The Beatings Will Continue Until Morale Improves

The Beatings Will Continue Until Morale Improves

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The market broke its losing streak last week with the S&P 500 closing nearly 6% higher, which was just over our maximum estimate we discussed in this note last week.

Surprisingly, investors were optimistic for stocks despite the Federal Reserve Chairman Powell’s dismal, recession-based comments to Congress last week.

We don’t have a great explanation as to why that played out the way it did. However, Powell’s commentary contained some very subtle hints that the Fed could come to the rescue again in a recession, so we suppose that was most likely the cause.

We think there is still a possibility the U.S. has another “near-miss” recession on the horizon; in which case, growth is negative for a quarter but turns positive again — and this exact situation happened in 2014 and 2015.

The consensus among “professional forecasters” is for positive GDP growth in the second quarter of 2%, but they also thought the first quarter would be positive, so…

One of the biggest reasons this is such a challenging question to answer right now is that recessions are rare while jobs are being added to the economy. However, it is also likely that the Fed will keep pushing interest rates until they achieve a higher unemployment-rate goal.

Yes, you read that right.

Officials at the Fed mostly subscribe to ideas about inflation developed during the “Great Inflation” of 1965-1982. The idea is that higher energy and food prices are incidental to the real cause of inflation, which is accommodative monetary policy that, in part, results in too many jobs.

It seems absurd, but the Fed’s unofficial target for unemployment is 4-5%, which is a lot higher than what it is right now. The Fed is unlikely to stop raising rates until more jobs are lost. Unless something changes that view, the Fed is unlikely to stop cutting rates if jobs are growing.

It all reminds us of the adage “the beatings will continue until morale improves.”

Looking Ahead

Last week’s news was focused on the Fed and inflation and that remains the case this week as well. Normally, we would also get the new unemployment report on Friday, but the Independence Day Holiday always pushes that report back a week. In the meantime, there are some other key news events to keep your eye on.

  • Monday, June 27

Pending home sales are out this morning and have extended the losing streak to seven weeks in a row. We don’t think average home prices will fall yet, but this tells us that we should still avoid industrial stocks and builders.

  • Thursday, June 30

The Fed’s preferred inflation measure the Personal Consumption Expenditures (PCE) index will be released before the market opens. The PCE has been dropping over the last few months. If it drops again on Thursday, we think that is the best entry point of the week.

What You Should Do

Last week, we recommended you avoid energy stocks and that turned out to be a good idea. Energy was down -5.5% for the week as one of only two sectors to lose ground. We also recommended you focus on Consumer Cyclical or “retail” stocks that turned out to be the best sector with a positive 9% return.

Because there isn’t a lot of news this week and traders will probably be checking out early before the Independence Day weekend, we are keeping the same recommendations and outlook. Energy still looks bad, and consumer stocks and tech likely have the best upside potential.

Here’s the bottom line: This should be a slow week while investors wait for unemployment data and earnings in July. We think there is limited upside in the short term, so traders should remain cautious about adding too much risk to their portfolios.


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