manassanant pamai
Exchange participants can act irrationally for a long time
The January rally went much higher than I thought possible. The Fed was still on its way to higher interest rates and was not about to “pivot”. The word pivot has been reshaped several times, from cutting rates this year to halting rate hikes to celebrating 0.25%, which has only hit a few more times this year. All of these stories were far too optimistic. While I can be accused of drinking some of that Kool-Aid too, I felt the economy could handle higher rates. Not only was ZIRP unnecessary, but keeping interest rates at zero was actually detrimental to the economy and made various assets such as Bitcoin “bubbly”. I figured that as long as interest rate hikes slowed down to allow the economy to adjust, a soft landing or even avoidance of a recession altogether while beating inflation was possible. I thought – incorrectly, it now appears that the Fed is only using 2% inflation as a desirable target. Once we dropped to the 3% mark, the urgency to tighten would lessen. Instead, two things have become apparent: 1) inflation is nowhere near 3% and 2) it’s “sticky” and may not get there with a leisurely 0.25% increase. Loretta Meister has already hinted at 0.50% for March, we’ll see later this week when as many as 5 Fed officials are set to make statements on Thursday and Friday. So will we get more restrictive comments to set the stage for a faster tightening? Will the Fed come out with a forecast that the interest rate will even go up to 0.25% and last until the end of the year and stay there until 2025? Can any economy handle this kind of pressure? What I mean is that expecting a rate hike at every FOMC meeting is in itself a hindrance to economic growth. How does a bank rate a loan that it knows could potentially yield 75 basis points more interest in less than a year? Can the borrower handle this type of business climate? Lending will only be slowed down and only given to the companies that need it the least.
Higher and some say much higher and longer
Greg Branch, founder and CEO of Veritas Financial, said on CNBC last week that he expects 6.25% to be the final fed funds rate (FFR). Who is Greg Branch and why should we care what he thinks? Because I think a long time ago, in late 2021, he predicted that the Fed was going to become very hawkish. I turned him into one of those permanent bears you always hear me bitching about. I wish I had listened to him back then. He was right every step of the way, and now I’m going to listen to him carefully. I don’t think anyone else is projecting such a high level. Suppose he’s wrong? He and others far more adept at watching the Fed and rate hikes will bring the terminal FFR range at least to that level. Undoubtedly, stocks have not priced in this level.
PCE is coming and can shake 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 key personal consumption expenditure report.
“The PCE price index excluding food and energy, also known as the core PCE price index, is published as part of the monthly personal income and expenditure report. The core index makes it easier to see the underlying inflation trend by excluding two categories – food and energy – where prices tend to fluctuate up and down more dramatically and more frequently than other prices. The core PCE price index is closely monitored by the Federal Reserve as it conducts its monetary policy.”
Of particular interest to Jay Powell are the service issues. This shows exactly the labor costs, wages and benefits that Powell is very focused on. He believes high employment is a spur to inflation. The old wage-price spiral of the 70s again. I think that’s nonsense, but Powell insists that the number of vacancies relative to the number of workers available is driving consumer demand and hence inflation. It can only be a convenient excuse to just keep raising until either the backbone of inflation is broken or the economy collapses. The latter alternative is currently not in the foreground.
2-year and 10-year interest rates stalled until last week
The real mover of the market was the tag team of the 2-Y and 10-Y. In my eyes it was the 10-Y that flew. The 10Y bond, however, retreated from a multi-month high of 3.90%. The 2-Y continued to rise rapidly, whispering close to a high 15 years ago – hitting 4.718% and settling at a return of 4.617%, a full 9 basis points for the week! The dollar played a no less important supporting role. The dollar rose to a 6-week high by the end of the week. Note that like last week, it was at a multi-month low of 100.09. This week it almost rose to 105. Is it any wonder Thursday fell hard as Friday followed before recovering somewhat before the close? The SPX and NDX were still slightly lower at -0.28% and -0.58% respectively.
What do we do now?
I make no predictions about the schedule. If the PCE core and particularly service spending is bad and Fedspeak is hawkishly talking about a return to a 0.50% rate hike at the end of this holiday week, then I can certainly see a pullback towards 3800. I’m not overall bearish, I’m not a super bull. I don’t currently see any signs that 2023 could reach last year’s old highs, let alone new highs. Also remember that after this week we have about 3 weeks to reflect on what the Fed is doing and saying for their next FOMC meeting on March 21st and 22nd. If a more aggressive tightening plan is discussed before and during the session, we could go down.
As it stands now with the data I have to project, I wouldn’t say we’re entering a new bear market. I just think that expectations of the recovery will be adjusted and indices can slowly start to rise again. Maybe they will break even higher if we really see inflation move out of the 5% to 7% range and move towards 3%. I set the spread to 7% for a reason and it’s not a typo. Larry Summers explained on Bloomberg TV this weekend that taking some numbers out of the calculation gives him an average inflation rate of 7%. He thinks the Fed is caught between rock and rock and is likely to push us into a recession, and it’s justified.
I don’t think so, the consumer is still strong and there’s a chance we’ll keep the workers, but if the number of incremental jobs per worker falls Powell might just call it a win before we hit a recession . I don’t blame market participants for taking the opportunity to celebrate the resilience of the economy and push prices higher, but let’s face it, the average P/E ratio on a Nasdaq stock is 18. We’re way overvalued. 3 weeks ago Tesla (TSLA) was a hundred dollars, this week it was inches under 220 and carrying a PE over 55. There are many such names, I am not picking TSLA. Equities have to reckon with higher interest rates. I know, going through the litany of hedging and shorting that our community at Dual Mind Research entertains one more time, I think you’re going to get bored. I’ll get bored telling them. Check out my last two articles that go into depth on how to prepare for this downturn. Yes, I’m about 3 weeks early again. I think from now on if I’m brave (or stupid) enough to make a time based prediction please add 3 weeks to the target. I will try to remember one such caveat. The market can stay irrational much longer than we think!
Ok, what trades can I talk about?
I looked through my entire long term account and trading account and did not open any new long positions. So let me talk about one sector that I will be adding to both my long term and trading accounts and that is energy. I will be adding to my holdings in Devon (DVN) they had a bad quarter due to temporary circumstances. If you’re a long-term investor, these are opportunities. I will definitely be adding to my EOG (EOG) resources and I have my eye on Apache (APA). If something more comes in, I will also add to this position. I want to collect more Eli Lilly (LLY), for a split second it fell to $320 on Friday but I wasn’t fast enough. Ideally I would like to get more under $320. I think the software isn’t quite finished yet so I still haven’t picked Palo Alto Networks (PANW) not because they excite me but because they offer a comprehensive package and I think they will expand the market share, because some CFOs are more interested in checking boxes than getting the best in each category. I added my confluent (CFLT) via a call option. I really like the price action there. I’m waiting for my Tech Titans names to come back to earth, but that might take a little longer around mid-March. However, if indices fall sharply this week and Amazon (AMZN) falls to $89 I would start adding stocks back, same goes for Alphabet (GOOGL) but a little lower than $83. I have not set wholesale prices for ServiceNow (NOW), Intuit (INTU) and Adobe (ADBE), but I would like them to be 30-50 points lower. Maybe I’ll get lucky next month. I feel the same way about chips and chip equipment manufacturers. I think they will come out of the chip glut this year and if they get knocked down enough I would love to own this sector. Sorry, I don’t have any specific requests. I’m sticking to my shorts going into the next month, which means I have to roll out a bunch of my puts through April to catch what happens at the next FOMC meeting.
I hope you all had a meaningful, if not happy, President’s Day.