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In 1991 Billy and Akaisha Kaderli retired at the age of 38. Now, into their 4th decade of this financially independent lifestyle, they invite you to take advantage of their wisdom and experience.

Lance Roberts Market Report

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Fed Hikes 75bps, No Pivot & A Hard Landing

It was a tough week for equities as the Fed hiked 75bps and signaled that “no pivot” in policy is coming. Such disappointed the markets in desperate need of some “encouraging news,” but none was to be had. Furthermore, the Fed slashed economic growth drastically, upped their unemployment projections, and kept inflation expectations elevated through 2023.

Markets broke through support and tested this year’s lows on Friday as selling was broad-based. As we will discuss momentarily, the market is now figuring out the rising risk of a policy mistake. On Friday, Goldman Sachs slashed their year-end price targets for the S&P 500 index. The “hard landing” scenario was most important.

In a recession, we forecast earnings will fall and the yield gap will widen, pushing the index to a trough of 3150. Our economists assign a 35% probability of recession in the next 12 months and note that any recession would likely be mild given the lack of major financial imbalances in the economy. As we previously outlined, in the event of a moderate recession, our top-down model indicates EPS would fall by 11% to $200.

For context, a 34% peak-to-trough decline in the S&P 500 index during a recession would only be slightly worse than the historical average of 30%. We see two risks that would create a more dramatic sell-off in equities during a recession. First, if inflation concerns were to limit the degree of monetary or fiscal policy support and interest rates did not fall, it could lead to even lower valuations or even larger economic and earnings growth declines than we model. Second, concentrated sector weakness, such as Information Technology in 2001 and Financials in 2008, could lead to an even sharper earnings and price decline.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

While Goldman is finally coming to grips with economic and fundamental realities, its expectations for only modest earnings and margin decline are still optimistic. As we discussed recently, earnings will likely revert to below $200/share just to reach the median long-term growth trend.

“More importantly, despite the recent downward revisions, the current estimates still exceed the historical 6% exponential growth trend, which contained earnings growth since 1950, by one of the most significant deviations ever.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

Such leaves the markets in a very tenuous position. However, in the short-term, markets are testing this year’s lows and are sufficiently oversold to provide a relief rally. However, there is little to get excited about until the Fed stops hiking rates aggressively and reducing its balance sheet. We will cut equity exposure levels on the next rally and raise cash levels further. Keep a watch on the MACD signal (top of the chart), as it will provide the best guidance for a sellable rally near term. There is a lot of congestion at the 3900-4000 level, which will provide sufficient resistance to cap a reflexive rally. Those levels provide a reasonable “sell” target for now.

 

 

 

 
No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

World’s Worst Economic Forecasters

The 75bps hike on Wednesday was priced into the market. However, the Fed’s “Dot Plot,” showing no “pivot” in policy anytime soon, sent markets lower. There was a 10-9 majority in favor of hiking above 4.25% this year, suggesting a fourth 75 basis-point increase in November is possible. (Chart courtesy of Zerohege)

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

As noted by Zerohedge:

“Remember, until Powell’s Jackson Hole speech, the Fed discussed a soft landing scenario with the economic projections at the June meeting reflecting that thinking.”

Furthermore, the market was also pricing a “pivot” in monetary policy by May of 2023. The problem is that the Fed’s new economic projections dashed those hopes, with growth estimates slashed and inflation elevated.

  • The Fed substantially revised GDP forecasts lower, with the median estimate for growth this year at just 0.2%.
  • Unemployment rate forecasts are up, with the median now at 4.4% for both 2023 and 2024.
  • The Fed doesn’t see inflation returning to its 2% target until 2025.

The problem is that while these statements clearly show that “no pivot” in policy is coming, they are also likely very wrong.

As we have discussed, the Federal Reserve is the worst economic forecaster ever. We have been tracking the median point of their projections since 2007, and they have yet to be accurate. The table and chart show the Fed is always inherently overly optimistic in its forecasts.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

The corner graph shows the sharp drop in economic growth expectations since the July meeting. If they were this wrong just a few months ago, how wrong will they be in 2023?

