Investors and advisors alike have suddenly become concerned that a new bear market is upon us. While the prospect of a bear market rearing its ugly head is always a possibility, the current economic landscape doesn't point toward a bear market in the immediate future.
The Fed, however, is playing at gamesmanship in order to keep equities under control - not exactly in the agency's job description. It's a bit of "slight-of-hand" that reminds me of the "Harry Potter" series. The Wizarding World created by the ingenious J.K. Rowling is a marvel and extremely entertaining. Among my favorites in the series of books/movies is "Harry Potter and the Half-blood Prince." The movie was released in 2009 and, of course, did spectacularly at the box office, earning $934 million worldwide on an original budget of around $250 million. Some interesting trivia about the movie and characters:
Some people may not be aware that Rowling was intimately involved in the production of the movies, which were based on her books.
Rowling was so involved that she hand-picked Alan Rickman to play Professor Severus Snape. She provided specific instructions on how to play the character and provided him with details about the character that were not revealed until the last novel.
Snape is revealed to be the Half-Blood Prince. While the movies do not provide much detail as to why, the book explains that he, in fact, named himself moniker as his mother's maiden name was Prince and his father, a muggle or non-magic person, was cruel to him.
The actor who plays Harry, Daniel Radcliffe, stated that this film was his least favorite and noted his acting job was not "very good." He has also stated that he was struggling with alcohol at the time and he can tell in certain scenes that he was "intoxicated."
Here's what we've seen so far this week...
The Fed's Slight-Of-Hand. According to the Fed's website, and what we've been told throughout the Fed's history, the primary functions of the Fed are to:
Set monetary policy to promote maximum employment and stable prices.
Promote the health and stability of the financial system.
Promote a safe & efficient system for U.S. dollar transactions.
Supervise individual financial systems and monitor their impact on the financial system.
Promote consumer protection.
Where in those responsibilities does it state that the Fed's job is to keep equity prices from rising? Answer - it doesn't.
Yet, in the latest minutes released from the early February FOMC meeting, it stated, "Participants noted that it was important that overall financial conditions be consistent with the degree of policy restraint that the Committee is putting into place in order to bring inflation back to the 2 percent goal." Additionally, the notes revealed that Powell stated, "Financial conditions didn’t really change much from the December meeting to now."
If overall financial conditions are a concern, but conditions didn't really changed much since the previous meeting, then why are Fed members Mester & Bullard stated they advocated for 50 bps rate hike in February? The December rate hike was 25 bps and, if indeed, financial conditions didn't change much, wouldn't 25 bps be the prevailing thought among Fed members? The reality is, the Fed is playing games with investors' emotions and little of the key language from the meeting is grounded in fundamental data. Let's look at what did actually change:
The Fed's favorite inflation barometer, PCE Prices, went from +6.3% in early December to +5.0% by late January. Seems like good progress on the inflation front. (More on the PCE Index in a moment)
Weekly Jobless Claims went from 230,000 in Mid-December to 186,000 in late January. That's good progress for the Labor Market.
GDP for the 4th quarter initially came in at +2.9% in late January versus +3.2% for the 3rd quarter. A decline would mean that rate hikes had indeed slowed the economy by year-end 2022. Why the need for 50 bps versus 25 bps?
What about equity prices you ask? Well there's the rub, isn't it? The S&P 500 Index was up more than 3.6% in the short time between the December FOMC meeting and the late January meeting. The Nasdaq Composite Index was up more than 4% in that same time period. (in whisper voice, this is what the Fed is really after)
And, bond yields? The yield on the 2-year Treasury Bond was down approximately 17 basis points between the December and January FOMC meetings.
It would appear that actually a lot changed during the meetings, contrary to Powell's statements. It sounds like equity prices went up, bond yields went down and the Fed switched from combating inflation to combating investor sentiment - again, not in their job description.
Data Isn't Everything, Or Is It? As a consummate protagonist in the Harry Potter series, one of Snape's famous quotes is, "Clearly, fame isn't everything, is it, Mr. Potter." When we have a lot of noise in the markets, and that is certainly the case right now, we have to drown out that noise and focus on what the data is telling us.
The current data is telling us a lot. First, we saw last week's release of January Retail Sales and the number was almost twice what the market expected. The year-over-year Redbook Sales data showed +5.3% and Consumer Spending for January was reported at +1.8%, higher than 1.3% expected. In other words, the consumer (2/3 of the economy) is holding up well.
The University of Michigan’s Consumer Sentiment exceeded expectations this morning, coming in at 67 versus 66.4. The Fed’s preferred measure of inflation, PCE Price Index, came in hotter than expected (just as PPI & CPI did last week). However, even by the Fed's own measurements, financial conditions are improving.
The Chicago Fed's Adjusted National Financial Conditions Index has declined 16 of the last 18 weeks, meaning financial conditions have loosened. Also, between mid-December and late January (time between the two FOMC meetings) the ANCFI declined 24%, but Powell said financial conditions didn't change between meetings. The Wealth Protection Signal (WPS) triggered last week to put cash back to work in equities. You might ask yourself, what about Tuesday's 2% decline in equities? The WPS tracks fear and volatility. Just because fear (Ted Spread Index) is near 5-month lows and volatility is near 10-month lows does not mean investors won't see a 2% decline in the markets on any particular trading day. As a reminder, we experience at least an 8% intra-year decline in the markets in 76% of trading calendar years (many of those in positive calendar years). In any given year about 7% of trading days result in a gain or loss of greater than 2%. However, 25% of trading days result in a gain or loss of greater than 1%. Was Tuesday's trading an anomaly? Time will tell, but the economic fundamentals have not broken down to the point that a bear market is on the immediate horizon - that is, unless the Fed decides to derail the train.
They Are What We Thought They Were. A post-game speech by then Arizona Cardinals Coach Dennis Green has become famous as he yells into the microphone that the Chicago Bears were the team the Cardinals thought they were, but the Cardinals lost the game because “we let them off the hook.”
Unlike the Bears, the Fed is a different, in that, they aren’t who we think they are. Spoiler Alert: for those of you who have never seen the Harry Potter series or read the books, you might want to skip down a little. Professor Snape, who Harry thought was his enemy, is actually proven to be his protector all through the series. While Snape was pretending to loath Harry, he was secretly working with Dumbledore to watch over Harry and help him.
The ruse was to keep Voldemort at bay and think that Snape was actually on the dark side. The Fed has also chosen to be the pretender. They have set their inflation target (PCE Prices) at 2%. Why this figure? If we look at the historical average of the PCE Price Index, it’s 3.3%, going back to 1960. A lower target of 2% allows them more flexibility to attempt to control markets. What we need to remember is that inflation, just like any other market metric, doesn’t move in straight lines (see our post from last week). One month of disappointing inflation data is not a recipe for disaster. As a reminder, gas prices increased by more than 10% in January, but has since declined by 4%, meaning February’s inflation data may look better.
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