Business

Opinion: No “soft landing” in Fed rate hikes. Look for recessions and buying opportunities when stock prices drop.


Is the bear market of 2022 over? Are we already in the early stages of the next great bull market?

S&P500
SPX,
-0.40%

ended 2022 with a 19% drop (the biggest drop since 2008). Meanwhile, the Dow Jones Industrial Average
DIA,
-0.49%

lost 8.8% and Nasdaq
COMPUTER,
-0.09%

33% off.

It’s a different story in 2023, with most US stocks picking up steam. This kind of price action leaves pundits, pundits, and CEOs skeptical of the possibility of any kind of severe recession and the Federal Reserve’s “soft landing” following a series of rate hikes. A soft landing is “a cyclical slowdown in economic growth to avoid a recession.”

Support for this idea comes from the fact that the Fed has raised interest rates significantly since March 2022, lowering inflation to around 6% from about 10%. The labor market has remained strong throughout, with the unemployment rate at 3.4%. Because inflation is falling, Wall Street expects (hopefully?) that interest rates will start falling sooner.

So, does the rise of Nasdaq and many speculative stocks really reflect an improving economy? I am reminded of this passage from the classic investment book, One Up on Wall Street, by Peter Lynch: “Centuries ago, people who heard the rooster crowing at sunrise decided that the sound The nape makes the dawn. It sounds silly now, but every day experts confuse cause and effect on Wall Street.”

On Wall Street, the roosters are stock prices. It seems experts are now confusing stock returns with the health of the underlying economy.

Basic is still important. A cock crow (prices rise) doesn’t mean the fundamentals have improved.

For example, by Carvana
CVNA,
-0.30%

business model not working. Unless Carvana raises cash through a secondary offering or a private bailout, the stock price is likely to fall to zero. The hard part about shorting Carvana is that most people know Carvana is in trouble. It doesn’t take long for a short-term offset to make a stock go up very quickly. Obviously then, we can ignore short selling in Carvana when assessing the health of the US economy and corporate earnings.

However, the picture doesn’t look much better when looking at earnings and growth from many Nasdaq-traded names. For example, the alphabet
GOOGL,
-0.14%

is one of my favorites, but its revenue in 2022 is up just 10% from 41% a year earlier. Worse still, the company’s YouTube revenue for the fourth quarter of 2022 fell nearly 8% from the previous quarter. Overall, Alphabet’s EPS fell to $4.56 in 2022 from $5.61 in 2021.

Looking at the fundamentals of the economy, it’s not clear that inflation is actually slowing down as much as the market might lead you to believe. Here is the breakdown from the latest CPI report:

With the exception of used cars and trucks, every other category increased, many of which increased by double digits. Looking at this makes us think we’re still far away The Fed’s target interest rate is 2%. The idea that the Fed will stop raising rates and/or start cutting rates at any time seems unlikely to us.

Calculation with the Fed

We’re not Fed-testers, but we don’t see a soft landing. Raising the federal funds rate essentially from 0% to 5% in less than a year is significant and we don’t think we’ve seen the full impact of that change yet. It’s important to remember that we are in Year One after nearly 14 years of 0% interest rates and quantitative easing.

Many companies like Carvana have a built-in business model and depend on 0% interest rates and easy monetary policy. It will take time for the trillions of dollars of liquidity the Fed has pumped into the market over the past 14 years to disappear from the market. We may be in the early stages of a recession and will not rely on the continued resilience of the labor market and consumer spending as signs that a recession will not occur. go out.

No one can time the next recession, and while we expect one to be imminent, that doesn’t mean you shouldn’t own stocks or buy more of your favorites. themselves during the recession. Each crash usually leads to a great buying opportunity. But we also don’t want to chase this market.

Cody Willard is the founder of 10,000 Days Fund Capital Management and runs 10,000 Days Fund, a hedge fund. Bryce Smith is an analyst at 10,000 Days Fund Capital Management. At the time of publication, Willard, Smith, and the hedge fund purchased GOOGL and have placed positions on CVNA. Location is subject to change at any time and without prior notice.

Than: ‘Not the time to buy’: S&P 500 exits ‘best era’ in decades for earnings growth amid ‘drying up’ liquidity

More: The stock market has just blown off steam after January’s terrible rally. These stocks and ETFs could power the next period.

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