It hasn’t been an easy few weeks – or months. Or years.
This week, as expected, the Federal Reserve hiked the overnight rate by 0.75% as it continued its fight against inflation.
The kneejerk reaction was bearish, but historically, a negative initial reaction to the Fed is usually reversed in the short-term.
The Fed has a few problems with its fight against inflation; besides increasing interest rates, increasing supply would also lower inflation. However, the Fed cannot control supply-chain issues or slowing economies outside the United States, which we argue is a more significant cause of inflation than low interest rates.
For example, Ford Motor Co. (F) dropped 12% on Tuesday as management warned that supply constraints (and rising costs) would hurt profits more than expected.
“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.” – Abraham Maslow
The economy faces many problems, but the Fed only has a hammer (raising rates). And unfortunately, there are enough compounding factors to make this repair job difficult (or impossible) to fix by just raising rates.
We are making this point to explain why the Fed is unlikely to stop raising rates anytime soon. If prices are rising because energy prices are high – and housing, consumer goods, workers, and cars are in short supply – the Fed will continue to use the only tool it has with the hope that it indirectly helps correct some these other issues.
So, while we don’t think we will see deeper lows in the fourth quarter, we believe the upside is also limited as the Fed continues to raise rates. In our view, the S&P 500 is likely to continue trading between 3,700-4,200 until there is a fundamental improvement in the inflation outlook.
MUST-SEE: 32 Straight Winners in 2022 and Counting
If you’re worried about running out of money in retirement or not having enough to retire in the first place…
Former fund manager shows you how one simple transaction can get you instant cash payouts of as much as $1,290… $1,525… and $1,795 IN A SINGLE DAY.
All for just $7.
Click here for everything you need to know.
What the Fed Did on Wednesday
Besides raising the overnight rate by 0.75%, the Fed also released its economic estimates, which include expectations for interest rates and economic growth.
The Fed increased its expectations for inflation (4.5%) and the overnight interest rate (4.4%) compared to what they said in June. Based on our available numbers, the overnight rate would likely be hiked again by another 0.75% in November, which might be a drag on the big retail fourth quarter.
The message from the Fed within the expectations is that they will push interest rates higher for longer to fight inflation. Additionally, they expect unemployment to rise to 4.4% by 2023 compared to the current level of 3.7%. So, although the Fed still sees positive GDP growth in 2022 and 2023, the underlying fundamentals are expected to worsen.
Two Things to Remember
1. First, the Fed’s projections are rarely accurate.
This isn’t a criticism; it’s a reminder that what they think will happen a year in the future is about as precise as anyone else rolling the dice. It could be worse… or it could be better. That means we must remain flexible about our strategy as events unfold this coming quarter.
2. Second, although the Fed expects to keep raising rates, they don’t have
It’s true; they can change course to increase them faster or even start cutting, which happened in 2019. We don’t think they will change course immediately, but you should not assume they are locked into a specific course of action.
The Bottom Line
It usually takes a few days for traders to digest the Fed report.
We can say with more confidence that the dollar is not likely to weaken much while the Fed is raising rates. That should boost consumer spending, but it may drag on the tech sector.
A strong dollar is not an argument for a deep decline in the fourth quarter, but it should help explain why we think the upside in the market is limited. A stronger dollar lowers profits earned internationally.
Because half the profits made by the companies in the S&P 500 are from international sources, that will put pressure on large-cap stocks.
We’ll keep an eye on this space, and we’ll update you as things progress.
Hang in there.
Regards,
John and Wade
