The market gods present patient investors with three gifts

Posted by Cam Hui -

Remember that equity investors tend to enjoy strong returns in the absence of recession, which dents returns, or war and revolution, which can result in a permanent loss of capital. With those caveats in mind, the market gods are presenting patient investors with three gifts from the three economic blocs in the world: the U.S., Europe, and China.
 

 

 

Powell’s dilemma

The “dot plot” published in the aftermath of the June FOMC meeting was starkly hawkish. Four members, likely Fed Governors Bowman and Waller, along with Barkin of the Richmond Fed and Bostic of the Atlanta Fed, projected no rate cuts in 2024. There is a significant minority on the FOMC who are opposed to a rate cut this year.
 

 

It should also be acknowledged that inflation is decelerating even as the Fed Funds rates stays steady, which has the effect of a de facto tightening of monetary policy as the real Fed Funds rate rises.
 

 

The lower-than-expected CPI and PPI readings in May served to underline this point. With both CPI and PPI reported, estimating the May core PCE, the Fed’s preferred inflation metric, becomes easier. The Cleveland Fed’s inflation nowcast is now calling for a May core PCE of 0.1%.
 

 

That’s why all FOMC members a projecting rate cuts in the future. The question is one of timing. While we are seeing are welcome signs of tame inflation, the market has seen similar episodes in the last half of 2023. That’s why the FOMC hawks don’t appear convinced.
 

In the wake of soft inflation reports, the market is pricing in two rate cuts this year. One in September, followed by a second in December.
 

 

Here is Powell’s political problem. The Fed will have difficulty cutting rates ahead of an election in the face of entrenched opposition within the FOMC without appearing to be helping the incumbent President. He can’t afford to have any dissents on a rate cut decision at the September meeting.

 

Powell’s challenge was to communicate an explicit process for a rate cut or pause at the September meeting while avoiding any discussion of his political problem, which he failed to do at the post-FOMC meeting press conference. All he could manage was to repeat the mantra that the test for any cut is greater confidence in lower inflation or unexpected weakness in the jobs market. Even then, he declined to specify numeric benchmarks for inflation or employment, other than to say that the Fed is looking at a spectrum of data.

 

Such an approach to communications policy is a recipe for failure. Unless we see a string of very soft inflation readings between now and the September meeting or a collapse in employment, the market is likely to be disappointed.That’s the opportunity setup for investors. The macro backdrop of continued strong growth looks like either a soft landing or even no landing. As long as EPS estimates continue to rise, stock prices should advance even in the face of a pause in rate cuts. Remember that recessions are bull market killers, and there are no signs of recession on the horizon.
 

 

That’s the first gift from the market gods for patient investors. A pullback from a delayed rate cut is on the way, and it’s a buying opportunity.

 

 

Macron’s gambit

Across the Atlantic, financial markets were rattled when French President Macron unexpectedly dissolved the National Assembly and called an early election in the wake of strong gains by Marine Le Pen’s far right Rassemblement National (RN) in European parliamentary elections.

 

The timing of the election calls was unfortunate. S&P recently downgraded French debt on May 31 and spreads against German Bunds are blowing out. Bloomberg columnist John Authers highlighted a growing risk to the eurozone’s financial system. The Greek Crisis was a problem that Europe could survive. France and Germany are the two pillars of Europe and France is too big to save.

Now comes the terrifying part. The Greek crisis was brought to a head when the radical leftist Alexis Tsipras became prime minister in 2014. A French legislature headed by the forces of Marine Le Pen might play the same role at a time when French indebtedness has made the risk of crisis much greater… there’s the risk that most scares investors — that the Rassemblement does get to form a government, and then provokes a crisis within the eurozone that the euro could not survive. That remains unlikely. But ultimately, Europe confronts a low-probability extreme event. These are just the things that markets can’t deal with. Judging how to respond is their nightmare.

 

 

What was Macron thinking? Has his political gambit backfired? An early poll shows the far right in the lead, the left in second and Macron’s party in third place. As a reminder, the French electoral system is based on runoffs. If any candidate doesn’t achieve a simple majority in an election, the top two candidates go head-to-head in a second round runoff.
 

 

However, the polling results are highly preliminary. Macron’s surprise announcement set off a scramble to set candidate lists and form political alliances. The parties on the left acted first by forming a Nouveau Front Populaire to field a slate of candidates, though the coalition appeared slightly shaky as the Socialists were opposed to the alliance.