There is an interesting CNN article titled, “What the Fed and Madonna have in common”. The main highlight: Fed Chairmen while trying to maintain their three main goals of maximum employment, stable prices, and moderate long-term interest rates have tweaked their methods to suit the running conditions of the economy during the Fed’s 109-year history since 1913. In the early 80s, Paul Volcker acted with more authority and power rather than seeking consensus. He did not give advance notice to markets about what the Fed could be doing. In a way, he was not dealing with a globalized economy and could be more focused on solving an American problem.
The Fed could be raising or lowering rates without much of a scheduled FOMC-type meeting. Even now the Fed has the freedom to do things in an emergency like how they dropped rates on a Sunday in Mar 2020 during the pandemic, it is very unlikely that the Fed will act inter- meetings without a level of real urgency.
The market consensus clearly for this week is for the Fed to raise rates by 75 basis points and I think that should happen. The Fed has almost telegraphed that to the public. Anything to the contrary will be the surprise element. For the month of Aug, we do not have an FOMC meeting and I don’t think we will have any Fed action for Aug. By September the inflation fear should start to roll off and I wouldn’t be surprised if the Fed stopped raising rates at all for some time.
What is very unique about this downturn in the markets that we have faced since last year is that, for the first time in over 50 years the S&P 500 is down 10% while bonds have also fallen close to 10% since the start of the year. It is normal for bonds and equities to be inversely correlated. But with the level of unprecedented printing that was never seen in the last 320 years, we cannot expect old conventions to hold true anymore.
Throughout the past six months, I have argued that the markets are going through a technical correction and probably a short recession too. A technical recession is when we have two consecutive quarters of negative growth which we got already. To put it in context, nominal growth is still running at 6%, meaning the economy is not stagnant but still moving. This means demand is still alive.
This is most visible in the recently announced banking earnings report. All four major banks produced excellent net interest income, thanks to the rising interest rates. All banks had positive things to say about the strength of the consumer. In the last few days, the banking stocks have been leading the way up.
Another company to look at is Halliburton. They are the biggest provider of products and services to the energy sector. They beat on earnings and revenue estimates. This should be a wake-up call for the investment community to energy and commodity companies, both of which are benefiting from structural supply shortages, and high prices - meaning expanding margins.
While these stocks have been hit hard including XLE which is down 27%, most of the commodities are priced in dollars and the relentless rise in the dollar has contributed to their poor performance. It looks like the dollar will be rolling over soon. I think this sector is poised for some positive cash flow enabling them to pay down their debts. Banking and commodity stocks should be the best opportunities in the next up move in the markets as the markets struggle with some technical headwinds.
The rising interest rate environment was surely going to hurt the high valuation tech sector. We have seen that play out very well. In the process, most of the banking and commodity stocks have been dragged down for non-fundamental reasons. The present low P/E and banking and commodity sector should be a gift.
The markets probably saw their lows on June 17th. We could be all set for a monster rally very soon. This is not the time to be bearish on the markets anymore. Smart money is most likely getting long.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.