Martin Pelletier: One should be careful if giving into FOMO is under consideration
Pedestrians pass by the New York Stock Exchange on Wall Street in New York City. Photo by ANGELA WEISS/AFP via Getty Images files The United States Federal Reserve hiked its rate 25 basis points last week and indicated there is still more work to be done on tackling inflation, but markets ignored this along with chair Jay Powell’s comments about future hikes.
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Access articles from across Canada with one account Share your thoughts and join the conversation in the comments Enjoy additional articles per month Get email updates from your favourite authors Perhaps it was the much more relaxed attitude in the tone of his speech than previous pressers that led to participants assuming it was a dovish update.
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As a side note, we’re sure the Bank of Canada breathed a collective sigh of relief after the Fed’s announcement, given how it indicated a week earlier that further hikes will be on hold in order to provide its recent tightening efforts more time to work through the economy.
Markets, especially the long-duration segments, also clearly liked what they heard, with the Nasdaq leading the charge higher, gaining nearly 2.2 per cent on the day and taking its year-to-date gains to just shy of an astounding 14 per cent. The inverse of duration, strong cash-flowing energy companies, bore the brunt of the selling as investors rotated back into growth and those companies offering cash-flow promises.
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Returns from 2022 bottoms:
Facebook +107%
Netflix +120%
Carvana +367%
Peloton +133%
Shopify +96%
Wayfair +145%
Tesla +74%
Redfin +183%
Zillow +73%
— Ben Carlson (@awealthofcs) February 2, 2023 Advertisement 4 This advertisement has not loaded yet, but your article continues below.
Looking ahead, there are now two prevalent arguments out there and a third one being ignored. The most common is that a recession is around the corner, which will bring lower inflation and interest rates. The other is what I call the Goldilocks scenario where there is a soft economic landing, inflation continues to fall below two per cent and interest rates can go back to low levels as permanent quantitative easing resumes.
The third view, but considered to be the least probable, is that central bankers capitulate too early, and loose financial conditions paired with strong employment impede the pace and magnitude in the drop in inflation.
U.S. core inflation (excluding food and energy) has no doubt fallen to more reasonable levels, coming in at three per cent in December. But we think that while the easiest part of the inflation problem may have been addressed, the toughest part remains in getting it below the coveted two-per-cent target, especially since commodity prices are rising again and the economy remains fairly robust despite all the rate hikes and tightening.
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Recommended from Editorial How investors can change their approach to tackling challenging market conditions Where investors might want to look if interest rates and inflation persist It’s time for investors to change their thinking if they want to get to the finish line For example, copper and aluminum prices have already gained 25 per cent and 20 per cent from their respective October 2022 lows. And lumber and gasoline are up 30 per cent and 23 per cent from their respective December 2022 lows.
Then you have a U.S. economy with record low unemployment with 517,000 jobs created in January. The latest Job Openings and Labor Turnover Survey (JOLTS) showed there were more than 11 million job openings in December, up from 10.44 million the previous month, and ahead of the 10.25 million expected. For some perspective, there are now 1.9 jobs available for every person seeking work. How is this going to impede ongoing wage hikes?
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Article content This isn’t good news for economists, who on average expect the unemployment rate to hit 4.8 per cent from 3.4 per cent, according to macro strategist Jim Bianco. He also points out economists expect zero growth in U.S. gross domestic product during the first three months of this year, and negative GDP growth in the following two quarters before rebounding later in the year.
Then there are those betting the economy will remain on a strong footing, deflation will come back and the Fed will resume easing by cutting rates. Not everyone believes this. “The S&P 500 has seemingly gone ‘all in’ on the soft-landing playbook,” Michael Darda, MKM Partners LLC’s chief economist, told Bloomberg. “Yet, this is incompatible with a chronically inverted Treasury curve, historically weak money growth and sustained weakness in other leading indicators”
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Article content .#Stocks just took a leg up on #FederalReserve Chair Jay #Powell characterizing financial conditions as having tightened quite a bit in the last year.
(Not sure which index he is using. The most widely cited ones show overall financial conditions as loose as they were a year ago)
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Article content What was the most interesting at the Fed’s Feb. 1 meeting was how Powell characterized financial conditions as having tightened quite a bit last year, when, as ex-Pimco bond manager Mohammed El-Erian pointed out, the Bloomberg Financial Conditions Index has done the opposite, rising to the loosest it’s been in over a year.
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Article content Over the past 20 years, the only two periods where conditions loosened as much as they have now were toward the end of the 2008/2009 recession and mid-2000, according to Liz Young, head of investment strategy at SoFi Technologies Inc.
Financial conditions have eased significantly over the last three months. In the last 20 years, the only two periods of time where conditions loosened further were toward the end of the 2008-09 recession & mid-2020. pic.twitter.com/OdyJ4PVVBl
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Article content All this gets me thinking that central bankers are simply de facto supporters of inflating certain assets. In the U.S., it’s long-duration segments such as technology, and in Canada, it’s residential real estate. Both happen to be the current primary drivers of economic growth, after all.
That said, perhaps they’re simply unintended but beneficial consequences of caving into the enormous pressure that higher interest rates are having on both our governments, which are keen on maintaining massive fiscal deficit programs.
As an investor, it’s important to have some exposure to those sectors with sensitivity to interest rates, but we think one should be careful if giving into FOMO is under consideration. More so, inflation protection has become that much cheaper and those who have made some healthy gains this past month may want to rebalance into those bread-and-butter areas of the economy that can make money right now. As the saying goes, “A bird in the hand is worth two in the bush.”
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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