Bulls Looking for Current Market Pivot to Stick
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Against a wave of disappointing earnings and guidance from America’s biggest and best technology companies, the very same set of FAANG+ stocks led a ferocious charge higher last week as traders and investors are betting on a kinder and gentler Fed policy to emerge from this week’s Federal Open Market Committee (FOMC) meeting.
Wagering against a Fed pivot has not worked out to date, but the bulls are more convinced the conditions for the Fed to soften its hawkish stance are somehow materializing. From the economic data that has crossed the tape of late, it seems a stretch to think that the Fed is nearly done with the front-end loading of hiking rates and quantitative tightening (QT).
In the past three weeks, Non-Farm Payrolls, the Consumer Price Index (CPI), the Producer Price Index (PPI), consumer sentiment, industrial production, building permits, new home sales, advanced Q3 gross domestic product (GDP), personal spending, personal income and core Personal Consumption Expenditures (PCE) came in above forecasts.
The key takeaway from the PCE report is that with continued income growth and slightly hotter-than-expected core PCE price growth — tracking price increases other than food and energy — the Fed has an argument to maintain its aggressive rate hike course. Mortgage Applications and Pending Home Sales both came in below forecasts.
Instead of penalizing the market further for what looks to be more embedded inflationary pressures, the market elected to stick with the “bad news is good news” narrative that a few pockets of weakness in the economy, namely the housing market, is drawing cash off the sidelines, afraid to miss out on further upside. “The market is starting to believe that there is an endgame in sight for this huge global tightening cycle,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.
The Fed has now pricked the housing balloon and has its sights set on the labor markets. It is hard to imagine that just six months ago, employers were paying big signing bonuses for new hires. To think that widespread layoffs are going to mushroom does not seem realistic when seasonal hiring for the holiday shopping season is about to get into full swing.
I have been traveling extensively for the past month, and airports, hotels, restaurants and entertainment venues are packed. Anecdotal evidence points to strong discretionary spending, thanks to a robust job market.
The U.S. economy added 263,000 jobs in September of 2022, the least since April of 2021 but above market forecasts of 250,000, according to the U.S. Bureau of Labor Statistics (BLS).
Notable job gains of 83,000 occurred in leisure and hospitality, followed by health care with 60,000 new jobs, professional and business services came next with 46,000 and manufacturing contributed 22,000, according to the BLS. The reading marks a drop from an average of 439,000 in the first eight months of the year, as higher interest rates and prices started to weigh on the economy. Still, the number continues to point to a tight labor market with employment about 500,000 higher than its pre-pandemic level.”
Hurting the market further was some selling in bonds that I think was more of a function of deepening recessionary pressures around the globe. Europe is arguably in a recession, with the European Central Bank raising its key short-term rate by 75 basis points last week to 1.5% in response to consumer prices soaring by 9.9% in September.
Like the Fed, the ECB is very late in responding to inflation that has proven worse and more persistent than the bank expected. Where have we heard that tagline before?
What is even more surprising is that if this pivot narrative was truly taking hold, then the 2/10 Treasury spread would not have widened out late last week, implying a slower economic growth rate in the first half of 2023. After narrowing the gap to 26 basis points, the spread jumped back up to 40 by Friday, and the market didn’t flinch. Impressive!
This past Sunday, Bloomberg reported that Goldman Sachs forecasts Fed rates peaking at 5% in March in what seems to be an acknowledgement of the ongoing and stubborn fight on inflation the Fed has on its hands. The three 75-basis-point hikes and a fourth one on the way just haven’t had the impact they had hoped for by now. Within the PCE report for September, shelter, spending, wages and salaries all proved sticky.
- Real personal spending was unchanged month over month and up 1.9% year over year (versus up 2.0% in August).
- Wages and salaries were up 0.6% month over month following a 0.3% increase in August.
- Rental income was up 0.2% month over month after increasing 0.2% in August.
Source: www.briefing.com
In trying to read between the lines as to why aggressive rate hikes have yet to rein in inflation and throttle back growth, the idea of an aircraft carrier taking five miles to come to a complete stop after the engines have been turned off comes to mind. Based on most companies reporting sales and profits this month, the economy held up well in the third quarter as it started to acclimate to rising interest rates. The fact that GDP advanced 2.6% in Q3 following two negative quarters should send a message that the Fed is likely going to remain hawkish in its policy statement.
Even with what looks like the writing on the wall for further rate hikes, the market sees the rate cycle ending in the next six months with the economy adjusting just fine to 4-5% inflation. Plus, the rally is broadening out and new leadership is taking hold. This might be why very few analysts have been able to fully explain the October rally and why a bottom might just be in. The bond market and the rate of inflation are looking to meet in the middle, and history shows that stocks can outperform in a 4% inflationary world. If I had to paint a landscape, this is what it would look like.
