As January comes to an end, stocks continue to act volatile. On Monday of this week, the S&P 500 put in a near-term low just above the 4,200 level before rallying to just above 4,400 on Wednesday. The 2-day rally happened ahead of the conclusion to the Federal Reserve’s January meeting of governors.
Following the meeting, Chairman Powell did his best to thread a needle with his comments. If he suggested more Fed tightening is coming than the Market expects, he risks sending stocks into a spiral. If he suggested too little action to control inflation, he runs the risk of accelerating it even further.
We think the Chairman did a great job of telegraphing to the Market a deliberate and reasonable approach to inflation. However, his comments were light on specifics and therefore question marks remain for stocks. This is what will allow volatility to persist through the end of this year.
In March of 2020, the Fed’s decisive actions to ease monetary policy, along with similar steps taken by the Treasury, prevented economic Armageddon despite the world economy shutting down. Since then, the Fed has kept its foot on the economic accelerator to prevent the continuing pandemic to derail the recovery.
The economy, while still showing signs of weakness in certain areas, appears to be healthy enough for the Fed to back off their effort to stimulate the economy any further. Employment has returned to healthy levels while rising inflation has set off fears of a return to the 1970’s and early 80’s.
We do not share the fear that inflation will continue to rise or even stay at current levels. Many forces are at work that will bring inflation down. Notably, the supply chain continuing to come online along with seasonal forces and productivity gains.
It is important to remember what we have been telling clients for several years. The Fed has been fighting the forces of DEFLATION since the Great Recession with little help from the Federal Government in the form of fiscal stimulus. It has been a long and drawn out fight but they appear to have won.
While inflation is a “silent thief” that steals the purchasing power of consumers, deflation is even more sinister in its impact on the economy. While inflation pushes prices higher causing a drop in demand, deflation leads to sharply decreasing prices which leads to a drop in supply. As manufacturers reduce supply in response to lower prices, this leads to layoffs and ultimately lower demand and a vicious cycle ensues.
Combating deflation is what led the Fed to Quantitative Easing and Zero Interest Rate Policy. Only when the Treasury stepped up, in response to COVID, and the Fed dug deep into their quiver for even more Quantitative Easing, did the threat of deflation go away. The spike in inflation is a signal that the war against deflation has been won. This spike will not last but the risk of policy mistakes that might lead to rising inflation is there.
On Wednesday, Chairman Powell did a solid job of laying out the path that lay ahead. This path has its share of forks in it based on how economic data plays out, but this path will ultimately lead the economy to firm footing with modest inflation and no threat of deflation.
We expect stocks to retest the low of Monday. This means the S&P 500 could see a 2-3% decline from today’s levels before finding support as early as next week. Sentiment is quite negative for stocks at the moment. This is a good set up for stocks as too much enthusiasm means all the buyers are in and only sellers remain. Negative sentiment means the buyers are on the sideline waiting to come in to the market.
A rally in stocks is what we expect to take shape soon. This rally could take us close to all time highs in the S&P 500 Index but we remain cautious in our outlook through the 2nd and 3rd quarter of this year. In response to any significant rally, we will be net sellers of stocks in our managed accounts. Taking profits soon will put us in a position later this year to take advantage of what we think will be a solid buying opportunity around the election.
As the Chairman describes the Fed’s approach to interest rate policy, KIG is “data dependent” when it comes to forecasting. While we maintain an outlook for stocks and the economy, we stand ready to tack the sails if the prevailing winds shift on us.
So, expect a retest of the recent low in the SP 500 Index, before a healthy bounce ensues. Expect the middle of the year to feel bumpy and scary. Around the election, as many question marks about future Fed and fiscal policy are answered, expect stocks to rally into the end of the year.
On a humble note, we want to thank everyone who voted Kessler Investment Group, LLC as “Best in Investment Service” in the annual People’s Choice section of The Republic. All of us here at KIG are passionate about our work and will continue to do our best for those we serve.
Kessler Investment Group, LLC
All information in this presentation is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic performance data is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Certain statements contained within are forward looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Please consult your adviser for further information.
Opinions shared in this presentation are not intended to provide specific advice and should not be construed as recommendations for any individual. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.