Professor Siegel's Weekly Commentary Archive
All Eyes Are on You, Powell
January 30, 2023
This is a big week for the markets. The Fed decision on Wednesday is the focal point and the Fed funds futures are predicting a downshifted rate hike of another 25 basis points (bps). I agree with 25 however if Powell instead chooses to 50 bps, there will be tremendous selling pressure for the risk markets, and we could easily see a 1,000-point drop in the Dow immediately.
But a Fed decision for 25 bp is not an ‘all clear’ sign for risk assets either. The press conference and tone for this 25-bp hike will matter. Does Powell concede there has been much progress on the battle over inflation or will he maintain a stubborn view that tightening must continue for much longer.
The markets clearly want this to be the end or very near the end of the tightening cycle. The bond market rallied significantly in the last three weeks on signs of inflation progress and worries about the fallout of higher recession risks, but is Powell paying attention? The markets are seeing three more rate hikes of 25 bps before the pivot later in September. Hopefully it comes sooner.
We currently have the steepest inversion in the yield curve between the Fed funds rate and the 10-year bond in the last 40 years, and this does not portend a great economic growth backdrop. Moreover, the money supply came in for December and the full year change in M2—the key cause of inflation—contracted 2%. We typically were seeing 5% growth figures in money supply up until the pandemic. You want this figure growing 4-5% for 2-3% inflation and 2-3% real economic growth. We do not want to see it contract. M2 contraction is a prime sign the Fed is overly tight—as that figure did not contract even in the tightening cycle of the 1970s and 1980s with double digit Fed funds rates.
I am still amazed jobless claims again fell. The layoffs we’ve seen so far have yet to come into the weekly jobless claim figures. But real economic data last week was mixed. The GDP report was nowhere near as strong as reported headline figures. A lot of the GDP strength was inventory buildup and better trade balance. Domestic demand and particularly consumption was quite weak, and most economists started downgrading their forecast for first quarter GDP to around 1%. Summarizing: the economic data it was not terribly weak, but it was not strong data either.
We are in the midst of earnings season and so far, approximately 70% of companies are beating estimates, as is normal. We had a huge miss for Intel, showing weakness for the chip makers. But as fourth quarter earnings continue to come in, they are largely showing ok results, with a nod towards guiding lower for 2023.
I still hold out hope that productivity growth can rebound and support corporate profits. I think the current guidance of $225 for S&P 500 earnings in 2023 is conservative even though it is higher than 2022 levels. I think firms are going to get rid of a lot of unproductive workers that could maintain these earnings. If we apply a 20x price-to-earnings (P/E) ratio to that level—and I think 20 is a fair equilibrium level of valuation and we do not have a severe recession—we can have a positive backdrop for the markets.
But we are reliant on the Fed pivot. All eyes are on you, Powell.
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