Watching the stock markets go up is only one thing that I see…here are the underlying conditions.
Monetary Policy: Restrictive
The Federal Reserve (Fed) is raising rates to “reduce demand” and signaling 5%ish as target. So, another 50-75bps up. Then watch to monitor the “lagged effects” as we course through 2023. Any “pivot” comes after that.
M2 growth – aggregate level essentially flat/slightly declining since May 2022.
QT – keeping a wary eye watching this. Interesting that the Federal budget ceiling fight takes most of the near-term pressure off this action.
Fiscal Policy: Stimulative
Key elements: Federal budget “fiscal pulse” relative to full employment is large. Then, there these legislations: Infrastructure Act of 2021, Inflation Reduction Act of 2022, and the CHIPS Act of 2022. Collectively: multi-$trillion, or 5%+ of GDP…
Political Influence
Rep Kevin McCarthy being elected Speaker of the House came with significant strings from the House Freedom Caucus. The first has started…dealing with our country’s debt ceiling. Showdown in late June? Further down the road, were stimulative legislation to be needed, the “hurdle” is now much higher.
Geopolitical Influences
Russia has reloaded for a massive new push in Ukraine with 300,000 new draftees. Russia’s military seems to be a “barbell”: human fodder and nukes. In between does not function well or consistently. The war is now clearly defined as a “proxy war”. Food and energy also caught in the middle.
China – now that “victory” over Covid has occurred, look for generally supportive economic policies as China moves toward #1 objective: Xi’s vision of “general prosperity”.
Europe – dodged a bullet with an easy winter so far, but still trying to cause a recession via tight monetary policy.
Japan likely changing their yield curve control (YCC) after April. New Bank of Japan Governor Ueda looks to be more balanced, at least on paper. Speculation is YCC shifts to the 5 or 2 year JGB.
Commentary
The combination of stimulative fiscal policy and tight monetary is contradictory, but not unheard of in our history.
March Fed meeting will likely reveal how the Fed “words” the final phase of their tightening. Ultimately, the issue is how does the Treasury yield curve “un-invert”.
Rates higher for longer: the Fed wants to “keep rate” as a policy tool. They haven’t had it since 2008. All recent borrowing at ultra-low rates now face rollover at higher rates.
But the Fed does not want to “break something” because a) they’d have to fix it and b) likely lose rate in the process. Think of it as the Fed “deleveraging” certain areas of the financial markets. Financial risk can be in seemingly safe places as the Brits discovered…
CPI versus price level: CPI can go to zero, but the cumulative price level increases remain ahead of incomes, so remain deflationary. Said another way: the standard of living for most has dropped.
Labor shortage? At 3.5% unemployment, why only 3.1% weekly earnings growth? Many are “underemployed” – not working anywhere near 40 hours per week. Companies have gotten good at this, they can “flex” hours in response to rising or…falling conditions. Add to this the newly unemployed in the info tech sector and other industries that benefitted from Covid.
Stock prices are ultimately about earnings. Companies have been very good at raising prices, the question is will they hold.
And then about sentiment, which can be measured by P/E ratios. Down from 19x in 2022, currently at 18x forward earnings. 15x is historical average. Bid the price of earnings higher right now?
As a stock picker, the strategy is to scan for those positioned for the envisioned 2024 economy. Then, wait on a better price. We’ll have several opportunities this year.
So, 2023 looks to be a transitional year. Be patient for (2024 economy) equity upgrades/additions. Finally! Being paid a decent return on a tactical asset while waiting. Short/ intermediate bonds continue to be useful to hedge near term expenses.