The Fed Is Lost at Sea

Stocks down, yields up... The Fed is lost at sea... Be your own captain... The high cost of government debt... Misery remains on the table... Pricing in 'higher for longer'... Weighing the risks...

Mr. Market can't shake the jitters...

Ahead of yesterday's Federal Reserve meeting, I (Corey McLaughlin) wrote that the "pause" of interest-rate hikes may happen, but the market has been jittery lately. Well, yesterday the pause did happen, and Mr. Market looks more uneasy...

Today, all the major U.S. indexes were down for the third straight day... bond yields hit fresh decade-plus highs... the dollar was up again... and more and more weakness for stocks is beginning to show.

Not only are the indexes trading below their 50-day moving averages, but today the small-cap Russell 2000 – which has closed down five days in a row – cracked below its longer-term, 200-day moving average. So did the equal-weighted version of the S&P 500.

While concerning, it should be noted that both of these indexes breached this technical level twice earlier this year – first during the bank crisis in March and again in May around the debt-ceiling drama. They rebounded both times to keep the broad uptrend in place since last October.

What gives?

For one thing, the Fed is lost at sea...

If any investors sailing the market ocean were seeking direction from Fed Captain Jerome Powell – "navigating by the stars under cloudy skies," remember – they were left aimlessly floating instead. At best, they might be enjoying a slight breeze at their back, but headwinds are in the area, too.

As we reported yesterday, in its latest round of economic projections, the central bank painted a rosy picture for the economy ahead... But when Powell spoke in a press conference after those outlooks were published, he essentially threw his hands up again as if to say, "We don't know anything."

Stocks, about even for the day until then, sold off as he spoke... The benchmark S&P 500 finished about 1% lower yesterday... and continued its downtrend today, closing roughly another 1.7% lower. And we were reminded again why the best idea is to be your own captain in the market, think for yourself, and see the market for what it is.

Yesterday, Powell was asked about the prospect of a "soft landing," meaning inflation reaching the central bank's supposed 2% goal without a significant rise in unemployment. Powell chuckled and said he would not guarantee such a thing...

Ultimately, this may be decided by factors that are outside our control.

Powell was also asked about the recent rise in bond yields, which could possibly eat away at the attractiveness of stocks and other risk assets. The 10-year Treasury yield is now close to 4.5%... its highest level since 2007 before the financial crisis.

Powell chalked up this behavior in yields not to rising inflation expectations, but perhaps a reacceleration of the economy and a recent increased supply of Treasurys. Now, thanks to the Treasury Department needing to issue about $100 billion of bonds this quarter alone to finance government spending, the former isn't stopping anytime soon. And an accelerating economy sounds suspiciously like inflation to us...

A giant package of mixed messages...

At the same time, Powell sounded like a guy who was nearly satisfied with the amount of work the Fed could do to fight inflation. The tack now for the USS Fed is to "proceed carefully," the captain said – most likely meaning one more rate hike in 2023 and that's it.

And the central bank projects that it will start cutting rates by sometime next year, but inflation won't return to 2% until 2026.

And touching on other factors, when asked about oil prices rising and now above $90 per barrel, Powell dismissed them as short-term moves. And on recent GDP growth expectations nearing 6%, he said the Fed will look at how that is a "threat" to reach 2% inflation but isn't sure about it right now.

He didn't sound quite like his hero Paul Volcker and certainly wasn't vowing to crush inflation. Yet he wasn't flashing a green light for investors that higher rates are finished, and he reminded folks about the 1970s and early '80s. This comment caught my ear...

If you don't restore price stability, inflation comes back, and you can have a long period where the economy is just very uncertain and it will affect growth [and] all kinds of things. It can be a miserable period to have inflation constantly coming back and the Fed coming in and having to tighten again and again.

So, misery is still on the table, too. Great. I don't necessarily disagree. The pace of inflation could rebound, causing the Fed to raise interest rates more than the market expects... if not later this year, then maybe into next year. We have seen this dynamic in play for more than a year. Now, throw in the possibility of a recession with it.

Reading through what sounds mostly like noncommittal, mixed messaging, Powell was saying – and Fed members showed in their projections – that interest rates will likely stay above 5% for the foreseeable future. But they're worried enough about the economy right now that they don't want to push the cost of money much higher.

Kick your rate cuts down the road...

So, that's what he said, and then we see what the market is thinking about it... I've listened to market commentators over the past 24 hours, and many of them seem similarly confused with what the Fed's plans are right now.

