With Thanksgiving behind us, Christmas looms as the next big event. Is this a Santa Claus rally or the beginning of a new bull market? One thing we know about this market is that Wall St. is very much like those kids expecting Santa Claus’s arrival. They can’t wait.
It seems this market can’t wait to see which way the economy goes. The consensus is that we are in a glidepath to a soft landing. The Fed finished raising rates this summer, and the Street can’t wait for rate reductions to begin, even if the Grinch (Mr. Powell) says rates need to be ‘higher for longer’. After watching the stock market waffle for almost 3 years as the consensus has flipped back and forth on this subject, you can’t blame us for taking a wait and see approach.
Following the pandemic, Fed Chair Jay Powell was soundly criticized for calling inflation transitory, and not reacting more quickly to the inflationary trend. That forced the Fed to play catch up with a fast series of 0.75% rate increases. Since then, Mr. Powell has been remarkably consistent in his message. The Fed will do what it takes to bring inflation back to target, and it will take more than hitting that 2% mark to convince them that the trend is sustainable. It is the market that has waffled, parsing each word from the Fed to an unreasonable degree and reacting wildly as a result. While it is true that the S&P 500 is near its peak, that peak was first hit 2 years ago. So, the question is this just another waffle? Or are we moving on to better things?
Our bias is to take the Fed at their word – higher for longer. The Fed always desires a soft landing, but they fear an inflationary spiral more, so they will tend to make sure that inflation is tamed. Whether employment and the economy can hold up while they hold their foot on the economic brakes remains up for debate. We’d love to be wrong, but historically, the Fed has not been very successful at managing a soft landing. Here is the evidence that they are likely to fail again.
- Leading Economic Indicators: down for the last 19 months in a row, and below the level that has historically indicated a recession
- Continuing claims for unemployment reached a two year high, albeit, still at fairly low levels.
- Third quarter earnings, while generally good, were a disappointment on the revenue line
- Job growth has been gradually weakening; permanent job losers (those not in a temporary lay-off) reached 1.65 million.
What muddles the situation is that we had substantial GDP growth in Q3, but in our view, it was not a ‘strong’ economy. A strong economy is one that grows organically with little input from fiscal or monetary stimulus. The economic growth we have experienced since COVID was produced first by substantial monetary stimulus (lower interest rates) and is currently supported by substantial fiscal stimulus (government spending). We have yet to see how the economy can perform when these factors are finally removed.
Somewhat ironically, it is these indications of economic weakness that have made the stock market so excited. All this weakness is taken to mean that the Fed has already implemented its last rate increase and now we can start anticipating rate cuts – Can’t Wait! We will get there at some point, but we are not willing say that time is now. Stay tuned!
What We’re Reading
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