While the Fed is currently pushing a “no pivot” stance, there is good reason to expect a pivot in 2023.

 

 

 

 

A 2008 Redux?

The September rate hike pushed the Fed funds rate to the highest since January 2008.

If you don’t remember what happened then, let me remind you.

In January 2008, the Fed was aggressively hiking interest rates amid a massive real estate bubble under the Chairmanship of Ben Bernanke. At that time, there was “no recession” in sight, “subprime mortgages were contained,” and it was a “Goldilocks economy.”

Eight months later, the market fell sharply, banks were on the brink of bankruptcy, and the economy was entrenched in a massive recession as Lehman Brothers filed for bankruptcy.

The Federal Reserve never predicted a recession and believed it could navigate a soft landing in the economy. They were wrong on multiple counts. As we showed previously, there are ZERO times in history when the Fed was hiking rates that outcomes were not bad to awful. After rates peaked and yield curves UN-inverted, recessions, bear markets, and crisis events occurred.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

I don’t like market analogs. However, the current Fed policy of hiking rates and reducing their balance sheet is the most aggressive policy shift since that period. Every market environment is different, but the similarity of market action this year is interesting.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

We are NOT suggesting another “Lehman Moment” is imminent. However, as noted above, a weaker economic environment, namely a recession, impacts asset prices as earnings and profit margins deteriorate.

Valuations are still not cheap, by any measure.

The Most Hated Asset

We discussed last week why “bonds” are likely to be the next “buy” of the decade. Interestingly enough, with bonds in the most significant bear market on record, no one wants to buy them. Such is the case historically, as investor psychology always contradicts investing realities.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

As I quoted then:

The action of the credit market is consistent with economic weakness and stock market trouble. I think you have to start becoming more bearish on stocks. Buy long-term Treasuries. Although the narrative today is exactly the opposite, the deflation risk is much higher today than it’s been for the past two years. I’m not talking about next month. I’m talking about sometime later next year, certainly in 2023.” – Jeff Gundlach, DoubleLine

I am reiterating this commentary because the recent actions by the Fed almost guarantee a recession, economic event, or worse. In such an event, the demand for “safety” will become a primary market consideration.

Such is because money flows from risk assets into Treasury bonds for safety when a recession occurs. We see this clearly in the chart below of corporate bond and Treasuries yields. While it hasn’t happened yet, corporate yields rise during a bear market or economic event as money rotates into Treasuries’ safety, causing long-dated yields to fall.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

While the Fed’s “no pivot” policy stance is driving up Treasury yields short-term, the reality is that each increase puts the Fed one step closer to a policy mistake. It is quite likely the Fed has already tightened more than the economy can withstand. However, given the lag time of policy changes to show up in the data, we won’t know for certain for several more months.

 

 

 

 

With the Fed removing liquidity from the markets at the most aggressive pace ever, the risk of a policy mistake is higher than most appreciate. Such is shown in the annotated chart from Chartr below.

No Pivot, No Pivot On The Horizon As Fed Hikes 75bps

While buying bonds today may still have some “pain” in them, we are likely closer to a significant buying opportunity than not.

More importantly, if we are correct, the coming bull market in bonds will likely outperform stocks and inflation-related trades over the next 12 to 24 months.

Such an outcome would not be the first time that happened.

Of course, buying bonds when no one else wants them is a tough thing to do.

The views expressed by Lance Roberts are not necessarily those of RetireEarlyLifestyle.com

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About the Authors

 
Billy and Akaisha Kaderli are recognized retirement experts and internationally published authors on topics of finance, medical tourism and world travel. With the wealth of information they share on their award winning website RetireEarlyLifestyle.com, they have been helping people achieve their own retirement dreams since 1991. They wrote the popular books, The Adventurer’s Guide to Early Retirement and Your Retirement Dream IS Possible available on their website bookstore or on Amazon.com.

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