The market was largely anticipating the "pause" or "skip" in Fed rate action this week. What wasn't anticipated was the increase in the Fed's terminate rate, which indicated two more rate hikes could be coming after this month. While the market initially reacted negatively to this news, it has since moved higher by 1% (as measured by the S&P 500 Index). Why is the market ignoring what's being termed as the "hawkish pause"?
Seeing as it's Summertime, I'm reminded of the 1989 film, "Weekend At Bernie's". Despite a fairly strong cast, the movie had average success at the box office, but has grown in popularity to basically "cult classic" status. Below is some interesting trivia about the movie:
The movie was filmed with a budget of $15 million and earned a little more than $30 million at the box office. As part of the budget, Bernie's house at the beach was built by the production crew and torn down after filming.
The title of the film on the original screenplay was "Hot and Cold." In fact, filmmakers had already commissioned the title song "Hot and Cold" written by Reggae musician Pipe Matthews and Police guitarist Andy Summers, which appears on the film's soundtrack.
Andrew McCarthy was not originally sought after for the role of Larry. Jonathan Silverman originally read for the part of Larry and Jon Cryer was being considered for the part of Richard. McCarthy expressed interest in the film, but after reading the script asked for the part of Larry and the director consented by switching Silverman and McCarthy's roles.
Terry Kiser, who plays the role of Bernie, was devoted to the part. He used multiple expressions in the film since he didn't have any speaking parts in the film after the character was murdered. Kiser's stunt double suffered a few broken ribs during filming the water skiing scene as he was dragged across the ocean surface.
Here's what we've seen so far this week...
Who Knows What The Fed Is Thinking? Is Fed Chairman Powell trying to fool the market or is he trying to fool the FOMC members?
Powell is reminiscent of Bernie who is fooling everyone that he's still alive. Or, is it that everyone around Bernie is just too stupid to sense that Bernie is a corpse? This week, Powell and the FOMC kept rates flat for the first time in 15 months. This was widely expected. However, when the Fed's projections were released, the market pulled back as the Fed increased the rate Dot-Plot from 5.1% terminal rate to 5.6%, indicating that more rate hikes are on the way.
However, as Chairman Powell's press conference got underway, the market quickly recovered before the close on Wednesday. You see, the Fed increased their projection for Unemployment from 4.1% to 4.5% at the end of 2024. Yet, the Fed bumped up GDP expectations from 0.4% to 1.0% in 2023 and they expect GDP to rise slightly to 1.1% by the end of 2024.
This doesn't compute, as an increase in the unemployment rate from 3.7% currently to 4.5% projected would equal about 1 million job losses - hello recession. The Fed's GDP projections however do not call for a recession by the end of next year. So, why is the market discounting the "hawkish pause"? Two reasons - inflation and track record.
First, the inflation numbers came out this week and were much lower than expected. Month-over-month, both CPI & PPI came in lower than expected and both were lower on a year-over-year basis. In fact, the University of Michigan's Inflation Expectation survey of consumers showed a drop from 4.2% to 3.3% (the lowest reading in over two years). The second reason for the market's optimism is that investors have just stopped believing the Fed. The Fed's track record on inflation hasn't been stellar - from "transitory" to inflation will hit 2.5% by December of 2022 to now, inflation won't hit 2% target until after 2024. Well, if CPI stays on it's current track, it will hit 2% in approximately 4 months from now. It's likely the Fed will be wrong once again and the FOMC will be hard pressed to raise rates twice more this year. Perhaps the meme is wrong and Powell's face should be on Larry - pulling the strings of the FOMC behind the scenes.
Nobody Else Knows That. One of the key scenes in "Weekend At Bernie's" is when Richard and Larry devise how they're going to avoid becoming the next victim of the hit man who killed Bernie.
Larry Wilson: I have an idea!
Richard Parker: [shouting] What? What is it?
Larry Wilson: Lomax told whoever he was talking to not to kill us while he's around.
Richard Parker: Yes, but Bernie's dead. He's not around anymore.
Larry Wilson: Yeah. I know that. You know that. Nobody else knows that.
The market is like Larry & Richard, while economists and prognosticators are more akin to everyone else in the film - unaware that Bernie is actually dead. The market began to see light at the end of the tunnel in October of last year, as evidenced by the Coppock Curve. The Coppock Curve is a momentum indicator that reveals long-term buy or sell signals for a particular index or investment. The Curve sums the moving average of the 14-month and the 11-month rate of change of the investment. when the Curve drops below zero, it's typically interpreted as a "sell" signal. When it moves above zero, it's typically a "buy" signal. Since October, the Coppock Curve of the S&P 500 Index has stayed above zero more so than in 2022 and the fluctuation below zero has been in smaller amounts. The Coppock Curve is affording a buy signal despite the "hawkish pause" news this week.
Retail Sales were reported this week for the month of May and the results were stronger than expected. Month-over-month, the reading was +0.3%, which was higher than the -0.1% expected. On a year-over-year basis, the reading was higher. In addition, the University of Michigan's preliminary Consumer Sentiment reading for June was the highest in 4 months. As we're stated continually throughout the last 8 months, as long as the consumer spends, the economy grows.
The Fed's GDPNow estimate for 2nd quarter Gross Domestic Product is +1.8% - not robust by solid. Both the Financial Stress Index and the National Financial Conditions Index (tracked by the St. Louis Fed and the Chicago Fed, respectively) declined this week, indicating that financial conditions support the current move higher by equities. For now, it's best to stay invested in your appropriate asset allocation and take advantage of the reduction in volatility in markets. If the current trend continues, the old adage of "Sell In May And Go Away" may have to be retired. Since April 30th, equities are 6% higher.
Here's the scene from the movie that inspired this week's Musings...
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