There is more than an equal chance that the Federal Reserve will raise interest rates by at least 25 basis points by the end of March 2022. Several analysts expect three more hikes by the end of March. the year. As an equity investor, this should concern you.
This week, the Consumer Price Index and the Producer Price Index came in as expected. But “expected” doesn’t mean anything good on the inflation front. On an annual basis, the CPI increased by 7%, while the PPI reached 9.7% for the whole of 2021.
And while economists wonder whether inflation and economic growth will ease this year, the omicron variant throws a big bend in those forecasts.
In my January 13, 2022 column “Defections Threaten the Economy,” I highlighted that millions of workers in the global workforce have been forced out of work while recovering from this highly contagious variant. It also created additional delays in the supply chain. Container and cargo congestion is growing among the top 20 ports in the world.
Since much of the rise in inflation was caused by supply chain issues, the short-term impact of more delays indicates to me a higher rate of inflation in the future. . As such, the Fed seems honour-bound to raise rates faster (and possibly 50 basis points, instead of the expected 25) in order to deliver on its promise to contain inflation.
But the bond vigilantes of the bond markets have already taken matters into their own hands. They pushed the yield on US 10-year bonds up to 1.72%. At one point this week, it soared above 1.8%. Most bond traders now expect yields to rise to 2% over the next few months.
So foreign investors, who typically line up to buy U.S. Treasury bonds at frequent government auctions, haven’t been as eager to do so. This week’s 10 and 30 year auctions were at their best. None of this has been good for the stock market.
If you’ve read my columns, you know that tech companies don’t do well in a rising interest rate environment. The best performing stocks, meaning stocks with little or no earnings but huge price gains, have felt the brunt of the downward pressure. But even the big players are feeling the pressure at this point, with the NASDAQ 100 down 10% from its highs.
Every time these market favorites try to rise again, they get pounded again. Investors, trained to “buy the dip”, have their fingers cut off. In fact, under most indices, anything that qualifies as speculative, be it crypto, electric vehicles, marijuana stocks, Fintech, etc., has been burned at the stake.
Readers who took my advice have hopefully avoided much of the carnage. If you haven’t taken action to reduce leverage in your portfolios, there’s still time. I expect we will see a rebound from oversold in the stock market on Tuesday next week for a few days. Why?
Earnings season is now upon us. Most investors eagerly anticipate the results of “FANG” companies and usually buy stocks in anticipation of this event. Since they represent such a large weighting in the overall market, FANG’s excellent earnings generally support the overall market. As such, I would expect the same to happen again.
The fly in this ointment is that while the earnings may be stellar, the tips won’t. Between the omicron variant, supply chain issues, inflation, and the Fed’s tightening stance on interest rates, the short-term future that FANG executives envision, I guess, doesn’t may not be as rosy as many investors expect.
If I’m right and the markets rebound, take the opportunity to reduce your exposure to the overall market. I’m still looking for a serious fix in the coming weeks. If the correction is strong enough, it’s likely that the Fed will back off on further tightening, but at this point that’s just a guess based on the Fed’s past behavior. Anyway, we’ll cross that bridge when we get there.
Bill Schmick is registered as an investment adviser representing Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401 or by email at [email protected]