Staying Fed Up

Well, I am becoming more convinced that the Fed is very unlikely to cut in March. I think it’s looking more like June, possibly July, and it could be less dovish than the market expects, maybe just one or two cuts in total this year. I think the market is miscalculating the affect of aggregate Fed tightening. The initial shock of higher rates has already hit and already abated and yet there are still plenty of residual inflation risks lingering, and now the wealth effect of the S&P means that the consumer still feels strong, and is prepared to spend on services. Add to that a still very tight job market, and I just don’t see the case for cuts anytime soon.

Of course, there are still major geopolitical concerns, and Trump’s resounding victory[ies] in Iowa [and New Hampshire] now seem to rule out the emergence of an alternate Republican candidate (neither Biden nor Trump will be Treasury bond market friendly given shared proclivity to borrow), but with the S&P’s market cap at 150%+ of GDP (gross domestic product) and 200% of disposable income, I believe there is a significant tailwind from that wealth cushion that investors are experiencing.

So, though I would forget March or May, I still think we’ll see the longed-for cut this year, but I don’t believe it will necessarily signal the start of a cutting cycle with regular cuts every other meeting. I think it would be more of a recognition that the neutral policy rate is not above 5% and should be seen as an attempt by the Fed to get below that level, or, put another way, after all that hiking it’s usual to have some cuts but how many cuts is uncertain and more than a few shouldn't be assumed certain. Finally, I think it’s possible that the long-discussed recession may be cancelled – maybe there is no recession now.

Let me share some other thoughts.

On the macro side, the shift higher that we have seen in recent years in oil production has led to a lower price which has been a reprieve for everyone, and arguably led to a split in inflation with lower commodity and goods inflation, and higher services inflation the main driver. Geopolitics could bring an end to that commodities reprieve, but I also wonder what increased oil production, particularly in the U.S., could mean for our willingness to intervene in the Middle East. I said before that I don’t think a Trump victory is ideal for the stock market, and the path to 5000 in the S&P 500 does not look to me like it’s found through anything other than big tech stock.

On that note, and switching to micro, I still worry about a binary market, with big tech alone driving returns, and its very heady valuation not being challenged by the market. Big tech and healthcare are doing OK, but banks have had their well-deserved rally now, and I think that could be it for them for now.

Finally, I still like Japan, and we’re overweight Japan in our allocation models – it’s a great play on Asia. It’s not as expensive as India, and it’s not as risky as China, where the relationship is still just so strained. So take a look at non-China emerging markets and Japan as good plays on Asia.

 

That’s it for now.

– David