Fed Says Hawk and Investors Hear Dove

Once again, Fed Chair Powell raised interest rates at the February 1st FOMC meeting and announced he would remain a monetary Hawk, raising rates even further and draining loanable reserves from the banking system for as long as it takes to bring core PCE inflation down from 4.4% to 2%. Powell added that he expected no Fed rate cuts this year. Investors heard this message loud and clear as a pivot to Dovishness, concluding that the Fed is winning the inflation battle, which will result in the Fed cutting rates later this year. Stock prices took this myopic view of faux Dovish comments and busted out to 5-month highs.  Stocks were undeterred by a 4 year low in beating estimated earnings this season.

Valuation concerns bottomed out in the 2nd and 3rd quarters of 2022, down significantly from their 28x high. Current Price – Earnings multiples bouncing between 16 and 19x are fair if there is no serious recession later this year.

The stock market views inflation as being in an entrenched downtrend and is ready to look past disappointing earnings in the same way it’s whistling past the Fed’s graveyard of future interest rates hikes. Our forecasts have been outlining a better-than-expected economy and targeting a near term stock market rally into an important high near mid-February in the S&P 4200’s. Equity indices are well ahead of schedule, having hit our resistance zone on February 2nd. Surprisngly, only a handful of our many indicators show a significant degree of being overbought here, so it’s possible that the strengthening economic data will push values above our resistance into the 4300’s with an elevated 19 Price-Earnings multiple. However, by the 2nd half of February, we expect investor momentum to run out of gas.

The large cap Dow has lagged the New Year rally, while the broad-based small cap Russell has outperformed. Seasonality has favored small cap and tech as well into a February top as compared to the Dow or S&P 500 Index.

Two of our three main stock market oscillators below are in the clear overbought zone warranting some caution ahead. The real test that may clarify the 2023 outlook will arrive when our expected correction period begins to climax in March. Should the S&P hold above the lows from December at our March low, in the 10% correction zone, it will be a healthy sign that further new highs are attainable in the 2nd quarter with small cap and growth leading the charge. A push under S&P 3800, negating the higher lows uptrend, would instead kneecap the market for the next few months and warrant a defensive posture. With inflation falling, unemployment at 54-year lows and healthy personal consumption levels, it’s understandable that longer dated free market interest rates (bonds) outside of the Fed’s purview are falling. This creates an even more inverted yield curve as the Fed forces short term rates higher while investors gobble up long term maturities, anticipating a return to a pre-Covid world of low yields.  The current round of weaker corporate earnings was already priced into stock prices at the lows last October when the S&P 500 was down 27% and the Nasdaq lower by over 36%. Small Cap estimated forward price to earning valuations reached historic lows a few months ago, indicating that most of the recession fear had been dealt with. Until there are indications of a new economic deceleration toward a serious recession, sentiment will continue to move in favor of no recession this year. The major investment houses expect significant weakness ahead, yet recent economic data shows an uptrend with falling inflation, which has provided an adrenaline boost for investors in the New year.




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