The Fed raised short-term interest rates by 75 basis points this week, lifting its target rate to 1.50% - 1.75%. The 75-basis point increase had been fully priced into the Fed Funds futures market prior to the meeting. Markets initially reacted positively to the news, reversing some of the bearish moves in equities and rates over the past few days.
Fed Chairman Powell offered a continued sanguine view of the US economy saying, “There’s no sign of a broader slowdown in the economy.” The Fed’s economic projections continue to show a recession will be avoided, the unemployment rate will barely rise to 4.1% (from 3.6% currently), and inflation will settle down to only 2.6% next year from current 40-year highs. Great news, right? Everyone keeps their jobs, we won’t have to pay over $100 much longer to fill up, and we can forget about skipping vacations to afford life’s other essentials.
Why then does the market keep selling off?
As shown below, the S&P 500 has faded the Fed’s rosy outlook after every meeting this year, continuing its bearish pattern of lower highs and lower lows.
The problem is that Fed Chairman Powell is not acknowledging the economic reality that the US economy is teetering on a recession after posting -1.5% growth in the first quarter of 2022 from over 6.0% in the first half of last year. In fact, the Fed’s Atlanta branch publishes a “GDP Now” report that incorporates real-time incoming data and clearly shows a rapid deceleration in the US economy (see below).
Remember, a recession is two successive quarters of negative GDP growth and we’ve already had one in the first quarter of 2022 and are very close to a second. Many other economic data points point to a broad-based economic decline, including:
JPMorgan points out that the 23% year-to-date decline in the S&P 500 implies an 85% chance of a recession. Recessions matter for investors since stock market declines are typically worse and last longer during recessions
Source: Ned Davis Research
Bottom line: As discussed on our website and in our quarterly calls, we have been concerned about the rampant speculative fever brought on by the Fed’s zero interest rate policy, excessive money printing, and the broad-based economic decline that was likely once the Fed reversed course by tightening financial conditions to combat the run-away inflation it contributed to.
Our indicators picked up on this early in 2022, and all VGA strategies have been defensively positioned after posting strong positive returns last year. We think there may be another 5-10% further downside before risks are adequately discounted but, as always, we will let our objective indicators guide our decision-making.
What this means for our investors is less of a decline or “drawdown” in their accounts to recover from once the bear market runs its course, which will pay big rewards over time. It also means a smoother and less emotional ride on the way toward achieving their financial goals.
VGA Investment Team
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