What a couple of months. The action in the markets has really been quite historic with extremes being hit in many directions and extremes being pinned on many measures. At the same time, we are having economic indicators that are appearing to show signs that the work that the Fed has been trying to put in with its tightening cycle has done what it had intended. In looking at 10, yes that is not a typo 10 consecutive rate increases since early 2022 have resulted in higher rates, bank failures, and massive increases in debt service cost to all borrowers. On top of this, the Fed has decreased the money supply at a dramatic rate.
Note above that the money supply has been declining at a rate of descent not seen since the Great Depression. Also please remember that this should totally be expected given that the spike of $5 Trillion being dumped on the economy by the current administration was also a spike that had never before been seen. So if the pendulum is going to swing, it should be expected that it would swing both ways. This is super important to remember. An increase spike at a level never before seen, followed by a decline that had only been seen during the Great Depression.
The next point that I wanted to bring up is a factoid of how the equity markets in the form of the S&P 500 act just after a Fed rate announcement. As seen below, the Fed announces its decision at 11:00 AM PST, and then the action happens. You can see that in the previous six meetings, the action after the rate increase has not been good. But this time, the Fed paused. This is a different action by the Fed, so it should be expected that the actions of the markets could be different as well.
Sure enough, the markets continued their ascent that they have been experiencing even though the news continues to be far less than good.
So what is it that is being seen that is telegraphing the intended thwarting of inflation is being accomplished by the Fed action?
As can be seen above, ISM manufacturing and services numbers are clearly on the decline. The Producer Price Indicator number is also on a decline at the same time. So the slowdown in PRICING is reflecting a lessening of the vigor of inflation. Thanks to Victor Cossel at Seaport Research Partners for putting together this terrific graphic.
At the same time, there is a very strange dynamic afoot. This time last year corporate insiders were forecasting a 5% decline in business activity, and this quarter they are forecasting a 5% INCREASE in business activity. This could very well be the reason why the equity markets seem to currently be pricing in a recovery in the next year. See the Philadelphia Business Outlook and Empire State (New York) Manufacturing Survey below. Note the reversal and spike upward on the recent measures:
Notice that this turning up has coincided with the equity market's recovery from the lows. The final point that I wanted to raise is that if this truly is a Bear Market Recovery, how long has it taken historically for the S&P 500 to recover? And how big have previous declines been, so we can know where these declines fit in the norm?
Following this week’s June Fed meeting, we remain bullish on the equity markets and still see further upside. The Nasdaq100 NDX closed at a one-year high and the S&P 500 SPX flirted with a new high this week after the meeting. Interest rates failed to make new highs despite the Fed’s hawkish follow-on commentary. Importantly, US 2- and 10-year interest rates remain below prior peaks and the Dollar fell. We think this is a bullish equity backdrop should inflation continue its disinflationary path lower, then the data will support an undershoot of the data-dependent Fed’s year-end median rate forecast of 5.6%. Many may not like the entry point at current levels however, we believe equity sentiment remains hesitant and post-event volatility (as seen in the chart above) measures pressed lower supporting an upside market bias into June month end and a light macro-economic calendar ahead. Our confidence in a benign Fed is reinforced by the disinflationary trends of the ISM’s Manufacturing & Services Price surveys and yesterday’s PPI (Producer Price Index).
Stay tuned and have a nice three-day weekend.
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