The Fed’s forecasts are just noise … what really matters for your portfolio … evidence of slowing demand and falling inflation … when to look for a market rally

A rebound is coming.

It doesn’t feel like it on days like today when the markets are a sea of red, but it’s coming – and possibly much than many investors believe.

To understand why, let’s back up to Wednesday’s big “nothing-burger.”

That’s how our hypergrowth expert Luke Lango described the outcome of the Fed’s September meeting on Wednesday.

From Luke’s Innovation Investor Daily Notes:

We don’t really understand why everyone is reacting so harshly to the Fed, its economic projections, or its actions.

But here’s our two cents: It doesn’t really matter.

In our Wednesday Digest, we took a bearish tone, detailing why the Fed might want to crash the market and the economy. Today, let’s balance that with a bullish perspective from Luke.

We’ll find out what’s most important for market direction right now, and why we should be encouraged, not battening down the hatches.

In fact, if Luke’s right, his favorite corner of the market – top-tier growth stocks – are going to rally 50%+ into the end of the year.

So, let’s shake off the recent market volatility and focus on the growing light at the end of the tunnel.

How seriously should we take the Fed and its latest forecasts?

For new Digest readers, Luke specializes in finding cutting-edge technology innovators that are changing our world – and transforming portfolio returns in the process.

On that note, since its June low, the tech-heavy Nasdaq rallied 23% higher, only to give up nearly all of those gains, now settled in at 2% higher than the June-low as I write. Meanwhile, over that same period, Luke’s Top 10 Buys in his Innovation Investor portfolio are averaging a gain of nearly 20% – despite the heavy selling pressure since mid-August.

Returning to Wednesday’s news, let’s pick up with Luke explaining why the market reacted so poorly to the outcome of the Fed meeting:

The stock market’s initial reaction to the Fed’s rate-hike announcement was because its forecast for future rate hikes and inflation went up significantly from the last meeting and are well-above what the market was expecting.

Luke explains that the Fed’s forecast for 2022 and 2023 inflation rose 20 basis points each from its June meeting forecasts.

Similarly, the forecasts for 2022 and 2023 core inflation rose 20 and 40 basis points, respectively.

Finally, the forecast for the Fed funds rate in 2022 exploded 100 basis points, while the 2023 forecast jumped 80 basis points to 4.6%. Coming into Wednesday, Wall Street had been pricing in peak rates of around 4%, so the 4.6% forecast was a record-scratch moment.

Taken together, these are very bearish forecasts and the market is reacting poorly. But Luke has a simple reply…

Don’t count on these forecasts actually playing out.

Back to his Daily Notes:

Overall, it was a very bearish set of projections from the Fed. But ultimately, they don’t really mean much.

Remember when the Fed said inflation wouldn’t be a problem a year ago? Remember when it said it would only hike rates a few times earlier this year?

The central bank’s projections have historically been about as inaccurate as possible, so there isn’t much credibility there. But more importantly, its actions are reactionary – they aren’t proactive.

In the model of the U.S. economy, the Fed’s actions are an output. Inflation is the input. You don’t predict outcomes by looking at outputs. You predict outcomes by looking at inputs because they determine the outputs.

[Wednesday’s market action] was quintessential evidence of that!

To Luke’s point, following the Fed announcement, stocks crashed nearly 1% on the hawkish projections.

But then they rallied off those lows to up 1.2% after Federal Reserve Chairman Jerome Powell said that the Fed’s projections were dependent on the data.

They then crashed again, ending the day down 1.7% after Powell-induced jitters returned.

Back to Luke:

C’mon now – if that doesn’t tell you that we shouldn’t be reacting to the Fed and its projections, then I’m not sure what does. All it’s doing is reacting to inflation.

If inflation stays hot, the Fed will stay aggressive. If inflation cools, it’ll back off with the rate hikes.

And so, we come full circle. Everything comes back to inflation.

Inflation – not the Fed – is what matters today. If it cools, all the stock market’s problems will be solved, and our growth stocks will soar.

So, why is Luke convinced inflation is falling?

To begin, there are major signs of slowing demand.

We recently received two pieces of data that put this dynamic in the spotlight. The first is downward revisions to the Atlanta Fed’s GDPNow forecast.

Here’s Luke with more:

For a while, it looked like the U.S. economy would bounce back in the third quarter after two consecutive quarters of negative GDP growth. As of early August, the GDPNow forecast for Q3 GDP growth was 2.5%.

However, that forecast has been steadily dropping ever since.

In early September, it slipped below 2%. Last week, it slipped below 1%. [On Tuesday], it dropped to 0.3%.

The advance estimate for Q3 GDP comes out on October 27, so there’s still more than a month left for new data to make or break the reading. However, considering the current directional trend, a third straight quarter of negative GDP could be in the cards.

Back to Luke on what that would mean:

If [Q3 GDP is negative], there will be no question about it: The U.S. economy is in a recession.

Such a confirmation will likely push the Fed toward more dovish policy as the year goes on.

As to the second piece of data showing slowing demand, Luke highlights shipping

Inbound containers at major U.S. ports like Long Beach, Savannah, and Norfolk are considered a leading indicator of economic activity because they are a coincident indicator of consumer demand. 

For anyone less familiar, a “coincident” indicator simply means that changes happen simultaneously (or very close to simultaneously) with some other variable – in this case, consumer demand.

Back to Luke with more details:

Those numbers were soaring in 2021. Now they’re crashing, and the collapse is showing no signs of relenting.

This is yet another datapoint underscoring that the U.S. economy is slowing, perhaps even more quickly than the headline GDP numbers are suggesting.

Consequently, we think the odds of a dovish pivot from the Fed are much higher than what the market is pricing in today.

Finally, what about inflation itself? Are there positive signs that it’s coming down in a meaningful way?

In answering this, Luke points toward a recent research note from Capital Economics. The firm’s economists believe a massive disinflationary wave is building in the U.S. economy.

Here’s Luke with those details:

The big points? Oil prices are crashing. Metal prices are crashing. Food prices are crashing. Energy and transportation costs are falling. And supply chains are rapidly normalizing.

Of particular interest, the firm’s proprietary product shortage indicator – which has historically been a very strong leading indicator of core inflation – has been plunging.

If this very strong correlation between the Capital Economics product shortage indicator and core inflation rates persists, then core inflation could fall back to 2% before the end of this year.

When to look for stocks to start rallying

Following Luke’s line of thinking, stocks are going to rally on evidence of weakening inflation. So, when will we receive the next significant update on inflation?

Here’s Luke with the answer, and also the final word:

The next big inflation data to hit the tape will be Oct. 13 with the September CPI. Whatever is reported on that day will be far more important than what the Fed said [on Wednesday].

We think that report is going to be very soft, and therefore, we think that regardless of what the stock market does over the next few weeks, it could be bracing for a massive October rally.

So, forget the Fed. Focus on inflation. Doing so will allow you to separate the noise from the signal in this market and make money despite today’s prevailing bear market.

Have a good evening,

Jeff Remsburg