But if you look at the futures markets and bond yields, this week's market action may reflect growing expectations of a slightly higher-interest-rate environment for longer than previously thought.

Compared with the expectations one month ago, fed-funds futures traders are now betting on the Fed's benchmark lending rate being about 50 basis points higher throughout next year. This same group of bond traders now thinks the earliest the Fed would cut rates is June.

This trading activity also implies that these folks don't expect a reason to cut rates – like a recession, for example – until later next year.

Could what we've been seeing in the stock market over the past two months be essentially a "pricing in" of the same idea, leading stocks to turn higher from here? Sure. But could things still get worse before they get better? Yes to that, too, like if unemployment should rise higher and sooner than expected.

Remember, the Fed's track record is one of the worst we've ever seen in the history of recorded predictions... Spend more time thinking about your investing goals and how to achieve them instead in the current environment.

Bond yields are now back at the levels they were before "quantitative easing." There is again a viable alternative to stocks, yet inflation remains a risk to the economy, along with plenty of other things.

Weighing risks in real time...

If you are looking for opportunities in the short term – as our Ten Stock Trader editor Greg Diamond covered today in a piece titled "The Best-Case and Worst-Case Scenarios" – Greg is watching several indicators before settling on an answer about the direction of this market.

He told subscribers he's looking at whether a "top" in oil will form – suggesting less inflation pressure. He's also looking at whether bond yields keep going higher, and how various stocks and indexes perform over the next week.

Based on his technical analysis, "the probabilities still favor the bullish setup"... but he's not counting out more downside ahead, either. So, he's not adding any new positions, but he's not cutting anything loose yet either, instead staying patient.

He's not the only one managing risk...

Today, our DailyWealth Trader editor Chris Igou outlined another potential bullish setup for his subscribers in the consumer staples sector, but he's not ready to pull the trigger on a trade yet. Chris' existing subscribers and Stansberry Alliance members can get the details here.

Stansberry Research senior analyst Brett Eversole, in yesterday's edition of True Wealth Systems "Review of Market Extremes," also shared a look at a retailer whose shares he says have been beaten down too much as of late. He said history suggests they could rebound close to 30%.

Stansberry Research senior analyst Bryan Beach also just yesterday recommended shares of a software company to his readers in Stansberry Venture Value. It's from one of his favorite sectors and trading cheap enough for him to buy today, with the long run in mind. As Bryan wrote, even this business's biggest critics on Wall Street think the stock has 50% or more upside in the next year.

On the other hand, like I mentioned yesterday, some folks like our friend Joel Litman are more bearish right now. Joel, the founder of our corporate affiliate Altimetry, actually hasn't been this nervous about stocks since 2007.

Importantly, though, Joel has a plan to deal with the risks he sees ahead. He's going to share all the details next Wednesday, September 27, in a free video event. If you sign up today, you'll get access to a free investing tool that Joel plans to talk more about next week.

Click here for more information.

New 52-week highs (as of 9/20/23): CyberArk Software (CYBR), Enterprise Products Partners (EPD), Omega Healthcare Investors (OHI), and Roper Technologies (ROP).

In today's mailbag, thoughts about yesterday's Digest, which focused on the latest message from the Federal Reserve and the situation many white- and blue-collar workers are facing today... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Your description of 'the fly-by-stars sailors led by Captain Jerome Powell' got me thinking – Powell is really like Captain Ahab obsessed with slaying Moby Dick (inflation) no matter the cost (economic ruin) because Moby Dick (inflation) once bit off Ahab's leg (transitory inflation still taunts him)." – Subscriber Steven I.

"The Fed has a perfect record. They have been wrong almost all the time for 110 years. I have found after being in the market for 56 years investing is easy: All you have to do is listen to the talking heads on TV. When they are all happy sell, then wait for doom and gloom, the world is coming to an end, etc. Then buy. I think the world will be coming to an end within the next couple of weeks." – Subscriber Alan W.

"Corey, While the Fed's 2024 changes 'seemed' hawkish today, they are as ephemeral as they were last month (and as changeable). Net? I seriously doubt Powell & Co. will raise rates again this year. Powell laid out so many excuses/headwinds that at least 'one' would not be a surprise. I expect stocks to rise and bond rates to fade somewhat, as Wall Street gets over today's TT (a type of tantrum)." – Stansberry Alliance member Bill B.

All the best,

Corey McLaughlin
Baltimore, Maryland
September 21, 2023