Market Update, Economic Outlook

Market Update: Fighting the Fed

February 03, 2023

There is an adage on Wall Street “Don’t fight the Fed”[i], which describes the relationship between Fed policy and the equity market. Essentially, accommodative Fed policy provides market liquidity and ripe conditions for positive equity market returns – i.e., buy stocks. And vice-versa, restrictive Fed policy drains liquidity and hinders equity market returns – i.e., sell stocks.

As we know, forty-year high inflation levels forced the Fed to move to a restrictive policy stance resulting in 425 bp of Fed funds rate increases and a 18.1% decline in the S&P 500 in 2022[ii].

Investors, always a forward looking and optimistic bunch (at least most of us), are now looking for that Fed ‘pivot’ to a more accommodative policy position and the start to the next bull market. Bullish outlooks, and the catalyst for recent market strength, point to decelerating inflation trends that will allow the Fed to soon halt rate increases and even begin cutting rates by late 2023[iii]. Fed chair Jerome Powell and the FOMC[iv] acknowledge the ease in inflation pressures, but their “…forecast is that it will take some time and patience and that we’ll need to keep rates higher for longer.”[v] It looks like investors are setting themselves up for a little bit of a fight.

Our own view is that the market may be just a bit ahead of itself. Even if the battle against inflation is won and the Fed begins its ‘pivot’, we are likely facing an economic slowdown, the depths of which are still quite uncertain.

As such, we maintain a cautious outlook on stock prices. The current 18.5x price/earnings ratio for the S&P 500 based on the FactSet consensus 2023 earnings estimate (the 2023 earnings estimate has fallen approximately 10% since June 2022[vi] and we expect it to fall further) seems to already discount best-case scenarios and leaves little room for disappointment – or the Fed landing a right-hook square to the jaw.

As mentioned in several of our recent outlooks, we expect volatility in the financial markets to remain somewhat elevated over the near term as investors looking for ‘pivot’ points evaluate earnings results, economic data and Fed ‘speak’, which will undoubtedly provide fodder for both bulls and bears – and bull and bear tug of wars. While the market fights it out, we suggest being prepared for near-term liquidity needs, but keep focus on your long-term investment goals.

Please reach out to your investment team should you have any concerns regarding the financial markets, economy, or your portfolio.

[i] Attributable to investor Martin Zweig

[ii] FactSet

[iii] Based on Fed funds futures - CME FedWatch Tool

[iv] Federal Open Market Committee – the committee of Federal Reserve Board of Governors and regional Fed Bank presidents that determines Fed monetary policy

[v] Transcript of Chair Powell’s post FOMC meeting press conference – February 1, 2023.

[vi] FactSet. S&P 500 2/2/23 closing price of 4,180 and FactSet consensus 2023 S&P 500 EPS of $226 (1/27/23)

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