In last week's Federal Reserve, post-meeting press conference, Chairman Jerome Powell said: "...and we will need to keep rates higher for longer..."
That is in the face of a stock market trading crowd whose narrative is that the Fed will be "forced" to lower interest rates by Q4 of this year.
Who do you believe? Trader narrators who missed last year's bear market beginning or the Federal Reserve Chairman telling you financial conditions would remain tight?
If the Federal Reserve continues with short-term interest rates around 5% and quantitative tightening, I'll take the under on how well the S&P 500 (SPY) performs the rest of this year versus the bullish trader's narrative.
I would note that Chairman Powell used the term "disinflation" 13 times in his press conference. Clearly, that's what he is watching. It will need to continue to see a Fed "pause."
Today's piece builds upon recent previous Macro Trends, including:
Macro Dashes - It's Not Interest Rates, It's The QT
In late 2021, I was discussing how Federal Reserve tightening, specifically quantitative tightening, was going to hamper stocks in 2022. The bullish trader narrative was that momentum was up and that the financial conditions were loose enough to support another up year.
The Fed Warned You, Are You Going To Fight The Fed?
Several magical trading system narrative makers even ridiculed me for pointing out the risk of tighter monetary conditions. They are now mostly among the bulls who are saying that the Fed "must" cut interest rates later this year. I think they're wrong again.
On Friday, we saw that the employment numbers exceeded expectations again.
The unemployment rate fell to 3.4% from 3.5% and 3.6% in the prior two months. This happened on 517,000 new jobs being created, which blew away estimates of 185k. I certainly expect revisions to bring the new jobs number down, but, not by much, it will still remain a significant beat.
Why does it matter?
First off, it matters because it gives the Federal Reserve a lot of cover in their fight against inflation. If unemployment doesn't rise above 4% anytime soon, then the Federal Reserve is unlikely to need to engage in countercyclical policy, that is, lower rates to stimulate the economy.
It also matters because you might need an inoculation against the next trader's narrative. Back in December, the narrative emerged that jobs growth reported by the BLS was overstated. The accuser? A new algo in beta testing.
Turns out, the BLS actually understated a bit in December. How do you like them apples?
What's good to know is that the BLS employment numbers, while lumpy and a bit time skewed, tend to be about right over rolling time periods. That is, like many things, a rolling time period smooths out some of the lumpiness. It does for the BLS too.
The jobs market is really strong and likely to stay strong for a while.
Here I'll throw out some anecdotal evidence. I build low-cost 401(k) plans for small businesses. Since Labor Day, I've talked to about a dozen business owners and company Presidents. Every single one has said they are finding it hard to find new people to replace people who leave or retire. And, every single one gave raises higher than they expected at the start of the year. And, every single one says they are still making good money even with the raises.
Without an event, that won't change fast.
I'll also point out that some are pointing to January appearing to be weak. I would not doubt that. The first quarter is historically the weakest quarter for the economy.
Just as Fed Chairman Powell said "we'll see" about how long rates stay high, I'd suggest to take a wait-and-see approach to how the economy, specifically employment, looks going into summer.
Rising unemployment has always been the best indicator of potential recession and changes to Fed policy. A weak summer would be an important clue to a change in Fed policy.
I have discussed with members of my investment service that Covid allowed the government to pull forward bailouts expected in the future, that is, a coming retirement crisis among Baby Boomers.
Never let a good crisis go to waste." - Winston Churchill
I believe that the Covid bailouts were deliberately larger than necessary in order to smooth away some of the coming Boomer economic problems.
Of course, many blamed inflation on those bailouts. That flies in the face of some key facts, of course. See what the BLS says is responsible for inflation (which again, I have discussed early on). This is from last summer.
Macro Dashes: SPY Should Double Bottom Or Worse On Energy Inflation
The market did double bottom a little worse a month after my article.
In any case, virtually all the evidence demonstrates that higher energy costs due to OPEC policy and Russian aggression, as well as, supply chain disruptions, primarily driven by China, are the main culprits for inflation.
Austrian school economists want to point to monetary inflation, but the reality just isn't so. And, just like they are largely forecasting a horrible recession on the back of Fed policy overreaching "again" - this time to the tight side - I don't think that's the case at all.
I think, just as energy and supply chains caused the last bout of inflation, that energy and supply chains could cause the next bout.
What if actions by Russia and inactions by OPEC lead to more energy inflation this summer or next? And, what if unleashed Chinese demand with the end of Covid Zero, leads to insufficient Chinese supply for certain exports?
Well, then the Fed has more inflation problems. And, it has nothing to do with money printing as the Fed is currently shrinking their balance sheet.
So, while we see what Russia and OPEC do this spring, summer, and autumn, and we also wait to see the impact of China's reopening, the Fed has to remain in a firmly tight posture. And, with employment conditions excellent at this point, there is no pressure to loosen too soon.
During the post-World War II period, recessions were cyclical in the face of secular growth that was generationally strong. Rebuilding after WWII led to the Baby Boomers' high income and high spending years. That was "fast" secular growth.
We are no longer in a higher secular growth period. Rather, as I have described for over a decade now, since my MarketWatch days, we are in the "slow growth forever" global economy. That is, from a secular standpoint, that is long-term, economic growth will be slow.
Understanding The 'Slow Growth Forever' Global Economy
Gone (hopefully) are the days of rebuilding a bombed-out Europe. Gone are the days of a globally young population earning more and spending more.
Today, we have an aging global population with incremental building and redevelopment - not secularly high growth.
So, in this period of slow growth forever, what should we expect?
As we are seeing in much of the developed world, including the United States, even at slower growth, we have a labor shortage. Something I discussed well in advance back in 2012:
"According to George Friedman in his book The Next Decade, by late this decade, we will be seeing a developing labor shortage in America. I, and many other dismal scientists, agree with that assessment."
In that article, I also strongly encouraged Boomers to get out of bonds and into stocks. Those who listened have thanked me.
So, even though I stand accused of being too bearish, I simply see what I see, as supported by the data. If we get a recession, it won't be horrible. It will be short and shallow because that is when the Fed will back off for real.
Quantitative tightening, the area I have tried to focus attention since...
Macro Dashes: The Fed Is Reloading Its Bazooka For Next Time
Financial conditions are highly influenced by the direction of the Fed's balance sheet. It is what controls the available funds for lending at the banks.
We saw that as the Fed balance sheet shrunk by about $500 billion, the stock market dropped by around 20% in the large caps and worse further down the capitalization scale.
I mentioned both the Goldman Sachs and Chicago Fed financial conditions indexes in my last Macro Dashes article. Suddenly, neither is loosening much anymore, as both have started to flatten out.
Per Goldman's recent report: "Note: The impulses assume that the FCI stays flat after Jan. 25, 2023. Source: Goldman Sachs GIR."
Less loosening, that is a slower rate of loosening or an outright reversal, could mean less exuberance for stocks, or even a correction, in the short term. Large-cap stocks, which take more money to move price, seem to be most at risk. And, especially, capital-intensive businesses, like real estate.
Correlations here are important. Technology, which took it on the chin last year, is correlated tightly to financial conditions - hence the recent rally pre the late week earnings.
Looser financial conditions are better for tech than any other sector. Followed by industrials and consumer discretionary.
WSJ noted though that U.S. consumers are starting to freak out. What gives? Well, cheap credit is going away and savings accumulated during Covid is being used.
So, there's a dichotomy. High employment, some raises, but tighter credit and lower savings. We'll see how that is navigated. For me, I'm very focused on tech, especially small-cap tech, and certain industrials of necessity.
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