Tomorrow (May 3) we will learn whether the Federal Reserve will raise the Fed Funds Rate by 25 basis points (1/4 of 1%) or whether they will leave rates alone. The market expects a quarter point hike along with guidance from the Fed Chairman that further hikes are on hold for the time being.
Our expectation is in line with that of the consensus. We put the odds of a “no hike” decision at around 25%. Regardless of the Fed’s decision, inflation is coming down and future rate hikes are unlikely.
While inflation is coming down, it remains above the Fed’s target of 2%. This is why many still believe the Fed is not done raising interest rates. Many others believe that the full effect of the rate hikes from last year has not been felt by the economy. This is why everyone will be focused on Chairman Powell’s comments at the post-decision news conference.
Investors expect the Chairman to tell us that, while there will not be further rate hikes, there will be no cut in rates for the foreseeable future. If, on the other hand, he suggests that further hikes are expected or that they are contemplating a cut in rates, markets will exhibit an uptick in volatility.
Ultimately, we expect to see inflation moderate and move closer to the Fed’s 2% target. We think stocks are set to move higher and not revisit the October 2022 lows as many others do. We also expect interest rates to decline as economic activity slows.
The S&P 500 Index is up 9% through April despite many experts predicting the first half of the year would see a retest of the October 2022 lows. Not only do we think the October 2022 low will not be retested this year, but we also expect the S&P 500 Index to climb by more than 20% through the end of this year.
The move higher by stocks will not be in a straight line and there will be sectors of the economy that will experience more difficulty than others. Specifically, we expect Financials, Industrials, Energy, Real Estate and Materials stocks to under perform while Technology, Consumer, Utilities, Healthcare and Communications stocks to outperform this year.
The third quarter of 2023 is when we expect to see weakness creep into stocks. We think May and June will be good for stocks, but the late summer could prove difficult as the reality of economic weakness becomes apparent to investors.
An interest rate cut by the Federal Reserve later this year is a distinct possibility no matter how much they want to resist doing so. An increase in the unemployment rate, continued disinflation and a drop in corporate profitability could force the hand of the Fed.
A cut to the Fed Funds rate and/or a healthy selloff in stocks could set the stage for a late-year rally. We expect this to happen and would not be surprised to see stocks approach all-time highs by the end of the year. Never underestimate investors’ appetite for growth if inflation declines and unemployment remains contained to the “white collar” sector.
The fallout from the failure of Silicon Valley Bank continues to impact markets and the economy. Our view is that the approach to investing in bank stocks has materially changed. To this end, we have significantly reduced our exposure to bank stocks and do not expect to see opportunities to invest there in the future. This said, we do expect the largest banks to grow and strengthen while regional and community banks start to languish.
It would not surprise us to see the number of banks in the U.S. (currently 4,000) to decline by half over the next five to ten years. Likewise, we expect to see the four largest banks double in size over the same period. With increased regulation, FDIC insurance costs and a slowing economy, the outlook for small- and mid-sized banks as investments is less than optimal. They will, however, remain solid as deposit and lending institutions.
Despite a dire outlook for the banking industry, we see tremendous growth ahead as Artificial Intelligence (“AI”), continues to grow in acceptance. We believe the impact of AI on the economy and stocks will be as significant as the Internet was during the 90’s and beyond.
AI will affect every business from denim companies, to airlines, to restaurants, to funeral homes, and every company in between. The efficiencies and growth that companies will experience over the next ten years will push stocks to all-time highs and beyond. This growth will offset the debt crisis, inflation fears, political wrangling, and any other impediment to prosperity.
In summary, we expect the Fed to raise rates by 25 basis points (for good measure) and indicate no further hikes for now. Stocks should be volatile but ultimately settle down before heading higher through June. A difficult third quarter for stocks could set up for a rally in the fourth quarter taking the major indices to 12-month highs.
The risk to stocks is that the Federal Reserve tightens too much and sends the economy into a deeper recession than the one we expect. While the Fed has clearly stated they will raise and hold rates as long as it takes to bring inflation down, they are also on record telling us they do not want to be part of the problem when it comes to the economy. A quarter point hike should not hurt the economy, but an indication that future hikes are on hold should help stocks. Time will tell.
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.