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Larry Berman CFA, CMT, CTA A Comment -- General Comments From an Expert A Commentary COMMENT Aug 12, 2024
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Yes. The Fed is always late; that's not a fault, it's the result of the process. Only the history books will tell us whether they've been too late. Too late means that they don't act until there's an event that they could have prevented if they'd acted earlier.
He can't see any indications showing that the US economy is in the path of harm. But these things can happen fairly quickly. There's no question that the labour markets are weakening, but "weakening" is a lot different from "weak". Fed Chair Powell has been very fond of saying that they're "data dependent". They have to wait until they see something before they act, can't just act on an idea.
It's a serious issue, they have to be measured, and they're doing that.
He expects 25 bps. Could easily do 50, but that might send the wrong message. If the market senses that the Fed is lowing rates because they're fearful of a weak economy, it will react very poorly. The Fed doesn't want to upset the markets, they want to be benign as they relate to the market.
It's not a very well hidden fact that this is just the start. He fully expects that before this cycle is finished, we'll see at least 100 bps drop in rates (even if that moves into 2026).
It'll be interesting to see how the markets do react to this afternoon's press conference. It's not the 25 bps that markets will react to. He's waiting to see if the tone is dovish or hawkish, how many dissents on the board there are, and how many board members would have actually preferred 50 bps. He'll be watching how the market grapples with the message from the written side (decision itself, dissents, dot plots) and from the nuances (how Powell answers questions).
It's all become highly politicized. Well known that President Trump wants to see rates fall, and he's populating the Fed with "his choices". This isn't new. We can go back to the times of Nixon and Ford to see examples of the many presidents who have pressured the Fed to move in a certain way, and who would appoint people to do their bidding for them. It hasn't always worked out so well.
He's in favour of the Fed remaining as independent as possible. But he also understands the reality of the politics surrounding the Federal Reserve.
In terms of quality, hard to argue against JPM -- best of breed. GS is tops on the investment banking side. If you're looking at valuation and opportunity, Citi would be a very good choice.
In the middle you have money-centre banks like WFC. BAC is also mid-tier. It's not as inexpensive as Citi, and doesn't have quite the pedigree of JPM, but positioned well to do very good things on earnings with a steepening of the yield curve.
He's overweight the banks, and has been for quite some time in anticipation of what's coming this afternoon from the Fed. The whole idea of investing is to get ahead of the money flow and not chase it.
Most product that retailers carry comes from a foreign jurisdiction. The reason is that we've gone through a couple of decades of globalization, where it was cheaper to produce in those foreign jurisdictions and so the model worked.
We're reversing that, but not doing it over a couple of decades. We're reversing it over a very short period of time. Ultimately, these tariffs have to be paid for by someone. Even though some companies might say they'll absorb them, the pressure will be relentless for them to pass them on to the customer. It's just a matter of how and when so there's the least amount of damage to their brand, company, and stock.
Jay Powell's rate cut of 25 basis points made a lot of sense, given the weakening job picture. But the market reaction was all over the place. The Fed did not surprise at all. Some investors were deluded into thinking Powell would give in to Washington and cut 50 points. He doesn't buy or sell stocks according to rate announcements.
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Market pricing in a US recession?
Last Monday's meltdown was frustrating, because you couldn't trade anything in Toronto on the Civic Holiday. He expected markets, after a shock like that, to bounce. And they did. He's not convinced that it's the beginning of another leg up. Lots more volatility to come. Calls for an emergency Fed cut were just crazy; a gap down of 20-25% may have made the case. No real credit stress to support such a move.
What is the market volatility telling us now? If you believe that it means recession, not just leverage being unwound, slowing economy, and Fed cutting cut rates, then equity markets are still grossly overvalued.
Look at a chart that tracks the S&P 500 along with times of recession. If you look at EPS on a trailing basis, when we go into a recession, EPS turn down. Always. The only questions for discussion are how much and for how long? Not "if". It's going to happen.
Another chart shows forward-based earnings expectations for the S&P for the current year, 1 year out, and 2 years out. Expectations going out show expectations of 10%, 13%, and 8% over the next 3 years. There's a recession coming. Those numbers aren't going to happen. Such a chart only makes sense if the Fed gets the calls perfect. At best, we go sideways.
There's no way with the most aggressive tightening cycle we've ever seen, and the whole rebalancing of the world, that this is a perfect outcome. Caution is still the message. Don't chase. Don't run out and buy the dip. If you're a day trader, that's all well and good. But if you're thinking long-term, strategic, you want to be defensive. Markets are very fully priced, rich, priced for perfection.
Months ago, he shifted his entire portfolio from public markets to private. Over the next year or two, the ride in the private markets will be much more friendly for returns than in the public space.
See his blog today for more details. If you look at history, the average bear market correction in a recession is 29% for the S&P 500. In 2022, we got a 20+% correction, but there was no recession. Many people think we're going higher, but he's not in that camp. Be defensive.