In Jan 2022, I wrote that I would start buying stocks / REITs in 2022 when I see the Feds pivot.
When the Feds start getting dovish, when they stop hiking interest rates and start thinking about cutting – that’s when I would be a big buyer.
I said that I see a Fed Pivot happening in 3 ways:
- S&P500 drops 30% or more (3500 or below)
- Credit Markets start to break
- Inflation goes away
There’s a big narrative making the rounds that the Fed has “Pivotted” this past week.
These people are pointing towards 3, that inflation will go away in the months ahead, allowing for the Feds to stop hiking and start cutting interest rates in 2023.
Market pricing does seem to back up this view
Since 16 June 2022 – the S&P500 has rallied 11%, back up to 4072.
While the 10 year Treasury yield has dropped from 3.48% to 2.68%.
So the market does seem to be pricing in something akin to a Fed pivot.
But… is this correct? Has the market bottomed for 2022?
Latest Fed Messaging can support this view
The Feds hiked interest rates by 0.75% the past week.
But that was already choreographed way in advance, and should not come as a surprise.
What did come as a surprise, was this line by Jerome Powell:
‘‘We are now at levels broadly in line with our estimates of neutral interest rates, and after front-loading our hiking cycle until now we will be much more data dependent going forward.’’
What this means, is that:
- No more forward guidance – the Feds will no longer tell you how big the next hike will be – how big the hikes are going forward will depend on inflation / economic data
- Fed thinks we are at neutral – Fed thinks the current Fed Funds rate of 2.5% is at “neutral” for the economy, where it neither stimulates nor restricts economic growth
How to interpret this? Feds turning dovish… or hawkish?
Unfortunately this ambiguous statement can be interpreted both ways.
It’s a case where you can literally interpret it the way that you want to.
If you think we are at peak inflation, and that inflation will go down going forward – then you would think we had a “Fed Pivot” the past week, and that this is the bottom for 2022.
If you think that inflation will stay sticky, then you think the Feds may need to hike more than expected, and the “Fed Pivot” lies in the future. Or in other words – the market will drop further.
Market seems to buy the “Fed Pivot”
Whatever the case – the market seems to buy the Fed Pivot narrative.
We had the strongest 2 day rally since 1970 after a Fed rate hike this week.
And the market is now pricing in a 0.25% hike in September (instead of 0.5%).
For what it’s worth – I don’t buy this narrative.
Let’s put it this way.
Inflation volatility is at 40 year highs.
Anyone telling you they can predict how inflation will play out the next 6 months is just plain lying.
In times like that, why should the Feds tell you exactly what they’re going to do the next 6 months?
Why commit to a path, and box themselves in the next 6 months? When their forecast can be wildly wrong?
Why not just wait and see, and respond accordingly?
If inflation stays strong the next 6 months, the Feds keep hiking. 0.5% and 0.75% hikes are all on the table.
If inflation goes away the next 6 months, the Feds stop hiking.
If inflation drops away completely and the economy goes into freefall, then yeah of course cutting interest rates makes sense.
So my view – is that the Feds remain committed to fighting inflation.
Whether this week was a “Fed Pivot”, will depend on whether inflation goes away in the months ahead.
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Has inflation peaked?
I wrote a pretty lengthy article for Patrons this week to share my views.
Without giving too much away, my thinking is that while inflation will likely come down in the months ahead, it is unlikely to drop to 2-3%.
Which raises a conundrum for the Feds.
Here’s an excerpt from the Patreon article:
So yes – we may see inflation coming down from the 9.1% headline number.
But will it go down to 2-3%?
More likely than not inflation stays at an elevated range for a while, say in the 5-6% range.
Will that be enough for the Feds to pivot?
The problem though, is that if financial markets and economic growth do not deteriorate significantly, then why would the Fed turn dovish with inflation at 5%?
The pain is low, so why give up the chance to tame inflation once and for all.
As with government policy, central banks are usually slow to change their mind. They wouldn’t want to change course until it becomes clear that their current path is unsustainable.
So the way I see it, if inflation stays at the 5-6% range, they won’t dial back on hikes until financial markets start to melt down or economic growth deteriorates materially – which we have not seen just yet.
US economy is still very strong
I see a lot of people pointing to the fact that the US is in a technical recession.
The important thing to note – is that these numbers are real growth.
Ie. These are inflation adjusted numbers.
When inflation is raging at 9.1%, GDP growth at anything lower than double digits is probably going to be negative real growth.
And c’mon guys – do you really expect the US Economy to grow at double digits?
This is the largest economy in the world, not some emerging market like Argentina (no offence to Latam).
So yes – real growth is negative, but nominal growth is still very strong at 5-6%.
I wouldn’t exactly call that a “Recession” that requires interest rate cuts and a restart of QE.
If you look at wage growth, unemployment, consumer spending, household balance sheets, most of the data backs up this view.
Heck, even Jerome Powell seems to think so:
Fed Chairman Jerome Powell told reporters Wednesday he does not believe the U.S. is in a recession, pointing to the labor market as a source of strength.
Mr. Powell said: “2.7 million people hired in the first half of the year, it doesn’t make sense that the economy would be in recession.”
I agree a recession (or economic slowdown) will come, I disagree on the timing
For the record – I completely agree that all this is coming.
I agree the labour market will slow, and inflation will come down, and economic growth will slow.
