an overall portfolio strategy. That portfolio can then be customized to your personal financial goals and risk tolerance.
To build a personal portfolio that strives to deliver returns, it is important to think about things such as your retirement goals, how long you have to reach those goals, and what your risk tolerance is … just to name a few.
At Navellier & Associates, our team is here for you. We will work with you to answer these questions and discuss a customized solution tailored specifically towards you and your retirement goals.
Right now, we are optimistic that the stock market should rally in 2023, especially if the Federal Reserve sticks with its plan to “pause” key interest rate hikes. But not all stocks will participate in the melt up, as the market continues to narrow and grow more fundamentally focused. We can help you build a personal portfolio of fundamentally superior stocks that will prosper in 2023.
In fact, here’s a sneak peek at how we select stocks for each of our custom portfolio offerings…
Our Proprietary 3-Step Stock Selection Process
At Navellier & Associates, our system was built to find inefficiency in the market, uncover what we think are the market’s best growth stocks, and utilize a disciplined quantitative and fundamental analysis system to create a customized portfolio for individual investors.
Consider an example of the three-step proprietary stock-selection process that we utilize for most portfolios:
- Quantitative Analysis: Using our proprietary screening process, we measure reward (alpha) and risk (standard deviation) indicators to the appropriate market capitalization range for each portfolio. We rank stocks based on the reward/risk measure and reduce the initial investment universe to a select bucket of stocks that fall into the upper percentiles of the reward/risk measure.
- Fundamental Analysis: We then apply fundamental variable screens to the stocks with the highest reward/risk measures. This shines the spotlight on which companies have exceptional profit margins, excellent earnings growth (and positive earnings surprise potential!) and reasonable price/earnings ratios (based on expected future earnings).
- Securities Optimization: We use a proprietary optimization model to maximize alpha, while minimizing portfolio standard deviation. This can efficiently allocate the stocks and create portfolios that are well diversified across sectors and industries.
Primarily, our goal with the three-step stock selection process is to develop portfolios that have a low correlation to their benchmarks, increasing diversification, decreasing risk, and maximizing profits for investors like you.
We’re still in the early innings of 2023, yet we’ve already seen firsthand how the stock market is narrowing. Investors are growing more selective, and growth stocks with accelerating earnings momentum at a time when earnings growth is dipping will continue to attract the most institutional buying pressure. So, we believe that now could be a good time for you to have a custom investment strategy that focuses on your financial goals and risk tolerance, as well as diversification.
Navellier & Associates can help you build your own customized portfolio strategy. We rely on our extensive research, trend analysis, customized strategies, and historic market knowledge to manage our client-only portfolios and help our clients take advantage of opportunities that are presented by market corrections—short and long-term—as well as raging bull market situations.
Our proprietary models are built to work on U.S.-based portfolios with a minimum account value of $250,000. If your portfolio meets these criteria, please contact my Navellier & Associates team. They are standing by ready to discuss your personal portfolio and investment strategy to help you make the most of 2023.
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If you decide you’d like to continue to manage things yourself, we hope that we have given you some important information to consider during your portfolio review.
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I’m confident that Navellier & Associates can help guide you to build a portfolio to navigate the current environment and help you achieve your individual financial goals in 2023!
All the best to you and yours,
Chief Investment Officer
Navellier & Associates, Inc. │ Private Client Group