“Hawkish in the rhetoric but not in the action.” That’s how Jeff Gundlach described the Fed’s surprise announcement that half of the FOMC members supported raising rates an additional 50 basis points this year, even though the Fed declined to raise rates Wednesday. The initial reaction: the S & P 500 dropped 30 points, and yields backed up. But something odd happened during the press conference: it all reversed. The S & P ended at 4,372, exactly where it was at 2 PM when the Fed made its announcement. That’s unusual: lately, stocks have tended to be lower during Powell press conferences. What’s up? There seems to be two potential explanations for the market’s reaction: 1) while surprised, equities are saying it can withstand fed funds moving up another half point, and/or 2) many believe the Fed won’t actually raise rates. Gundlach, the bond king billionaire, doesn’t think the Fed is going to hike again. “Talk is cheap,” he said. But an equally strong argument can be made that after more than 500 basis points of rate hikes, stocks can handle another 50 basis points. The main evidence: the Fed statement itself. The Fed reiterated that “job gains have been robust” and then proceeded to raise its estimates for GDP, and lowered its estimate for how high the unemployment rate will rise. In the press conference, Powell said that “the conditions we need to see to get inflation down are coming into place,” but the process is still going to take some time. Sounds like a soft landing. Just don’t say it Powell declined to endorse a soft landing for the economy, but he reiterated there is a path to getting inflation to 2% without seeing the kind of sharp downturn and large job losses that we’ve seen so many other times. In English: I am not saying a soft landing is happening, but we could make it. The stock market certainly believes in the soft landing. The S & P 500 is trading at a nearly 19 times forward multiple, which is not only not a recessionary multiple, it is a multiple typically associated with an expanding economy. Goldman Sachs also seems to believe it: it says the labor market, while still resilient, is showing signs of normalizing, inflation is moderating and the economy is stabilizing. “The combination of a stabilizing economy with normalizing inflation leaves us with a 2023 growth forecast of 1.8% (annual average), well above both the private-sector consensus and the Fed’s view,” Goldman said in a note after the FOMC statement came out. Their odds of a recession: 25%. Here’s what really may be driving the Fed’s decision to be more hawkish than expected: Powell says forecasters, including those at the Fed, have consistently thought inflation was turning down, and have been wrong. He seems to be saying, “Better to overtighten than lose credibility.” Where do stocks go, and what does low volume mean? The market has a different problem: short-term it is very overbought but, more importantly, it is pushing the limits of the soft landing story. The S & P is up nearly 5% this month alone on a belief the job market will remain strong and the Fed is done. The main hope for the market now is that the mountain of skeptics still waiting for the recession to begin, still waiting on the sidelines, will begin to capitulate. Bulls point to recent trading volume, which has been awful. Even ETF volumes have been terrible. It seems clear the recent rise in the market has been largely due to a lack of selling interest, rather than some huge spate of buying enthusiasm. That is true: stocks can rise on light volume if sellers have been exhausted. However, the meteoric rise of options trading in the last few years has made watching volume a bit less reliable as a demand indicator. “Twenty years ago, if an investor wanted to invest in a stock, say ahead of earnings or a Fed meeting, they would have had to buy the actual stock and their activity would show up in volume,” Jeffrey Yale Rubin at Birinyi Associates told me. “But the growth and availability of options has enabled traders to still take a directional bet on an individual stock all the while having less capital committed had they actually bought the stock.” Regardless: the bulls have a point. A lot of investors are still on the sidelines, particularly those sitting in short-term Treasury bills. Remember all those people who piled into short-term Treasuries in March and April? They were delighted to get 4.5%-5.0% on their investment. But the S & P is up over 500 points (more than 13%) since bottoming at 3,855 on March 13th. Will all those investors happy to get 5% on their T-bills then catch FOMO now, and finally go back into stocks? And we may not even be able to claim there are mountains of investors on the sidelines for much longer. The latest American Association of Individual Investors (AAII) weekly survey showed bulls at 45.2%, the highest since November 2021. Bears are at 22.7%, the lowest since July 2021.
