The Directors Script: Happily Ever After Under Cloudy Skies?
The stock market script for the rest of 2023
Summary: Expect turbulence in the market as market investors conflict over Fed interpretations. As long as inflation is not raging this market might have some upward lift left in 2023. The key to it all is consumer spending. In the US, Main St and Wall St have adjusted expectations to high rates for a little longer -- there is an expected lag in the impact of monetary policy.
Maybe with the return of Monday Night Football, we can all discuss inflation a little less (the irony is that I am forced to finish this article on Monday night). But it is still the topic of dinner parties and social gatherings. And it is very real. I am rethinking the once-affordable-but-now-very-expensive Thai restaurant down the street.
The future of inflation is still driving the market. Everyone is navigating by the same script for the next week and the next FOMC meeting (Sept 19th) and the rest of the year.
That script is the roadmap Powell laid out at Jackson Hole. With FOMC happening next week, it is worthwhile to reflect on what Powell said and what it means.
"As is often the case, we are navigating by the stars under cloudy skies"
For those not actively watching the market, the speech highlights major trends impacting housing/shelter, employment, and interest rates. It is much longer than previous speeches and warrants serious consideration.
We cover:
đđ» Why is the Jackson Hole Symposium Important?
đđ» Powellâs Economic Script
đđ» What This Means for Investors
đđ» Why The US Economy Is Still So Strong
Why Is Jackson Hole Important?
For those who never heard about the Jackson Hole Symposium. First held in 1978, it was initiated by Robert P. Black, who served as the President of the Federal Reserve Bank of Kansas City at that time.
Started in a period of economic upheaval (the crisis of the 70s), the symposium served as a platform to exchange ideas and solutions. Networking and global collaboration to fight inflation were key motivations.
And that is still the case. Inflation and fighting inflation are global matters. No one country can address inflation in a domestic capacity alone. There is such a huge emphasis on the Fed that is is easy to overlook that the Fed is part of a global machine. The Fed does not operate unilaterally, it does not operate in a vacuum.
Inflation and growth are global phenomenon and the quest for price and economic stability in todayâs world is a global dance. We will come back to this later.
Powellâs Economic Script
Powell had a long speech. There are some critical road markers he laid out for the investing community. This one phrase perfectly sums up the Fedâs sentiment.
"As is often the case, we are navigating by the stars under cloudy skies"
Meaning: We have no previous playbook to deal with todayâs labor, housing, and consumer. It is not going as expected.
Here are the key excerpts worth remembering.
âAlthough inflation has moved down from its peakâa welcome developmentâit remains too high.â âWe are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive levelâ
Meaning: Still higher rates for longer
âThe final category, non-housing services, accounts for over half of the core PCE index and includes a broad range of services, such as health care, food services, transportation, and accommodations.â âGiven the size of this sector, some further progress here will be essential to restoring price stability.â
Meaning: Powell was highlighting services is still sticky
"Twelve-month inflation in [services] has moved sideways since liftoff. Production of these services is also relatively labor intensive, and the labor market remains tight."
"Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response."
"Job openings have declined substantially without increasing unemploymentâa highly welcome but historically unusual result that appears to reflect large excess demand for labor."
Meaning: Labor is still tight and driving up input prices for companies. The Fed will watch labor and wages, especially job openings.
"Getting inflation down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions."Â
Meaning: Powell is looking for evidence in a slow down for the economy.Â
"We are attentive to signs that the economy may not be cooling as expected. So far this year, GDP growth has come in above expectations and above its longer-run trend, and recent readings on consumer spending have been especially robust."Â
Meaning: Consumers have the capacity to handle more pain. The Fed is hoping consumers would slowdown without more pressure from the Fed.
"The housing sector is showing signs of picking back up. Additional evidence of persistently above-trend growth could put further progress on inflation at risk and could warrant further tightening of monetary policy."Â
âThe market rent slowdown has only recently begun to show through to that measure.â
Meaning: The interest-rate housing sector is not as sensitive to interest rates â frustrating the Fed. The Fed is focused on rents as a measure of housing inflation as well. Â
What This Means for Investors
We are back to a bad-news-is-good-new-for-investments scenario. Investors are trying to divine when interest rates come down and which ones. Another forecasted 25 bp interest rate increase is not phasing investors â the markets are up since Jackson Hole.
Why? The lag. Investors are convinced the Fed will have to slowdown since it takes 12-18 for interest rates to work through the economy. We are at 18 months from the 1st interest rate hike.
Also, after such an aggressive rate hiking cycle, how much higher can the Fed hike? Some countries in Europe are approaching a pause or cut rates. Remember. The fight against inflation is a global dance and actions in one part of the world could influence policy in another part.
The key to continued strength is a strong consumer (consumers drive 2/3 of the US economy). Employment is as good as it going to get and more likely to slowdown. The hope is services PCE and the job reports donât get too hot. To review what the Fed outlined:
Bullish for markets: Weakening in the employment reports, sticky services PCE inflation going down, stronger consumer spending
Bearish for markets: Strength in the employment reports, reinflation â especially in services PCE, weaker consumer spending
Why The US Economy Is Still So Strong
As Powell said, the economy confounds the Fed. After one of the most aggressive hiking campaigns in recent memory, the US economy is still strong! What is different this time? What has changed? The Fed doesnât have as tight a grip on money as in the past:
While the Fed tightened the economy, the government continued injecting the economy with money through acts such as the CHIPS Act and the IRA.
The majority of homeowners took advantage of low rates to refinance their homes. They are less sensitive to rising interest rates.
Businesses issued debt with rock-bottom interest rates during the pandemic. Free money.
Shadow Banks have kept the economy humming with alternative sources of capital.
Once you look pass the Fed cloud cover, the economy and the markets are still in a cheery moodâââfor now. In a future post, we will look at where clouds are starting to form for 2024.
If you have any questions, leave a comment. Thanks for reading Embrace the Chaos! Sharing perspective that makes sense.
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- Vikas Kalra, CFA