Stocks had a mixed close yesterday but were mostly lower as recession fears could not be shaken off. Stocks had another wild, roller coaster of a day yesterday underscoring the reality that we just ain’t there yet when it comes to investor sentiment.
Pick your poison. Is it the Fed and higher interest rates that are bothering you, or is it the potential for a recession…or both? It is kind-of a catch 22 isn’t it. If the Fed thinks that the economy is going to head south, it slows its rate hikes or even lowers them, and stocks respond with a rally. Accentuating the rally would be bond traders bringing yields lower on long maturity treasuries, which would be lapped up by bullish tech investors, driving those shares higher. It sounds good to you until you remember that the reason for the rally was…potential for a recession. We saw that scenario play out with just a subtle hint by Fed Chair Jerome Powell last Friday which sent stocks higher. The markets have been expecting at least two 50 basis point rate hikes in both June and July, however there is an underlying fear that the Fed may surprise us with some larger moves, say, +75 basis points. The reason for the fear is last week’s inflation figures which came in hotter than expected. Further, are some more hawkish Fed governors that have aired their opinions on more aggressive hikes. So, when Powell suggested in a radio interview that the Fed would not raise in +75 basis point intervals, markets responded with a relief rally. By yesterday however, the excitement wore off and traders found it difficult to make any positive intraday rallies stick, resulting in a volatile session. These moves are typical as beleaguered bulls wrestle with stampeding bears to regain control over the markets once again. So, what’s it going to be, a more aggressive Fed, a less aggressive Fed, or a recession? Don’t worry if you don’t have the answer, no one really knows at this point.
According to some strategists, tighter monetary policy could take between 6 and 24 months to have a negative effect on the economy. Remember, the whole reason for the Fed’s hawkish policy is to get consumers and businesses to spend less aggressively in order to enable inflation to moderate. Of course, that “less aggressive” spending will result in an economic slowdown. So, if those strategists are correct, we could experience an economic slowdown anywhere from September this year through March of 2024, assuming we started the doomsday clock when the Fed first raised its key lending rate in March, earlier this year. Fed Funds are now at 75 basis points, but according to most economists the Funds rate is still far away from slowing the economy. That rate, known as r-star (r*), or the neutral rate is about +175 basis points higher, somewhere around 2.5%. The 2 expected +50 basis point hikes in June and July would certainly get us closer, but we would still need at least 2 more hikes to get to r-star, or beyond. Well, it just so happens that Fed Funds future have factored those in already, expecting the key lending rate to be at around 2.77% in December. That means that somewhere between July and December, some combination of hikes will get us +200 basis points higher. So, is that the point at which we start the doomsday clock for recession? That would bring us to next (not this) summer for a potential recession. Does all this mean that the Fed will actually raise rates by +50 basis points 4 more times between now and the end of the year? Further, does this all mean that we are going to experience a recession? The answers to those questions are “no” and “no”, not necessarily. Despite the rhetoric, the Fed is not keen on putting the economy into a recession, instead it is seeking a soft landing, which would be a moderation in consumption and lower inflation, without recession. The Fed can only achieve this if consumers pull back just enough, but not too much, to cause companies to lower their prices, or at least stop them from growing by +8.3% (last week’s CPI release). The Fed can only achieve this by being extremely responsive to real time economic signals. In other words, it must take its foot off the brakes at the first hint of economic decline. These subtle negative signs can and already have begun to appear. An example is yesterday’s minor economic release of Empire State Manufacturing, a regional Fed report put out by the NY Federal Reserve. It is a survey of manufacturing entities in the NY Fed’s region, as its name implies. It came in at -11.6% while economists were expecting a +15% difference between surveyed businesses reporting positive versus negative business conditions. Last month that number was at +24.6%, making the -36.2% month over month swing in sentiment the second largest deterioration of perceived business conditions on record behind, you guessed it, April 2020, the start of the pandemic. Now, regional Fed reports do not typically get a lot of fanfare in the markets, and New York is hardly the manufacturing center of the country, but one thing can be assured, the Fed is certainly taking notice. Will similar declines happen in other Fed regions? We will have to wait and see as these begin to roll out this week and lead up to June’s FOMC meeting. The market may not take notice, but there are plenty of other headline-grabbing releases to be considered over the 29 days until the next FOMC meeting. Namely, Retail Sales, which will come out this morning. Retail is where it all begins, and that is expected to have grown by +1% in April. Anything short will certainly be noticed by the Fed…and the market. Bad, in this case, may be perceived as good…by the markets at least.
WHAT’S SHAKIN’
Walmart Inc (WMT) shares are lower by -6.75% in the premarket after it announced that it missed EPS estimates by -12.06% while beating revenues by +1.78%. The company lowered its full-year EPS guidance to reflect a -1% decline after it was expecting slight growth. Dividend yield: 1.51%. Potential average analyst target upside: +11.2%.
Take-Two Interactive Software Inc (TTWO) shares are higher by +5.35% after it announced that it had beat EPS estimates by +11.22% while missing Revenue targets by -2.79%. Despite the revenue miss and its weaker forward guidance, its pipeline of upcoming releases is expected to drive sales higher in the quarters ahead. Potential average analyst target upside: +66.7%.
YESTERDAY’S MARKETS
Stocks attempted rallies several times during yesterday's session ultimately pulling back for a mixed close as investors remain concerned over Fed policy and the possibility of recession. The S&P500 slipped by -0.39%, the Dow Jones Industrial Average rose by a slight +0.08%, the Nasdaq Composite Index fell by -1.20%, and the Russell 200 Index gave up –0.52%. Bonds gained ground and 10-year Treasury Note yields fell by -3 basis points to 2.88%. Cryptos declined by -1.15% and Bitcoin gave up -3.58%.
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