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Old Belief Systems Die Hard

CAMS Weekly View from the Corner – Week ending 12/16/2022

December 19, 2022

When the Chairman of the Federal Reserve approaches a podium with prepared comments in advance of a much anticipated press conference we can trust said comments are scrubbed over in detail in order to ensure the intended message is being conveyed. With this in mind while also stepping back and looking through the lens of recent decades the Federal Reserve has accommodated, or back-stopped markets time and again with cheap and easy monetary policy anytime the going got a little rough in market(s) land.  This became well known as the “Fed Put” and has become an entrenched expectation of Fed behavior among collective market participants as recent decades have unfolded.  Has this changed?  Hold the thought. In their defense why wouldn’t they entrench such a belief system with collective human behavior being what it is (do something consistently enough and expectations adjust in that direction) in light of the consistency of Fed actions over so many years.  Underlying the Fed Put was a theory that offered a “wealth effect” would kick in whereby as asset prices rose and people became wealthier it would ultimately raise all boats throughout the economic system.  Unfortunately, not all theories pan out into reality given enough time.  The wealth effect approach did not raise wages nearly as much as it benefitted asset prices It was through this process where the adage “bad news is good news” evolved in that a touch of bad news and surely the Fed Put would kick in and make it all good again – in asset markets at least.  Market participants seem to continue to be hard-wired to the Fed Put/wealth effect and bad news is good news approach and seemingly cannot fathom a world different from this in light of Fed behavior in recent decades.  Price Inflation is the Bogeyman In the recent decades alluded to what was not present was a price inflation backdrop that came anywhere near the levels experienced in the previous two years.  This price inflation is sticky. Chairman Powell may be trying to emphasize to all involved that times have changed and the Fed Put/wealth effect approach is over as the Fed is in a dogfight against this sticky price inflation issue regardless of how bad Wall Street/collective market participants may want them to abandon their price inflation diligence. Circling back to our opening paragraph whereby the Fed Chairman’s prepared remarks are scrubbed to detail; at last Wednesday’s press conference Chairman Powell opened specifically addressing the American citizenry rather than the more broadly used “families and businesses” as has been the case in recent opening remarks.  In addition, he immediately reemphasized their 2% inflation objective.  As Fed Chief he is the nation’s chief banker and seems to be sending that message to the citizenry and perhaps simultaneously offering a subtle message to market participants that market difficulties are on the back burner of concern.  The front-and-center concern is that of the citizenry at large and the debilitating price inflation the everyday citizen is experiencing.  Regardless of whether this was his intention clearly the overarching message in last Wednesday’s press conference was price inflation as well as their 2% objective which was presented in drumbeat fashion to emphasize they are not letting up on their focus.  Updated Price Inflation – Is The Progress Hyped-up?  Progress in any endeavor is a subjective statement.  One person’s view of the same result can be labeled “progress” while another’s may be much less enthusiastic.  Importantly, Chairman Powell has emphasized in recent statements and press conferences that headline price inflation measures are not the focus.  The focus is more inside the price inflation storyline via metrics such as Services, Core Services ex-housing, Core CPI and Core PCE to mention a few. In keeping with the Fed’s focus below are Core CPI, CPI Services and the Cleveland Fed’s Median CPI.  All three are more drilled down measures identifying how deep and broad within the economic system price inflation continues to be.  You can assign your own description of progress or lack of accordingly. All three reflect the year-over-year percentage increases in the price inflation measures and all date back 30 years.  Our red arrows highlight how our current readings have no experience to compare to in the three decades depicted.  Said differently, if the Fed is truly serious about their 2% price inflation objective our current price inflation level remains historically high as well as miles north of their stated objective.

Want a Peek Into the Immediate Future? Chairman Powell has shared numerous details in what the Committee is looking at in terms of price inflation measures as well as underlying economic inputs for the various measures. One underlying input that we will highlight is wage growth rates being we have shared views on it throughout numerous editions since the price inflation story took hold.  In light of the Chairman’s focus on the employment market and wage growth rates as one of several underlying inputs of the price inflation backdrop, in coming weeks and months these measures will be market movers.  With this the proverbial “bad news is good news” can take hold if the employment market weakens and/or wage growth rates weaken notably and we would not be surprised if such news is met with a positive stock market reaction.  The question is of course will it be a day or week long positive type reaction or can it be more substantive.  To underline this forward point we quote Chairman Powell from last Wednesday’s press conference:

“And it’s very fundamentally about the labor market and wages. If you look at wages, look at the average hourly earnings number we got with the last payrolls report, you don’t really see much progress in terms of average hourly earnings coming down.  But we will be looking for wages moving, you know, down to more normal levels where workers are doing well and, ultimately, their gains are not being eaten up by inflation.” https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20221214.pdf We want strong wage increases. We just want them to be at a level that’s consistent with 2 percent inflation. Right now that — if you put into — if you factor in productivity estimates, standard productivity estimates, wages are running, you know, well above what would be consistent with 2 percent inflation. https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20221214.pdf

We have to acknowledge that nothing is certain with the Fed in light of its history.  Even as we continue to openly acknowledge and emphasize how serious, firm and committed they are in this price inflation battle will they continue?  That is the question but to this point they have continued to be relentless in their actions and their public comments.  With this markets may be setting themselves up for downside as collective participants continue to seemingly insist that their old belief systems relative to the Fed are accurately intact.  2022 – It’s a Wrap! This is our last Weekly View for 2022.  We appreciate your readership and if you have also entrusted us with managing your assets we sincerely thank you.  It has been quite a year in 2022 with 2023 offering a wealth of twists and turns to navigate as well.  We will pick back up on the Econ/Market trail with these Views in early January.  Merry Christmas and Happy New Year to you and yours!  I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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