The Fed’s Bark Might Be Worse than Its Bite - Optimism Remains for the Second Half of 2022
Ancient Chinese mythology relates the charming tale of the flexible bamboo and the defiant oak. During the Monsoon season strong winds assaulted these plants. The stubborn oak was broken in half, but the resilient bamboo bending to a superior force survived to stand straight when the winds changed. While thoughtful people can easily see applications of this moral, the one concerning us here is the maxim of not fighting the ticker tape.
- James Dines
The Ivory Hill RiskSIGNAL remains red, and we are still hovering around our maximum cash levels, which is a very solid 57%-60%. The market is oversold, but any rise in prices should be taken with a grain of salt and patience is prudent at this time. In time, the market will come down. Having a lot of cash could be very good for us when the market rips higher. Breaking the February 22 low on the S&P 500 will likely send it down to the 3,550 to 3,700 range if fundamentals do not improve in the very near term.
What the Fed Decision Means for Markets
The Fed’s bark on inflation may be worse than its bite. I think that's the main take away from yesterday's FOMC decision and press conference. The Fed raised interest rates 50 bps for the first time in more 20 years, but it also caused a rally by removing the possibility that the Fed would be even more hawkish than is currently priced into markets (at least near term). Why do I say that?
The most important Fed event yesterday wasn’t the 50-bps hike. Everyone knew that was coming and with the S&P 500 down more than 10% this year and Nasdaq down 20%, that’s adequately priced into stocks. Instead, the most important event yesterday was Powell saying that a 75-bps hike was not on the table going forward.
That indication, which was clearly deliberate, combined with the Fed following the previously announced QT schedule ($95 billion/month starting in September) and some cautiously optimistic commentary on inflation from Powell imply that the Fed may indeed be “max hawkish” right now. That may sound like a negative, but the current “max hawkish” has been priced into stocks, and as the market only really cares about what’s coming next, if this is as hawkish as the Fed will get (50-bps hikes) then there’s room for stocks to rally.
More broadly, this reveals a potentially positive out-come for stocks over the medium term. If the Fed talks tough on inflation yet doesn’t raise rates as much as feared (say a bit above 2%), and we have a natural backing off of inflation based on supply chain fixes and a modest slowing of economic growth, then the scenario exists where inflation declines but still runs in the 3%-4% range, but the economy does not go into recession. That outcome would be positive for inflation-linked assets (stocks, commodities, hard assets like real estate) and in theory a return to the old highs in this outcome shouldn’t be ruled out.
Now, I’m not saying that’s what’s going to happen, as it’s too early to tell. And I’m not flip flopping on my general 4,200ish-4,600ish range on the S&P 500. What I am saying is that the market has aggressively priced in a lot of Fed rate hikes, and if the Fed is talking tough but doesn’t actually hike as much as expected, then inflation will stay elevated but not crazy high, and that’s a long-term tailwind for stocks, commodities and real assets (and negative for bonds).
Now, this obviously isn’t a done deal, and if inflation gets worse people will fear more hikes and a more hawkish Fed. That makes inflation data VERY important (including in tomorrow’s jobs report). But if the Fed has talked tough but doesn’t back it up and we do not go into recession (there will definitely be economic slowing, but that doesn’t mean recession) then the TINA trade in stocks will be back on, and amidst all this negativity I want to make sure everyone knows that potentially positive outcome.
More broadly, I’ve said for the past several weeks that there are three headwinds on stocks: Fed hawkishness, the growth worries from the Russia/Ukraine war, and growth worries from continued Chinese COVID lock-downs. It appears one of those (Fed hawkishness) got better yesterday so we should expect a rally. But for the resistance at 4,600 to truly be challenged (or for a rally to even get to that level) we’ll need to see improvement on all three, so we’ll continue to focus on Ukraine and China for signs of improvement.
Tactically, we should expect a bounce in the hardest hit sectors: Growth, tech and high-multiple stocks. But we continue to prefer tactical allocations to value, defensives (utilities, health care, consumer staples) and low volatility stocks because I don’t think this volatility is over yet (again, a positive path forward may be starting to emerge, but we’re a ways from it becoming the most likely path for the stock market).
S&P 500 performance in the first four months of the year shows that there is a good chance that the market could rise in the last half of 2022. History suggests that a weak start to the year could last for the intermediate term, which would support a tactical underweight to stocks. However, a second-half rally is still a likely possibility. Looking at history, there have been 13 times in the past, where the first four months of the year were in the red, and only 4/13 times did the S&P 500 not recover and end the year in the green. Of those 4 times, the market recovered the following year. So, there is a 66% chance the market will recover from the drop and end this year higher. This is important and if you’re a cautious optimist, which I am, when the market conditions get more favorable there will be some great buying opportunities with the monster cash position we have built up.
I have built an amazing list of growth and tech stocks that have dropped down so drastically that you could consider them value stocks at this point. I am cocked-and-locked and ready to go with our list and continue to add to it every day.
The markets will work itself out over time. I can’t guarantee anything in my line of work, so I will give you some odds. The odds of this market bottoming and moving higher are 99.9%, and the odds the markets will make new highs are 99.9%. The only question is when does that happen? Only time will tell.
And remember – the one fact pertaining to all conditions is that they will change.
Feel free to reach out to me and use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President