The Future Is Further Away
Recently in a CNBC interview, I admitted what I’ve gotten wrong so far in 2023 is that I thought it would be more obvious by now that an economic contraction was imminent. Persistently strong labor data continues to roll in, baffling the bond market and bringing expectations for higher rates more in line with what the Fed is signaling for the rest of the year. I am as baffled as the bond market by some of the data.
Just two weeks ago, the market was expecting two rate cuts before the end of the year, which flew in the face of what the Fed was telling us they’d do. After hearing Jay Powell speak twice in less than a week, markets finally believed the message more and not only increased their expectations of the terminal (i.e., highest) rate, but pushed out the expectation for the first cut from November into December of this year.
The future is further away.
Jerome Powell reiterated in a speech on Tuesday that inflation is deflating, but the job is far from over. Markets cheered the interview, with both a risk-on rally in stocks and a dip in Treasury yields. Soft landing hopes and expectations remained in the spotlight, and there hasn’t been much new news to refute them.
As we await the rate level that the Fed deems “sufficiently restrictive,” the debate over the timing of this cycle is perhaps the topic that will test conviction the most. The fastest and most aggressive rate hike cycle in 40 years seems to have resulted in the calmest and slowest effect on the economy.
Again, the future is further away.
The Fed Funds rate above the 2-Yr Treasury yield suggests rates are already quite restrictive and should be having an effect on demand and activity in the economy.
Meanwhile, a structurally tight labor market keeps companies in the hiring game and wages at an elevated level. But somehow, with higher wage costs and lower revenue projections, company earnings are still expected to grow in 2023 and 2024.
Everyone’s a Contrarian and Someone’s Wrong
Over the last 12 months we’ve experienced multiple short-term rallies and multiple bottoms afterward, with sentiment swinging wildly throughout.
After strong price action over the last 4 to 5 weeks, the contrarian view is now held by those who are cautious, and the increasingly popular view is soft landing or no recession at all. Just a couple of short months ago, that was reversed.
Regardless of your view, you could fall into the consensus and contrarian camps in the span of a few short weeks without shifting your opinion at all.
These quick reversals in sentiment and jumpy consensus views are exactly why calling inflection points in markets is so difficult. You’re on the right side of the call until you’re not, and if you change your investment allocation every time sentiment moves, the only thing consistently increasing in your portfolio is probably trading costs.
It Feels Too Easy
If the lows are in and we’re well on our way to happily ever after, most of the traditional indicators are wrong. There’s also the complication that Quantitative Easing has turned into Quantitative Tightening, and profit margins are contracting — albeit from very elevated levels.
Neither of those forces bode well for a clean and lasting bounce, but the muted effect so far supports equity market optimism.
Still, I think it feels too easy to be in the midst of a V-shaped boom. It also feels too easy that equity valuations deserve multiple expansion before the Fed even pauses, and that the economy can go on relatively unaffected by the most restrictive monetary policy we’ve seen since the early 80s.
My Dad was a basketball coach for decades, and one of his favorite phrases to use during timeouts and halftime pep talks was, “If it were easy, it wouldn’t be any fun.” I’ve always loved that quote and I say it to myself often. In the case of markets however, it would be great if it were easy once in a while. The reality is that it’s not easy, and this has been one of the hardest cycles to navigate in our lifetimes. But that’s what makes us all constant students of the market — and call me nerdy, but I did always think school was fun.
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