“Generals always fight the last war.” This quote is often attributed to Winston Churchill and certainly seems true with the Federal Reserve. By no means am I a Fed hater, I see it as the least bad option when it comes to managing supply and striking the right balance between growth and inflation. A bit like Churchhill thought of democracy. I see that the Fed has been wrong to take inflation seriously too late. Now, I see the economy slowing sharply (which will do a better job of curbing inflation than rate hikes) which is negative for asset prices alone, but the Fed’s brutality will aggravate that condition . In today’s comment, I’ll talk about this in more depth. I will also mention a specific scenario that could trigger a significant and counter-trend movement on the stock market (SPY). Read on to find out more …
(Please enjoy this updated version of my weekly comment posted on July 7thth2022 of the POWR Stocks Under $ 10 bulletin).
As usual, we will start reviewing last week …
Since closing last Monday, the S&P 500 (SPY) has fallen 3%. We have returned about half of the advance of the last few weeks. As we have seen, the risk of inflation is falling, while the risk of recession is rising sharply.
This is evident if we look at the performance of the sector. Areas such as biotechnology / software / pharmaceuticals are surpassing and higher lows and higher highs are being reached, while cyclical / energy / materials are falling to the new 2022 lows.
A couple of months ago, we were observing that energy was still close to its highs although it was becoming clear that the outlook for economic growth was faltering. And he determined that he was not tenacious.
Fed policy mistake?
It also appears that these trends intensified in mid-May, when the Fed raised rates by 75 basis points and indicated that another rise between 50 and 75 basis points was likely.
This is possibly a good idea if economic growth was strong enough to withstand this headwind as it was earlier this year or for most of 2021. Instead, the economy is slowing, with a big help from the Fed, and the Fed keeps spinning. the heat goes up.
In my opinion, the Fed is wrong.
It’s like you’re cooking eggs, and if you expect it to be perfectly cooked in the pan before transferring it to your plate and into your mouth … then it’s almost certainly overcooked and a little dry and gummy. You want to put out the fire when it’s a little undercooked, because it will continue to cook even on your plate.
I think the Fed should reduce the heat or even pause a bit to let the impact of this initial set of rate hikes occur.
But perhaps there is a better explanation. Perhaps the Fed is so scared of the prospect that inflation will stall and a long-term problem that it is willing to design a recession.
Or maybe the Fed deserves more credit and knows exactly what it’s doing. He simply sees this as the price to pay to regain his credibility in the face of the market.
From that perspective, the worst outcome would be for the Fed to pivot too soon, restart inflationary pressures, and then have to start another series of rises.
We’ve talked about past recessions to help us understand what’s happening now. I continue to think that there is some merit in the analogy from 2000 to 2002, as we had multiple shocks that caused the initial drop in stocks.
Then the shares plunged even further, as these shocks caused a drastic downward turn in earnings.
This is where we are right now. The bearish force of higher rates has been neutralized at least in the short term. In fact, the fall in long-term rates could support some parts of the stock market (SPY).
But now we need to keep an eye on the gains, as this could be the next “shoe to go down” and activate the next lower leg.
Upward catalyst potential
There is a bullish scenario that I don’t see being discussed. It’s basically that once inflation reaches peaks and changes (very likely this has already happened), it continues to fall faster and lower than people expect.
It could be a combination of the Fed’s stifling economic growth, the normalization of pandemic problems, and the reversal of trade driven by the food and energy boom.
In essence, the rapid and sharp fall in inflation would take away pressure from the Fed in terms of rate hikes. It would also reduce the risk of inflation. In essence, it would bring us closer to a Goldilocks environment of mild inflation and strong profit growth.
So that sums it up. Shares could fall to new lows if weakness begins to have a significant impact on earnings. But, we could also see that these minimums are maintained if inflation falls by a substantial amount, which would lead to a drop in interest rates in the long run.
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All the best!
Chief growth strategist, StockNews
Publisher, POWR stock bulletin for less than $ 10
SPY shares. To date, SPY has decreased by -17.49%, compared to a% increase in the S&P 500 benchmark during the same period.
About the author: Jaimini Desai
Jaimini Desai has been a writer and financial reporter for almost a decade. Its goal is to help readers identify risks and opportunities in the markets. He is the chief growth strategist at StockNews.com and the publisher of the POWR Growth and POWR Stocks Under $ 10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
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