Can the Fed save equities from their worst December in over 40 years?
Head of Equity Strategy
Summary: Big macro indicators suggest that the Fed has ample leeway for a rate hike tonight, but a raft of other evidence suggests the central bank should keep policy as is. Whichever path the Fed chooses will be directionally critical to equities in the weeks and months ahead.
Collapsing oil price (driven by both weaker demand and surging supply) sucking inflationary pressures out of the economy.
Stocks in cyclical industries (financials, real estate, materials and industrials) are declining, rapidly discounting significant headwinds for the economy (see chart).
Credit spreads are widening and this December is the first month (in a long time) of no new issuances of high yield bonds. Leveraged loans are also seeing cracks, indicating that recent rate hikes have materially impacted financial conditions.
Populism is still in vogue and income/wealth inequality is still high, so a policy mistake is significantly more costly for society.
The economy is in the late stage of the business cycle with low capacity in both the labour market and production.
Loud voices from the US president to this Sunday’s WSJ Op-Ed by Stanley F. Druckenmiller and Kevin Warsh (the latter a former member of the Board of Governors of the Federal Reserve System, 2006-2011) are putting pressure on the Fed to stop hiking. Watch the replay of today's Morning Call where our Head of FX Strategy, John Hardy, goes through the various scenarios for tonight’s FOMC decision.
The US-China conflict on trade, intellectual property rights, market access etc. is creating headwinds for the economy.
The Chicago Fed National Activity Index is still suggesting above trend growth and leading indicators in the US are also still high.
Economic activity is slowing in both Europe and China, lowering external demand for US goods and services.
Level 1 liquidity in the S&P 500 futures limit order book is around 80% lower compared to one year ago, so markets are running on such low liquidity that any shock to the system could create large domino effects.
While the big macro indicators are still above trend and thus give the Fed the green light for another rate hike, these indicators are lagging and likely sending false signals compared to more timely signals coming out of financial markets. In a late stage of the business cycle, central banks should put a higher weight on financial market indicators and less on macroeconomic indicators, and if the Fed is doing this tonight they is plenty of ammunition for not hiking the Fed Funds Rate. The risk tonight is that even if they go ahead and hike the interest rate while spinning it dovish with a an indefinite rate pause, the market is likely to sell off as it will be seen as a potential policy mistake.
Broadening the perspective, global equities are now below their average valuation since 1995 (see chart) and this is using data as of November. With global equities down 6.5% in December, this indicator is likely approaching valuation levels not seen since early 2016 when the last bull market began. But when markets are switching into risk-off mode and liquidity dries up, fancy long-term valuation arguments are often not what creates good timing. So take this helicopter perspective for what it is. A compelling case for equities if we don’t see a policy mistake and China delivers on economic stimulus.
Quarterly Outlook Q2 2022
Quarterly Outlook Q2 2022: The End Game has arrived
- Shocks from covid and the war in Ukraine have forced the global financial and political world to change, but what will the end game be?
Energy crisis could turn energy stocks into secular winnerWith long-term expected returns for the global energy sector close to 10%, we look at 40 stocks that could be set to cash in.
The great EUR recovery and the difficulty of trading itIf the terrible fog of war hopefully lifts soon, the conditions are promising for the euro to reprice significantly higher.
Tight commodity markets – turbocharged by war and sanctionsWith supply already tight, commodities keep powering on. But will it last for yet another quarter?
Between a rock and a hard placeGeopolitical concerns will add upward price pressures and fears of slower growth, while volatility will remain elevated.
The Great ErosionInflation is everywhere and central banks try to combat it. But will they get it under control in time?
Australian investing: Six considerations amid triple Rs: rising rates, record inflation and likely recessionWhile global financial markets are struggling in an uncertain world, the commodity-heavy Australian ASX index is poised to keep a positive momentum.
Cybersecurity – the rush to catch up with realityWith the invasion of Ukraine, governments and private companies are rushing to reinforce their cyber defenses.