Stocks closed in the red yesterday as traders hoping for a dovish Fed mourned their day-earlier losses. The band wagon of job cutters and hiring freezers is starting to fill up and the markets are taking notice.
An obscure balance. I am going to ask you to turn back time… in your mind. Don’t worry I am not going to go full-retro here. I just want to you try and remember last spring. Ah, springtime. Chirping birds, budding blooms, vivid sunrises… WAIT [record scratch], I am getting off track. There was another heart-warming theme going on during that time. Stocks were booming. Why? Well, for one, earnings growth was off the charts, and that counts for something. That’s not the primary source of elation. Come on, you know what it was. THE FED!
Inflation had just ticked up from the Fed’s target rate of +2.0% to around +4.0%. This rare occurrence was troubling, but given the post-pandemic supply chain problems, it was sure to work itself out quickly---ish. The Fed calmed nerves by writing off the spike as being temporary, transitory. By the onset of summer, inflation bubbled higher to around +5% and transitory was still a buzzword. No worries for stocks, still on the climb. Some astute investors began to worry that the Fed might have to raise interest rates to conquer inflation. That might not be good for stocks, but not to worry. The Fed reminded us that unemployment was still quite high. Actually, unemployment was just below 6%, which is quite high relative to the multi-decade lows we experienced prior to the pandemic. The Fed pointed to a big poster on the conference room wall with a big scale. On one side was JOBS and on the other side was INFLATION. That is, of course, the Fed’s dual mandate. The Fed used that to justify lower interest rates for longer. Oh, sorry, for reference, the Fed Funds rate was 0% during that period. Bond yields were lower than current, though they were higher than their all-time 2020 lows. But still, 10-year Treasury note yields were just north of 1.5% and they ticked lower in the summer as the Fed was determined NOT to raise interest rates. The messaging was that the employment situation had to make a meaningful recovery before the Fed could even consider rate hiking.
Meanwhile, back at the ranch. Crop yields were lower, chickens had to be destroyed due to bird flu, cattle herds were shrinking… microchip orders were late to arrive, assembly lines were frozen, car lots were empty, cash-only bidding wars for homes were all around, gasoline prices had topped $3 a gallon due to the high demand of commuters returning to offices. Now you remember, the prices of everything were rising and it seemed impossible to even find some of things you wanted to buy. You, like me, probably overpaid to replace a pronounced-dead dishwasher.
That left stocks a continued ticket to ride… higher. The Fed messaging was clear “don’t worry about inflation, focus on the weak labor market.” So, we did… and stocks rose higher yet. After all interest rates were at 0% and the Fed had no intention of raising them. UNTIL THEY DID. Interestingly, by Labor Day of 2021, the unemployment rate fell bellow 5% and was on a clear downward trend. The Fed could not ignore that its last reason for holding rates at 0% was slowly fading. The Fed could also not ignore that inflation, after plateauing throughout the summer, began to climb once again. A storm was brewing, and stock investors began to get jumpy causing volatility to rise. Then it came. In November, the unemployment rate was around 4% (it was nearly twice that a year earlier) and the Consumer Price Index / CPI printed at +6.8%. The handwriting was on the wall, but we needed to hear it from Chairman Powell… which we did in his congressional testimony where he mentioned that it may be appropriate to raise rates at some point.
I would like to say, “the rest is history,” but we are still living in the regime that followed this lookback. Remember that poster at Fed HQ of the scale? Well, it has tipped in big way. Unemployment is back to multi-decade, pre-pandemic lows and inflation hovers defiantly at multi-decade highs. What is the market now fixated on? The labor market, of course. Not improving it, but rather, seeing it weaken. You see the Fed has taken to using the labor market, as it had last year, as a driver of policy. Last year it wanted it to improve, and this year, in a complete reversal, it wants to see it decay. Well, the Fed has its hand on the levers of the economy, so whether we like it or not it is incumbent on us to pay attention to what it is doing. The Fed raised Fed Funds in another giant-sized hike 2 days ago and the Chair made it crystal clear that the hiking will continue. We will hear lots more rhetoric from Fed members starting today, as the FOMC meeting blackout period ends. That rhetoric will become reality at the next FOMC meeting a little more than a month from now. Between now and then, we will get 2 monthly employment numbers, 2 CPI releases, and 1 more PCE Deflator to inform the Fed’s decision. That all starts today with the release of October’s employment situation from the Bureau of Labor Statistics. The Unemployment Rate is expected to rise slightly to 3.6%, still low by historical standards. If you are hoping for a rally in stocks, you would like to see that number come in significantly higher and the accompanying Nonfarm Payrolls number to come in significantly lower than expected. After all, the Fed has told us to focus on employment, once again. PS. There no actual poster at the Fed… I took literary license.
WHAT’S SHAKIN
Microchip Technology Inc (MCHP) shares are higher by +9.32% in the premarket after the microcontroller manufacturer announce that it beat EPS and Revenue estimates by +1.25% and +0.56% respectively. The company offered forward guidance that exceed analysts’ estimates. The company relayed that it sees supply chain issues easing and that customer demand was still greater than supply. Dividend yield: 2.20%. Potential average analyst upside potential: +33.8%.
Starbucks Corp (SBUX) shares are higher by +4.48% in the premarket after it announced that it beat EPS and Revenue estimates by +12.40% and +1.24% respectively. The company saw a +7% quarterly increase in same store sales, exceeding estimates. Dividend yield: 2.50%. Potential average analyst upside potential: +15.5%.
PayPal Holdings Inc (PYPL) shares are lower by -6.52% in the premarket after it beat on both EPS and Revenues. However, the company lowered full year guidance below analysts’ estimates. The company experience a slowdown in spending across its platforms and announced that it would be shuttering offices and reducing headcount to lower expenses. Potential average analyst upside potential: +39.8%.
YESTERDAY’S MARKETS
Stocks traded lower yesterday in the wake of hawkish comments from the Fed a day before. The S&P500 fell by -1.06%, the Dow Jones Industrial Average slipped by -0.45%, the Nasdaq Composite Index dropped by -1.73%, and the Russell 2000 declined by -0.53%. Bonds declined and 10-year Treasury Note yields gained +4 basis points 4.15%. Cryptos lost -0.86% and Bitcoin added +0.31%.
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