Nowhere To Turn

There’s nothing you can do.

Just as the Fed has no “good” options at a time when combating the proximate cause of record-low consumer sentiment (inflation) means kicking consumers when they’re down (with rate hikes), investors and traders who missed the window to fade the selloff in rates and/or play the bounce in equities, may be bereft.

US equities came into Fed week on track for their best monthly gain since October (simple figure below). But jumping in now risks chasing an ill-fated bear market rally ahead of mega-cap tech earnings and into a second consecutive “largest since 1994” rate hike from the Fed which, in a testament to just how perilous the inflation outlook really is, now counts as a moderately “dovish” outcome.

I’ve tried (really I have), but I can’t get on board with the idea that the end of earnings revisions is anywhere in sight, nor am I particularly enamored with the notion that a (still hypothetical) turn lower in 12-month, headline inflation will prompt a Fed rethink.

On the earnings front, I still think forward estimates for aggregate (i.e., index-level) profits are wholly implausible, even if my view is now incrementally less pessimistic. A huge chunk of S&P market cap reports this week. By Friday, I may be right back to doomsaying or I might be singing the praises of America’s tech titans. We’ll see.

As you can imagine, Morgan Stanley’s Mike Wilson is similarly unconvinced that modest revisions are sufficient. “We are more convicted in our view that bottom-up NTM S&P 500 earnings estimates are too high and have meaningful (i.e. 10%+) downside from the recent peak of $240,” he wrote Monday. “So far, that forecast has only dropped by 0.5% making it difficult for us to agree with the view the market has already priced it,” he added, noting that although he “could be wrong,” the scope of the deterioration in revision breadth is “extraordinary.”

The figure (above) plainly argues in favor of Wilson’s view. “We believe this is just the first of what is likely to be several disappointing quarters before estimates finally trough,” Wilson went on to say. “Therefore, recent positive price action to some earnings cuts is unlikely to be the low for most stocks.”

As for the Fed, consider the amount of pressure they’re under. Although Democrats are wary of job losses (e.g., Elizabeth Warren’s exhortation for Powell to avoid “driving the economy off a cliff”), the White House has declared inflation public enemy number one. It’s certainly Biden’s archenemy in public opinion polls (figure below).

Although this is a somewhat meaningless factoid (some of the “best” presidents had low approval ratings at the same point in their presidencies, including Clinton and Reagan), at 41%, Biden’s approval rating last month was the lowest for any president in modern American history through June of their second year, including Trump. Make no mistake, it wouldn’t be as bad were it not for runaway price growth for gas and food.

So, to the extent the White House believes the Fed is capable of engineering lower inflation, Biden isn’t likely to push back against a hawkish Fed. As an aside, I’d note that the persistence of inflation complicates Biden’s already difficult calculus vis-à-vis the student loan moratorium and potential student debt cancellation. To the extent those currently not paying plan to resume payments once the moratorium ends, canceling their loans is likely to be inflationary. For those who don’t plan to pay (which is a lot of borrowers), I suppose it won’t much matter, although if those balances disappear from credit reports, it could allow scores of former students to open new credit cards and buy homes, which, at the risk of coming across as insensitive, isn’t really what the economy needs right now.

Coming quickly back to the Fed, as much criticism as they’ve endured, I doubt seriously that even an outright collapse in headline CPI would be sufficient to dissuade the next 75bps of hikes following Wednesday’s 75bps move. There’s just too much on the line. The chances of a 2008-style recession are vanishingly small. On Sunday, Robert Holzmann said the ECB may be willing to “endure” a “slight” recession if it meant arresting inflation. The Fed is thinking along the same lines. And they’ll be compelled to say that, explicitly, soon enough.

For market participants, this is a difficult juncture in a perplexing environment — a fork in the road when you’re already hopelessly lost. “With many macro investors positioned for further weakness in both bonds and equities, periods of relief present a challenge: Are they signs of a tradable turn in those trends or a time for patience while waiting to reposition for a resumption of this year’s tightening trend?” Goldman’s Kamakshya Trivedi and Dominic Wilson wondered.

They answered their own question. Sort of: “We think that the impact of the positive supply shock from the commodity price drop that we have already seen — and potentially broader goods price relief ahead  — could still provide some near-term support, but we think it is still probably early to position for the kind of shift in inflation and Fed policy that would mark a convincing trough in bonds and equities and probably too late to chase the relief in areas that have led the recent reversal.”

Again: There’s nothing you can do.