Because that is exactly that the Feds want.
The inflation problem is caused by a mismatch between supply and demand.
The Feds cannot do anything about supply.
So they have to crush demand.
If the consumer keeps spending, if the job markets hold up strongly, then that demand doesn’t come down meaningfully.
So the Feds will have to keep hiking and keep tightening, until that slowdown starts to show up in the data.
The Feds think we are at neutral rates now. If they need to go into restrictive territory to combat inflation, so be it.
So for the record, I think the recession calls, and the calls for a Fed Pivot, are too early.
So FH… when bottom?
I know many of you don’t want to bother with the macro and just want to know exactly where the bottom is.
When do you FOMO into this market.
The simple answer, is that I don’t know.
Gun to my head I would say maybe 2023, but that’s not a call I would express with any degree of certainty.
Markets will bottom before a Fed Pivot
What I will say though – is that the market will bottom before a Fed Pivot.
The market will anticipate a Fed Pivot, and risk assets will rally before the Fed formally announces a pivot.
Because of this, if you want to time the bottom perfectly, you need to front run the Fed slightly.
You need to make a call ahead of when the Feds will actually pivot, and start buying then.
Do you necessarily need to time the bottom?
Which raises a conundrum.
If you want to time the bottom, you need to buy before a Fed Pivot.
Which means if you are wrong on your call, you end up eating a big loss.
The alternative of course, is to wait until it is clear the Feds will pivot.
Either we see inflation coming down significantly to the 2-3% range, or we see Jerome Powell give clear comments that he will pivot.
Sure, you probably miss a 10-20% move from the bottom if you wait for this, but you do miss out on a big potential decline, and you should still capture a bulk of the subsequent bull market.
When will I invest $1 million in Stocks / REITs in 2022? (as a Singapore investor)
I still think I buy when the Feds pivot.
I don’t see the events of the past week as a Fed pivot, so I would start buying in size yet.
If I’m wrong, I just wait until a Fed pivot is clear enough to me, then I start buying.
Sure – by playing cautious maybe I lose 10-20% upside. Maybe more depending on how cautious I am on calling the Fed pivot.
But frankly, I am not in a desperate need to time the bottom here
Capital preservation is more important to me than capturing that extra returns.
But I suppose it really depends on individual risk appetite.
The more adventurous may want to try their hands at timing the bottom before the Feds officially pivot.
Really up to you.
Calling central bank mistakes is literally the name of the game
I know not everyone is comfortable with this kind of investing – calling out central bank mistakes.
But I just wanted to put it out there that if you want to do macro investing, calling out central bank mistakes is literally the name of the game.
George Soros didn’t make a billion betting that the Bank of England was right.
He made a billion betting that the Bank of England was wrong.
Same logic here – the money is made by understanding what the market is pricing in, vs what central banks will be required to do.
Central banking is always kind of a confidence game.
If the market believes Jerome Powell can tame inflation, they will price it in, and you solve the problem.
If the market doesn’t believe Jerome Powell can do it, then you’re in trouble.
For that reason, Central bankers will always say they are going to do A, right up until the day they announce they are going to do B.
This is how the game is played.
Feds are caught between a rock and a hard place
The way I see it, the Feds are caught between a rock and a hard place.
Keep hiking rates and cause a deep US recession.
Or go easy and allow inflation to rage.
The truth probably lies somewhere in between.
They will accept lower growth, but they will tolerate higher inflation.
But how we get there, and where is the eventual middle ground path the Feds will be forced to take – that’s where the money is made.
Closing Thoughts: There is value in this market
That said, I absolutely do not deny there is value in this market.
I’ve been sharing with Patrons for a while that I think recession risk is mispriced, and there is opportunity in the cyclicals and commodities.
The rally the past few weeks has proved that out, and there could be room to run as we head into year end.
Too many investors are positioned too heavily short or in cash.
Which usually means the pain trade is up.
And you can see my full views on where I think value lies, and the stocks / REITs that I like on Patreon.
But make no mistake, we’re probably headed into a 2023 global recession.
So you don’t want to overstay your welcome too.
For long term investors, this might just be one of the trickiest markets in a while.
And for long term investors, I would probably say be patient, and be humble.
1 year Singapore Savings Bonds might be yielding close to 3% by year end.
In a climate like that, the opportunity cost of cash has gone down a lot.
Stay patient, bide your time, and let the market come to you.
Worst case if you’re wrong, just buy when the Feds make clear their pivot. You’ll still capture a big chunk of returns from the next bull market.
With rapidly rising interest rates – it might pay off to look into refinancing if your loan is coming due.
I know a lot of you have been writing in for my views on fixed vs floating loans, and I plan to write a full article for this.
But in this market – I think you’re pretty much forced into taking floating. The banks themselves know interest rates are going up quick, so the fixed rate loans are priced in such a way that they aren’t sufficiently attractive (in my view).
In the meantime, there’s a fantastic tool by Property Guru.
Do give it a try if you’re close to refinancing.
It’s completely free – you just input your mortgage details, and the tool lets you know whether you’ll save money by refinancing.
If the answer is yes, they’ll give you recommendations on what loan to take.
If the answer is no, you can set up a reminder for the tool to remind you when its time to refinance.
I set up the reminders for my own properties just this week and it’s pretty neat.
Do give it a try here.
As always, this article is written on 30 July 2022 and will not be updated going forward.
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