By: Matt Garrott
It’s been 15 months since the Federal Reserve started to raise interest rates. A streak of 10 hikes in a row came to an end at the recent June meeting. The market expects this to be a skip, not a stop or pause as the Fed expects another two hikes (skip, hike, skip, hike) according to their dot plot. JPMorgan’s Dr. David Kelly doesn’t think additional hikes are justifiable. The dot plot also shows rate cuts starting next year. Historically, the dot plot is almost never right. Two more hikes might not make sense to economists like Dr. Kelly, but it would keep with the Fed’s history of overcorrecting. While economic data continues to hold up or even improve, a monetary policy mistake could be the trigger to what is starting to feel like the most anticipated recession ever. The market is pricing in one remaining hike in 2023, not two. CPI is 4.0%. The Fed Funds rate is 5-5.25%. After a year of aggressive hiking, the Fed Funds rate is in line with market rates.
Was inflation transitory? It’s been 26 months and 10 interest rate hikes since the last time inflation was 4%, that sure doesn’t feel too transitory. 28 months ago, inflation was 1.7%. The “easy” job was getting from 9% (where we were 12 months ago) down to today’s rate of 4%. It will be much harder to tamp it down to the Fed’s target of 2%, especially without setting off economic hardship. The components of inflation are often interconnected without moving in lockstep. For example, 2.5% of CPI is auto insurance which is up 17% over the last year. Insurance premiums lagged the dramatic increase in automobile prices. Overall inflation continues to trend lower, but it will likely be a bumpy ride down.
A recent Wall Street Journal article asked where’s the recession we were promised? Commercial Real Estate is in trouble. The Winnebago indicator (a real thing) is flashing warning. Dr. David Kelly says we’re “one banana skin away” from slipping into recession, but the economy has been resilient so far. Commercial Real Estate might not be a meltdown, but a slow grinding headwind instead. Energy and employment look encouraging on the surface. Digging deeper, the Strategic Petroleum Reserve must be refilled someday. Some of the employment data may not be as robust as it first seems. Despite all the economic uncertainty, by traditional measures the bear market is over, as the S&P 500 hit a level 20% above its previous lows during this past quarter. It lasted 282 days. The average bear according to Bespoke Investment Group lasts 286 days. With the bear ending 10/12/2022, we are 261 days into a bull market which on average lasts about 1,000 days.
Investors tend to focus on relative return on the way up and absolute return on the way down. There’s chatter around the “Magnificent Seven” stocks that are leading the S&P 500 (Apple, NVIDIA, etc). Some people think it’s a cheap or unearned rally because of the lack of breadth. However, if the situation were reversed, no one would be saying “Don’t worry, it’s only seven stocks that are dragging the rest of the market down”.
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