Does the Market Still Need Fed Support?
If you are a regular reader, you will know that as stocks have powered on up this year, I have basically remained bullish. There have been a few times when legitimate risks were evident and I felt that some caution was advisable but, overall, there has been no reason to panic out of long positions. As I said, that has been consistent, but what has changed over the last few months is why I am bullish. For a long time, it was all about the Fed, now it is more about the economy.
The Fed is still supporting the market, of course. They have been buying bonds, effectively printing money, and handing it to banks who then invest it, at least partially, in stocks. Interest rates are still at zero on the short end and extremely low all the way out the curve. The short-term impact of that has been to prop up equities. The potential return from capital appreciation and dividends is more attractive relative to bonds when lending your money to the government for 10 years gets you only a 1.3% return. That is why the 1-year chart for the S&P 500 looks like this:
The Fed’s hope all along has been that those short-term impacts of their policies would simply tide us over until the longer-term advantages of easy money would kick in, without any lasting negative effects of inflation. There is mounting evidence that this is what is happening.
On Friday, when the Producer Prices Index (PPI) rose more than expected, the market barely moved. That was because rising input prices had lost their ability to shock or scare not just traders, but also FOMC members. The Fed has declared that this “cost push” inflation is the result of temporary dislocation of supply chains and would be transitory, so even a high print of PPI could be essentially ignored. This morning when the more influential consumer price data (CPI) came in better than expected, that opinion looked justified.
A more real danger of lasting inflation comes if either a labor shortage or rising consumer prices push wages up. Commodity prices will drop if the “transient” pressure eases, whereas wage increases tend to be sticky. However, if wages are simply catching up after being depressed since the “great recession” in 2009, then increasing the disposable cash of consumers is a positive. That is what appears to be happening.
The upward wage pressure is coming largely from firms like Amazon, who are expanding and hiring workers, but in their case, expansion is simultaneously causing job losses in conventional retail. The reluctance of those displaced workers to move from one low wage job to another is forcing companies to increase compensation a bit at the lower levels, but it is more about a temporary disruption than any permanent dislocation. Importantly, too, wage increases at the lower end tend to be spent quickly, boosting economic activity. Wage increases that increase economic activity are still inflationary, of course, but they are essentially good for stocks.
The upshot of all of this is that we are moving rapidly towards a situation where it seems that the economy can support stocks at least at current levels, if not higher still, even without the Fed’s help. That creates a fundamental shift in outlook, where the impact of data and news on the Fed’s actions become less influential, and conventional metrics regain their fundamental power.
The technical picture is also supportive at these levels, If, as has happened eight times already this year, the 50-day moving average (the blue line on the chart above) holds, then a bounce back is coming. If it breaks, it will prompt some selling on a technical basis, but even then, economic fundamentals will lend support and, on that basis, the current weakness looks more like a buying opportunity than a reason to sell.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.