Head(wind)s or Tail(wind)s

Fed Announces its First Rate Hike During FOMC Meeting 

Today, the Fed announced the continuation of their policy towards normalization, beginning with the expected 25 bps rate hike, the first since 2018. The committee now expects to raise rates 7x in 2022 and importantly, to get to 2.8% Fed Funds Rate next year. This is above their neutral rate, and more restrictive than expected. The Fed expects GDP to be 2.8% in 2022 and 2.2% in 2023, which is still above trend. They also now forecast Core PCE to be 4.1% this year, falling to 2.6% next year. They believe the unemployment rate will be 3.5% and remain there for the next two years after 2022. We continue to believe the Fed will be data dependent this year and next, to measure if their new tighter policies have an impact on inflation and GDP growth.   

It’s important to consider the Fed has a dual mandate of employment and inflation. Employment is basically where it should be and has drastically improved, post pandemic. Inflation is much higher and this is why the Fed is taking action. It’s also important to remember the US economic data remains above trend in ISMs, PMIs, Factory orders, Durable goods…and the consumer remains strong. In fact, Retail Sales reported today is up a robust 25% from 2 years ago. 

Chart 1: The ISM Survey is a Diffusion Index; Levels Above 50 Represent Expansion¹ 

Chart 2: Strong Retail Sales and  Elevated Job Openings² 

Headwinds in Focus, Tailwinds Stronger 

Last week, we discussed the market uncertainty and how we are seeking opportunities by focusing on what we do know, while closely tracking what we do not know. This week, we’ll focus on the headwinds and tailwinds within the market. Understanding both the headwinds and tailwinds gives us a more complete view of where company profits and the markets are likely headed. We do not believe a recession or stagflation environment is on the horizon, but those concerns do require monitoring and analysis. 

Headwind dynamics include the Fed tightening, a flattening yield curve, negative real wage growth, rising inflation/ oil prices, decelerating profits, COVID and Ukraine. We’ll put into perspective these headwinds within the current market environment. 

Flattening Yield Curve 

The 2-10 year spread is roughly 30 bps – narrowing from its widest 157 bps in March 2021. Spread inversion tends to be a recessionary indicator, though the 3 month-10 year spread is a superior indicator and has not narrowed in the past year. The importance here is that the bond market has been heavily manipulated given the massive QE over the last 2 years.     

Chart 3: 2-10 Year Spread (Right) and 3 month-10 Year Spread (Left)³ 

While the Russian geopolitical environment is generating near-term uncertainty, the Fed’s tightening policy should support a general shift upward in the total yield curve – particularly because the underlying economy is strong and can stand on its own. Progress towards the Fed shrinking their balance sheet will also support a steepening yield curve. Financials are the most significant beneficiaries of a rising and  

steepening yield curve and we would anticipate net interest income to rise as a result of the yield curve movement. 

Rising Inflation/ Oil Prices 

Inflation, and its impact on the consumer, remains a concern. A number of risks persist, including global COVID-related supply bottlenecks, supply impacts from the Russia/Ukraine war and the stickier impact from rising services inflation, wages and rents. Consensus forecasts are for oil prices and CPI to decline over the year, keeping the Fed from overreacting. Fighting inflation and high oil prices is now a priority for the Fed and the White House. 

Negative Real Wage Growth 

Strong wage growth numbers are being eroded by record levels of inflation. Lower real wages tend to lead to weaker spending – however, a strong jobs market and wealth effects offset this headwind, keeping retail sales resilient. 

Job openings remain elevated and as companies continue working to improve staffing capacity with higher wages (e.g., MTN announced a new $21 minimum wage this week). Consumers will benefit from wage growth and companies will offset higher wage costs with efficiency gains. Consumer strength is supported by strong retail sales data, which increased +4.9% m/m in January and +0.3% m/m in February – equivalent to +17.6% y/y.  

Decelerating Profits 

The reopening economy is alive and many participants are benefitting from strong pricing power, amid pent-up demand. Demand continues to drive pricing and profits. The consensus 2022 aggregate EPS estimate for the S&P 500 has increased steadily year-to-date and analysts currently anticipate a growth rate of 9.1% y/y – a faster annual EPS growth rate than seven of the last ten years. 

Chart 4: Above-Average EPS Growth Expectations in 2022 and 2023⁴ 

COVID and Ukraine 

COVID cases are plummeting, mask mandates are being relaxed and offices are being reopened. While outbreaks are not fully behind us, our expectations is that COVID will continue to have a much more diluted impact on the economy with minimal likelihood for further lockdowns or restrictions. 

Ukraine continues to generate uncertainties and the conflict is problematic for a long list of reasons. Our conviction is in the history – that conflict-driven volatility tends to result in fairly rapid recoveries. During historical times of geopolitical disruption gong back to WWII, markets were up one month later 66% of the time, and up one year later 83% of the time. On average, markets returned an approximate +12% on year later. 

Bullish on the Tailwinds 

While we monitor the trends, our conviction remains in above-average 2022 GDP that will surmount headwinds from Fed tightening and global macro, on the basis of sustained consumer demand, a robust labor market and a capex boom. We are closely monitoring consumer demand, which is supported in the macro data (+17.6% y/y retail sales, 11.3 million job openings) and by company narratives, sharing record backlogs and inelastic pricing. 

We are selective in companies which we believe will be beneficiaries of the tailwinds – companies with strong balance sheets (e.g., free cash flows for M&A and shareholder returns programs), secular opportunities (e.g., reopening themes, pricing power) and attractive valuations (e.g. growth at a reasonable price). 

Chart 5: Consensus Real GDP Forecasts⁵ 

Stephanie Link: CNBC TV Schedule 

Sources

1. FactSet (chart)
2. FactSet (chart)
3. FactSet (chart)
4. FactSet (chart)
5. Credit Suisse (chart)

Disclosures 

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.