Hawks win, doves win, growth stocks lose

Stocks slipped yesterday after Biden nominated Powell for a second term as Head Fed.  Traders played hot potato with a wave of Treasury auctions, pressuring yields higher and growthy growth stocks lower.

N O T E W O R T H Y

What’s the score?  If you read my note from yesterday morning, you would have heard the saga of the growing kettle of hawks in the little woods behind my garden and the lone couple of doves in the weeping cypress that dominates my front yard.  The big question was which would be the top foul when the first buds of springtime emerged.  Well, yesterday President Biden gave us some insight into the answer… or did he?  We were expecting a pre-holiday announcement for Biden’s pick for the next Fed chair.  We knew that the race had come down to the current Chair Jerome “Jay” Powell and Fed Governor Dr. Lael Brainard.  Powell, a Republican was brought to the top Fed spot by President Trump.  You may recall that Powell was initially considered a hawkish leaning, conservative banker who often drew ire from the President for keeping rates too high.  Really, who likes high interest rates?  Low interest rates make most voters happy because they can buy more stuff.  Buying more stuff makes stocks trade up, which everyone likes that… even folks who don’t own stocks (true fact, you can check me on it).  In late 2018, the market was less than stellar, that is to say it was really doing badly.  Never mind a Santa Rally, the month was being called the worst December since The Great Depression.  Powell raced into action and announced that his Fed would do whatever it took to help the economy.  The once-hawk had been reborn as a dove and the markets celebrated.  Ultimately the Powell Fed lowered rates after corporate earnings growth dried up in mid-2019.  This marked the first “mid cycle adjustment”… ever.  You see the Fed typically lowers rates when the economy is contracting.  In 2019, the economy was not contracting, though it was showing some signs of fatigue after the longest expansion in history.  Powell’s shift and policies in 2019 would ensure that the expansion would continue.  The market liked the maneuver as well and dotted the year with a significant gain, specifically a +28.88% rise.  For the record, that is higher than the S&P500’s average annual return of around +10%.  Ok, so far so good, the Fed Chair was beloved by the stock market as well as the economy, and he even stood up to President Trump, proving that the Fed was apolitical.  The next year, 2020, was not supposed to unfold in the way which it did.  The pandemic rocked the world economies causing a wave or recessions and market crashes.  It is unfair to not at least mention that sadly, many people lost their lives as well.  Morale was low everywhere… Wall Street, Main Street, and Elm Street.  The Fed, led by Powell was the first authority to act with… well, authority.  No bickering, no backstabbing, no politics… the Fed leapt into action with an unparalleled monetary stimulus plan, too long to recap in this note.  The Powell Fed was firm, decisive, and absolutely critical in the recovery.  Not only did the Powell Fed enact extremely accommodative monetary policy, but it jawboned Congress into aggressive fiscal policy.  For the record, it usually happens the other way around with politicians jawboning the bankers.  No one can argue that the Fed under Powell did an outstanding job at getting the economy back on track.  One of the side effects of his good job is the recent rise in inflation that is front and center in all our minds right now. 

Tackling inflation is also spearheaded by the Fed and usually requires rate hikes.  Who likes rate hikes?  Pretty much no one except maybe banks… though they have figured out how to make money in all environments.  Stock markets generally don’t like rate hikes… though they too have figured out how to rise in higher interest rate environments.  So here we are with stocks trading just below all-time highs and inflation flashing its sharp teeth.  What is a Fed to do?  Beat down inflation by raising rates?  Well, yes, unless the Fed wants to cause a stock market tantrum.  You see, higher yields/rates diminish the current value of future earnings growth.  That future earnings growth is critical to the very growth stocks that carried equity markets higher in the past several years.  So, if that is buffered, well stocks are technically… or theoretically overvalued.  Therefore, raising rates is a tricky business.  Not only does it have a real effect on the cost of borrowing, but also on the psyche of the market.  As alluded to earlier, there is proof that consumer sentiment is higher when stock markets are on the gain, even if those consumers don’t own stocks.  Ok, so what is better for consumers, rising stock markets or rising grocery bills?  You don’t have to answer that question.  I simply want to underscore the tricky situation we are in just now.  So, if you were the President, who would you want to nominate… if your recent approval ratings have been slipping due to inflation.  Lower rates = happy markets, lower rates = continued inflation.   Not so easy, eh?  Jay Powell has perhaps been one of the best Fed chiefs at managing investor sentiment.  He has the ability to give investors a feeling that he will do what is necessary to make the greatest number of players happy… or the least amount of players unhappy.  He has done this flawlessly without ever showing his hand or committing to anything.  Seems like that would be the right medicine for the current state of affairs in the market and the economy.  We know that rates will have to go higher at some point in the future, we just need assurances that the hikes will not be too quick or come at an awkward time for the market. 

Powell was the easy choice for Biden.  The President also chose runner up Lael Brainard as the Vice Chair.  Brainard, the only Democrat on the Fed Board of Governors, is known as a dove who favors stronger banking oversight.  Though Powell will have a greater impact on rate policy, Brainard will have a louder voice than in the past.  Seems like the duo is a win for the markets, and they celebrated initially yesterday, after the announcement.  After Fed watchers had a chance to dissect Powell’s post-nomination comments, the market perceived some of his remarks as being concerned about inflation… in other words… hawkish.  As a result, bond yields rose causing a selloff in growth stocks.  Yesterday was also a difficult day in the Treasury markets as many auctions were crammed into a single day, ahead of the holiday.  Lots of supply and hawkish comments.  As one would suspect, demand was weak, causing the auctions to tail, which ultimately led to yields racing higher.  Stocks with the greatest potential future growth?  Well, they drew the heaviest selling in yesterday’s session, which means that stock markets are now factoring in more aggressive hiking.  Fed Funds futures now predict a 78.4% chance of at least one rate +25 basis point hike at next June’s FOMC meeting.  Just a week ago, that probability was a slimmer 67.6%.  The same futures are now favoring at least 2 +25 basis point hikes by September.  So, the big question still remains, who won yesterday, the doves or the hawks?  It is a bit early for me to take inventory of hawks in my wood, but I did spy the pair of doves huddled snugly together in my cypress… they are a resilient duo.

THE MARKETS

Stocks traded lower yesterday, led by growth and tech shares after yields climbed in response to Biden’s Fed Chair nominee’s comments.  The S&P500 slipped by -0.32%, the Dow Jones Industrial Average added +0.05%, the growth-heavy Nasdaq Composite Index dropped -1.26%, the Russell 2000 Index lost -0.50%, and the S&P500 ESG Index traded down by -0.33%.  Bonds fell and 10-year Treasury yields gained +8 basis points to 1.62% while 2-year Note yields jumped by +8 basis points (a significant jump for the front end of the yield curve).  Cryptos sold off by -4.04% and Bitcoin erased -5.48%.

NXT UP

• Markit Manufacturing PMI (Nov flash) is expected to show a rise to 59.1 from 58.4.
• Markit Services PMI (Nov flash) may have risen slightly to 59.0 from 58.7.
• Richmond Fed Manufacturing Index (Nov) is expected to come in at 11 after printing 12 in October.
• This morning’s earnings: Burlington Stores, Best Buy, Analog Devices, Abercrombie & Fitch, Dick’s Sporting Goods, and American Eagle Outfitters all beat on EPS and Sales.  After the close, we will hear from Dell Technologies, HP Inc, VMware, Anaplan, Nordstrom, Autodesk, and The Gap.