Lesson not learned

How the stock market keeps getting it wrong about the Fed and what to about if you are a tech CEO/CFO

When someone has been your friend for such a long time, it can be hard to admit that they are no longer fighting in your corner. That friend is now your enemy. This harsh lesson is not being accepted by tech investors, and Powell is determined to teach this lesson to markets.

Entrepreneurs have been waiting for a window to raise money and so are watching what he is doing with interest. If you are a CEO/CFO here is what you need to know:

The Bad News

1. The Fed will act forcefully and it will take time - read this as rates are going to continue to move higher and will likely stay high. Economists right now are forecasting rates to rise to just under 4% by the end of the year and then stay there for all of 2023 as we wait for inflation to trickle down before rate cuts resume by end of 2023 or 2024 earliest.

2. Labour market is red hot - demand is exceeding supply. Job cuts have had some impact on open positions but that is just easing the labor shortage from a record high. What The Fed is terrified of is spiralling wage inflation. That is very hard to reign in once it starts.
   
   This chart of job openings from JOLTS shows the demand supply mismatch. Job openings are highly elevated compared to history, despite reports of extensive layoffs. Yes, we have come off a bit, but we are still at record highs.

   

   
   

3. Recession - The Fed is ready for a recession if that is what it takes to tame inflation.

4. Consumer sentiment is very depressed. In fact its the worst on record (see University of Michigan Survey below, chart is back to the 60s)
   

   

5. Is the market cheap? No. There are many measures we can look at but the one below shows the equity risk premium from S&P (How much am I being paid to take equity risk) it has barely budged from the highs (i.e. the market has just adjusted to higher rates but not recession risk.)
   
   

   

6. Curve Balls - Three major curve balls that I see. The strong like a bull USD is acting like a wrecking ball for the world. Emerging markets are particularly being impacted negatively. Once we have line of sight to a peak in rates, hopefully it calms down but if USD marches higher its a big risk (just look back at 98 Asian crisis, Argentina default, Mexican debt crisis etc). Second is Sovereign risk. Japan and Europe (or more specifically Italy) have huge debt burdens coupled with ageing populations and government policy that is setting up a potential economic time bomb. China’s property market is collapsing after years of excess and banks are going bust. So far all these issues are contained but if the rat was to escape is could cause everyone huge issues. The third is more to do with social unrest from higher energy prices this Winter. Germany has done a great job in destroying demand aggressively so it looks like they will stave off a total energy collapse but heating is going to be very expensive and the poorest in Europe and the UK are going to be hurting.
   

The Good news

1. Commodity prices are no longer rising (but they also aren’t really falling anymore either)
   

   

2. Auto prices are set to fall towards the end of the year (was contributing to US inflation but hadn’t affected Asia as much)

3. Consumer Debt - remains under control with very low defaults, so far and consumer spending still is robust (even if that is shifting to credit cards)

4. Asian countries - Are in a far better fiscal and policy position then in both 1998 and 2008. Most countries have some sort of energy price subsidy or cap which isn’t sustainable in the long run but in the short run is containing inflation. Signs of fiscal and monetary excess that were so obvious in the past are less prevelant (except China) and are far less reliant on external borrowing than in the past. If there is going to be a battle, Asia is in fighting shape.
   

   

   
   

Conclusion

1. The Fed is not going to save us. They are here to do a job which is to control inflation. Capex/hiring decisions are sentiment driven and so markets still trading at this level is going to frustrate the Fed

2. Markets will remain volatile as we pinball through inflation/no inflation scares

3. Rates are going to stay higher for longer as the Fed waits to see the impact of higher rates, risk is rates go higher than expected not lower

4. We are at least 15 months from seeing rates roll over BUT the good news is that markets usually bottom 6-9 months before the end of the recession. That could mean that 2H 2023 we could see things improve and the fund raising environment start to pick up again.