What came to mind over the weekend was applying Occam’s Razor when interpreting the Fed plans and what the means for the economy and stock market, states Steve Reitmeister of Reitmeister Total Return.
For those who are not immediately familiar with this philosophical concept, then here is the boiled down version from Wikipedia:
“Simpler explanations are more likely to be correct; avoid unnecessary or improbable assumptions.”
In this case the simpler explanation is to take the Fed at their word. That probably two more rate hikes are coming, and the jobs market will be a casualty in their war against inflation. I share this insight versus those who somehow think it is more logical that the Fed is bluffing about their future intentions. That is a long shot friends...and thus seems like a grave mistake to bet on that outcome with higher stock prices. Remember that an ongoing mission of the Fed going back many administrations is the necessity for clear and consistent communication. This is the best way for investors to act in orderly fashion with the least disruption to the market.
Now consider how consistent Powell and other Fed officials have been on their messaging. Like these talking points that are echoed time and time again at the multitudinous Fed speeches the past several months:
- Inflation is an economic disease that must be eradicated for the long term benefit of the economy.
- There is more work to do to tamp down inflation to 2% target
- Two more rate hikes likely this year
- Unemployment rate will climb to 4.5% before it improves (yet remember that at no time in history has unemployment rate ever climbed that high without going at least 1% higher. Meaning the Fed is underplaying the likely negative effects of their plans).
- The greater risk is for the Fed to end their efforts too early allowing inflation to rise from the ashes. (Meaning better to create recession than allow inflation to rise again). Which is why they keep saying...
- No rate cuts until 2024
- Recession still the base case
But once again those numbers are skewed towards gains in the usual mega cap suspects. Looking out to the small and mid-caps, both are firmly in the negative column since the Fed announcement. Also in the negative camp for investor sentiment is the spike in rate hike expectations for the 7/26 Fed meeting. A month ago, only 19% saw another quarter point hike in July. That probability is now up to 77%. Note that the Fed’s favorite inflation gauge is Core PCE which comes out again on 6/30. No doubt that report will adjust the odds once again. So, keep your eyes on that.
The bear market has been firmly in hibernation mode all year long. Dormant...but not dead. So, for now I think investors are in wait and see mode. No need to advance higher given the gains already in hand. And no need for a nasty correction either. Maybe a modest 3-5% pullback allowing a trading range to emerge between 4,200 and 4,400. The more serious the Fed is about all the pronouncements above, the more likely a recession is in the forecast which brings with it a return of bearish conditions. A bearish hedge or straight up shorting of the market will be the trading path to profits.
Whereas the more quickly annual inflation appears on pace for 2% or less, without unemployment rising, then indeed the Fed stuck the soft landing. This will be a bullish green light to emerge into the next long term bull market. Risk On growth oriented investing is what pays the bills here with an overweighting of small caps (given how much they are lagging large caps at this time). I will continue to monitor the all the relevant inputs to give updates and trading adjustments as the situation dictates.
Is it possible that stocks keep going higher even with everything I stated? Unfortunately, yes...just like every stitch of advancement above 4,000 in my opinion. Meaning the market is not always logical. That is why we talk about the pendulum of fear vs. greed to appreciate how far away from the rational middle ground. And right now greed is winning more than it should be. But not across the board.
Greed is only working in a small group of mega caps and tech stocks associated with AI. Not a full blown 1999 tech bubble...but could continue to bubble up. My focus on calling it a bull or bear market is not so much about the S&P 500. Rather it is about market breadth which has improved the past month...but has a long way to go to make one believe that a new bull market is emerging.
More likely we are at another point of consolidation to truly assess if conditions are warranted for further advancement. Right now, I think odds are tilted in the other direction. But am open to waving the bullish banner if more of the facts line up. Until then I will continue to recommend our balanced approach and the adjust more bullish or bearish as the facts dictate.