By David Nelson, CFA CMT
Everyone loves predictions. Sports, politics, markets, even chess, it doesn’t matter. If it can produce a winner or loser someone is going to make a prediction and even more will risk dollars betting on the outcome. You can go from Hero to Zero in a New York Minute if you make the wrong call.
It’s the nature of the beast and it’s the risk we take generating a market call or stock prediction. Right now, strategists like myself are putting together a 2023 game plan. The elephant in the room is still the Federal Reserve and the risk-free rate.
CPI
Key to that, of course, is inflation expectations. On Thursday, we got another inflation print that continues to head in the right direction. The CPI Consumer Price Index came in down 1/10 of a percent. That’s what I said. Down month over month, the first negative print since 2020.
CPI falls 6 months in a row
And even more important, six months of a falling CPI since it peaked in June. Oil, airline fares and used cars all chipped in with lower prices to help drive consumer price inflation lower. Despite this good news, markets ended that day with a yawn up just 3/10 of a percent.
So, where’s the love and what’s it going to take for stocks to finally break out of jail?
To be fair, stocks had already rallied on the heels of a softer than expected wage number in week 1 and just prior to the CPI release added to those gains in advance of Thursday’s inflation report.
Bottom line, while inflation is well off the highs, the bigger challenge will be to go that last mile and approach the Fed’s long term target of 2%. It begs the question, what does that mean for markets this year?
Market Disconnect?
Right now, there’s a market disconnect. Markets are pricing in a full Fed pivot. On the other side, the Fed continues to send a tough message that rates need to move higher. In fact, Minneapolis Fed President Neil Kashkari is on record saying the Fed needs to hike to 5.4%.
What the Bulls Say
The fed is talking tough and investors aren’t buying it. One of them is wrong. This is what the bulls say. Two-year yields have stopped going higher and the terminal rate or the peak Fed funds rate expected by investors has been moving sideways for the last few months.
Two-Year Yields
Here’s where I come out. 2023 will be the transition year. It’s going to take the next six months to digest higher for a longer rate policy. The good news is that the current terminal rate may be enough to tame the inflation beast, taking away some of the potential downside in stocks.
Terminal Rate
However, to get inflation to fall and go that last mile back to 2%, we’re going to have to live with an elevated Fed funds rate for longer than the market suspects. For my call to prove wrong, we’re going to need to see estimate revisions start to trend higher.
We can’t expect multiple expansion to be the driving force behind equity returns. Not with rates approaching 5%. The Fed may stop hiking, but unless we see significant progress on reaching that 2% goal, I don’t see them cutting. That leaves earnings. In the long run, that’s what stocks follow.
A ten percent return this year? I think it’s doable. But most of the gains are going to come in the back half of the year, in part because I think margins are going to be a challenge.
Markets are a forward looking mechanism. By June, investors will start to shift their focus to 2024 earnings, which I think have a lot better shot at delivering.
S&P 500
The S&P 500 has been in purgatory trapped in a down trend that started more than a year ago.
Stocks have been rejected one, two, three, four times trying for a fifth. Maybe attempt #5 is a charm. To be convincing stocks will have to break above the downtrend and even better take out the previous high and start to live there.
S&P 500 – Friday’s Close Zoomed In
Price momentum is a powerful aphrodisiac. A breakout just North of 4100 would force a lot of short covering and performance chasing.
Banks kick off earnings season
Four of the largest banks reported Friday in advance of the long holiday weekend. While the reports were mixed for JPMorgan (JPM), Bank of America (BAC), Citi (C) and Wells Fargo (WFC), all four ended the day higher despite bouncing between gains and losses in the pre-market.
In an interview with Reuters lead banking analyst from Goldman Richard Ramsden pointed out some of the challenges. The competition for deposits is forcing banks to pay higher rates as investors shift to treasuries and high yielding money markets.
During the JPMorgan conference call management indicated that Net Interest Income for 2023 is uncertain.
Nevertheless, on this first series the bulls have moved the chains down the field and still have the ball.
On deck is a never-ending parade of economic data and earnings reports. Goldman and Morgan Stanley kick off the week Tuesday and on Wednesday PPI inflation data takes center stage.
Earnings dominate the rest of the week with Netflix (always a market mover) after the close Thursday.
A year from now I’ll be doing an end zone dance to celebrate the victory or a mea culpa speech on why my call didn’t pan out. You can’t win if you don’t swing the bat.
