ACTV - Stocks Falling Finally Getting The Fed Message: Higher For Way Longer

Summary

• Good news will be bad news, as well as bad news being bad news.
• I think the Fed will only ease up when we see the economy crashing. Then we should be worried about more than our stocks.
• The Fed’s message is higher for longer, when will the rate rise stop? It could be +6%.
• We have Fedspeak at the end of this short week, Thursday and Friday will have 5 speakers from the Fed.

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 on the path to higher rates, and in no way was going to “pivot”. The word pivot has been transmogrified several times, from cutting rates this year to stopping rate rises, to the joy of .25% just a few times more this year. All of these narratives have been way too optimistic. Though I can be accused of imbibing some of this Kool-Aid as well, my conceit was that the economy can handle higher rates. That ZIRP was not only unnecessary but holding down rates to zero was actually harmful to the economy, making various assets “bubblicious” like Bitcoin for example. I thought that as long as the rate rises slowed so that the economy could adjust, then a soft-landing or even a totally avoiding recession while defeating inflation is possible. I thought – falsely it now seems, that the Fed was only using 2% inflation as an aspirational goal. Once we fell to the 3% handle the urgency of tightening would subside. Instead, two things have become obvious, 1) Inflation is nowhere near 3%, and 2) It's "sticky" and may not get there with a leisurely .25% rise. Already Loretta Meister has broached .50% for March, we will see later this week when no less than 5 Fed officials will make statements Thursday and Friday. So will we get more restrictive commentary to prepare the ground for more rapid tightening?? Will the Fed come out with guidance that the rate rises even at .25% and will go on into year-end and stay in place until 2025? Can any economy handle that kind of pressure? What I mean is, if it is expected that at every FOMC meeting, there will be a rise in rates, that in itself is a barrier to economic growth. How does a bank price out a loan that they know can possibly be 75 bps higher rate in less than a year? Can the borrower handle that kind of business climate? Lending will just slow down, and be given only to the businesses that need them the least.

Higher and some are saying much higher, and for longer

Greg Branch, Founder & Managing Partner of Veritas Financial, last week on CNBC said he expects 6.25% as the terminal rate for the Fed Funds Rate ((FFR)). Who is Greg Branch and why should we care what he thinks? Because way back I believe at the end of 2021, he predicted that the Fed was going to turn super hawkish. I dished him off to be one of those perma-bears you always hear me gripe about. I wish I had harkened to him back then. He has been right every step of the way and now I am going to listen to him intently. I don’t believe anyone else is projecting that high a level. Suppose he is wrong? He and others who are clearly more adept at Fed watching and interest rate rises will at least push the range of the terminal FFR to that level. No doubt stocks have not discounted that level.

PCE is coming and it can roil the market

Previous Core PCE -- December ‘22: 4.4 November ‘22: 4.7 October ‘22: 5.1 September ‘22: 5.2

Below is the BEA's (Bureau of Economic Analysis) own definition of the Core Personal Consumption Expenditures report.

“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 Outlays report. The core index makes it easier to see the underlying inflation trend by excluding two categories – food and energy – where prices tend to swing up and down more dramatically and more often than other prices. The core PCE price index is closely watched by the Federal Reserve as it conducts monetary policy.”

What is of particular interest to Jay Powell is the Services Expenditures. This closely indicates the labor costs, wages and benefits which Powell is very focused on. He believes that high employment is a goad to inflation. The old wage-price spiral of the 70s all over again. I think this is nonsense, but Powell insists that the number of open jobs to the number of workers available is pushing up consumption demand and that is pushing up inflation. It may just be a convenient excuse to just keep raising until either the back of inflation is broken or the economy breaks. Right now the latter alternative is not a priority.

