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This is a very important week for markets

May 02, 2023

 This is a very important week for markets because by Friday’s open, we’ll know:

1) If the Fed
hikes 25 bps and is pausing, 2) If growth is rebounding or rolling over, and 3) If the labor market is moving closer towards the “balance” the Fed needs to feel confident wage inflation won’t be a problem. And with the S&P 500 above 4,100, the answers to those questions need to be: 1) Yes, the Fed is pausing, 2) Growth is stable or rebounding (and not rolling over) and 3) There is moderate deterioration in the labor markets). From an indicator and event standpoint, the key event this week is Wednesday’s FOMC meeting.

The second most important event this week is Friday’s jobs report, because the labor market remains incredibly resilient, and it’s hard to envision the Fed pivoting or cutting (assuming they do pause) if unemployment is under 3% and the economy is still adding hundreds of thousands of jobs every month.

The third most important event this week is the ISM PMIs, as we get the manufacturing PMI today and the services PMI on Wednesday. The regional surveys have shown mixed results so far in April, but the bottom line is if the services PMI drops below 50 (and the manufacturing survey stays solidly below 50) then that will increase “hard landing” concerns, and as we know, that’s the one worry consistently pressuring markets.

The “hike/pause/pivot/cut” narrative combined with expectations for a soft landing have powered the S&P 500 to current levels, and as long as those expectations are met this week, the rally can hold and even continue. However, if those expectations are not met this week, then the disappointment could be intense, and a 5%ish air pocket in the S&P 500 shouldn’t shock anyone if 1) The Fed signals more rate hikes are likely, 2) The ISM PMIs both fall below 50 and 3) The jobs number comes in “Too Hot,” because that will imply a stagflation environment with no Fed relief, and at 4,100, the S&P 500 is much too high for that environment.

Meanwhile, too few policymakers or investors are following what’s happened to the M2 measure of the money supply.  (the greater the money supply, the more the inflation) After surging about 40% in the first two years of COVID, M2 hit a plateau in early 2022 and then started dropping last summer.   M2 is down 4.1% in the past eight months, the steepest decline since the early 1930s.

If this decline is real (there are some reasons for skepticism given that the Fed releases these data less frequently than in the past and with less detail) and if it continues through 2023, then by 2024 the economy could be in for not only a recession but also a sudden and sharp decline in inflation.  Why the press never asks about a decline in M2 that we haven’t seen since the Great Depression is a mystery.

Also, a mystery, is whether anyone in the press corp – even just one journalist – has the bravery to ask Powell in public how the Fed is financing its day-to-day expenses now that it’s paying banks more to hold reserves than it earns on its portfolio of Treasury and mortgage-backed bonds.  The Fed has negative cash flow and has lost more than its actual capital.  Is the Fed letting some of these bonds mature and using that cash for expenses?  Is it printing money?

So far this year, we think most investors have convinced themselves of overly pleasant narratives about the economy and the path for monetary policy.  One of them is that the Fed will cut rates this year.  We don’t think this happens and maybe a re-thinking of those pleasant narratives starts soon. I don’t think the Fed will cut rates and I think they will continue to raise rates for a few months. As soon as the markets accept that, the more sustainable the rally after the end of rate increases.

According to FactSet Research, we have seen 53 percent of the S&P 500 component companies report their results for the first quarter of 2023. Of the 53 percent that have reported, 79 percent have reported earnings that beat expectations (a 3-percentage point increase over the previous week’s reading), while 21 percent met or missed expectations. When looking at revenues, 74 percent of companies that have reported have beaten expectations while 26 percent have fallen short (both of these figures improved meaningfully last week). The 74 percent of companies beating on revenue expectations is above the average rate of the last 1, 3 and 5 years, and is a very positive sign for the overall health of corporate America.

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