Broker Check

What we do know now is that the economy is slowing...

April 17, 2023

Markets started last week with hard landing and stagflation concerns but thanks mostly to the drop in CPI and PPI, those concerns eased, and stocks logged a solid rally on the week. And to be sure, the restart of broad disinflation is a positive, as headline CPI and PPI both fell sharply, and numerous inflation indicators are now approaching pre-pandemic levels.

That drop in headline inflation readings emboldened investors who have embraced the “hike/pause/pivot/ cut” Fed script that is the underpinning of this multi- week rally. However, what last week’s data did not do is close the concerningly wide gap between those “hike/ pause/pivot/cut” expectations, and the economic data and Fed speak reality that is directly refuting those expectations.

Now, to be fair, more times than not the market is right on Fed expectations, as the market is pricing in what it thinks will happen with the data while the Fed mostly speaks on what is happening right now. So it’s wrong to say these market expectations for a hike/pause/pivot/ cut are unreasonable, although I do obviously think they are aggressive and leave a lot of room for disappointment (and we saw a hint of that on Friday via the pop in inflation expectations, which is why stocks dropped).

To that point, we should all expect this Fed expectations pendulum to swing back and forth (between optimism and pessimism) over the coming months, as it has since the Fed started hiking in 2022. That’s because we won’t know if the hike/pause/pivot/cut thesis is right until we see core CPI and assess how deep the economic slow- down will be.

What we do know now is that the economy is slowing. The data we’ve seen in the past two weeks has been remarkably clear, including Friday’s soft retail sales report. In uncertain markets such as this, it’s helpful to find the clearest trend and follow it. Right now, amidst Fed and inflation uncertainty, it is certain that the economy is slowing. The only questions are how quickly and how much does it slow.

If the current risks in the market persist, which include Fed expectations being incorrect (no pivot or cut), inflation staying too high, an economic hard landing, more banking stress, geopolitical flare ups, then more conservative positioning cushions portfolios from any steep decline (say more than 10%). That is the reason we persist in our defensive positioning.

Bottom line, markets remain resilient and that matters, but that resiliency is based on this aggressive idea of a Fed hike/pause/pivot/cut strategy and an only gradual slowing of economic growth (not a hard landing). Those outcomes are possible, but the market remains aggressive in its expectations, and we continue to worry that leaves stocks open to near-term disappointment, and the possibility of a 5%-10% air-pocket, so we’d continue to use rallies like this one to ensure exposure and volatility are where everyone is comfortable, as at 4,200 the S&P 500 has priced in a lot of good “things” happening, and if they don’t, stocks will drop.

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