Interest rates in the 2-Y and 10-Y have stalled until this past week

The real mover of the market was the tag team of the 2-Y and 10-Y. To my eye, it was the 10-Y that was flying. However, the 10-Y retreated from the multi-month high of 3.90%. The 2-Y continued to rise rapidly, coming within a whisper of a high going back 15 years -- It reached 4.718% and settled at 4.617% yield, that's a full 9 basis points for the week! The dollar played a supporting role no less important. The dollar surged to a 6-week high at the end of the week. Consider that like last week, it was at a multi-month low of 100.09. This week it nearly went to 105. Is it any wonder that Thursday fell hard than Friday followed before recovering a bit before the close? The SPX and NDX were still in the red moderately by -.28% and -.58%, respectively.

Where do we go from here?

I am not making any predictions about the schedule. If the PCE Core, and especially the Services expenditure is bad, and Fedspeak by the end of this holiday-shortened week is hawkish talk about going back to a .50% rate rise then I can totally see a drop toward 3800. I am not overall bearish, I am not a super-bull. I see no evidence right now for 2023 to reach the old high of last year let alone make new highs. Also bear in mind we have about 3 weeks after this one to worry about what the Fed does and says for their next FOMC meeting on March 21-22. If a more aggressive schedule of tightening is mooted leading up to and during the meeting then we could go lower.

As it stands right now with the data I have to project forward, I wouldn’t say that we are going into a new bear market. I just think expectations of the recovery are going to be adjusted, and the indexes can start inching up again. Perhaps they break even higher if we really do see inflation move out of the 5%-7% range and move toward 3%. I made the spread to 7% for a reason and it is not a typo. Larry Summers stated this weekend on Bloomberg TV that if you strip away some numbers from the calculation, he comes up with a median inflation rate of 7%. He feels that the Fed is between a rock and a hard place and will likely throw us into a recession and that is justified.

I don’t have that view, the consumer is still strong, and there is a chance that we keep people employed but if the number of additional openings per laborer drops, Powell might just call it a win before we fall into a recession. I don’t blame market participants for taking the opportunity to celebrate the resilience of the economy and bidding up prices but let’s be honest the average PE of a Nasdaq stock is 18. We are way overvalued. 3 weeks ago Tesla ( TSLA ) was a hundred bucks, this week it was inches below 220, and carrying a PE of over 55. There are a lot of names like that, I am not picking on TSLA. Stocks have to discount higher interest rates. I know if I go through the litany of hedging and short positions our community at Dual Mind Research is maintaining once again, I think you will be bored. I will be bored recounting them, Check out my last two articles that go into details of preparing for this downturn. Yes, I am about 3 weeks too early once again. I think that from now on if I am brave (or dumb) enough to make a time-based prediction please add 3 weeks to the target. I will try and remember such a caveat. The market can stay irrational for a lot longer than we think!

Ok, so what trades can I talk about?

I went through my entire long-term account and my trading account and I didn’t initiate any new long positions. So let me talk about a sector that I am going to add to both my long-term and my trading account, which is energy. I am going to add to my Devon ( DVN ) holdings, they had one 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 little more, I will add to that position as well. I want to accumulate more Eli Lilly ( LLY ), for a split second it fell Friday to $320, but I wasn’t quick enough. Ideally, I would love to get more under $320. I think software hasn’t finished going down, 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 expand market share because some CFO is more interested in checking off boxes than getting the best in each category. I did add to my Confluent ( CFLT ) via a call option. I really like the price action there. I am waiting for my “Tech Titans” names to fall back to earth, but that might take a little longer toward mid-March. However, if the indexes are going to fall hard this week and Amazon ( AMZN ) falls to $89 I would start adding back shares, 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 would like them to be 30 to 50 points lower. I might get lucky next month. I feel similarly about chips and chip equipment makers. I think they are going to emerge from the chip glut this year and if they get beaten down enough I would like to own that sector. Sorry, I don’t have any concrete longs. I am holding onto my shorts going into next month which will mean having to roll out a bunch of my Puts to April to capture whatever happens at the next FOMC meeting.

I hope you all had a meaningful if not enjoyable President’s Day.

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