Avoiding the rocks takes foresight and patience

Stocks fell yesterday, led by tech and discretionary stocks as China lockdowns put the chill on stocks. COVID is still with us, and it will continue to impact supply chains with China’s aggressive lockdown policy.

Breaking with the ranks. I like to compare the economy to a large cargo ship. If you find yourself in NYC and have the good fortune to take a ferry ride anywhere near lower Manhattan, you can see the large ships lined up to enter the mouth of Newark Bay enroute to Port Newark. On some days, the container ships are lined up for miles. If you look carefully at their wakes, you can see how they are adjusting to make turns far in advance. Ok, so perhaps you are not so ambitious. You may prefer to keep your feet on the ground. You can visit the historic 17^th century artillery batteries at Battery Park, or the new Little Island at Pier55 on the Hudson River. From both locations you can observe the many barges being pulled and pushed by colorful tugboats as they ply the busy river. As you might guess, similar to those large container and tanker ships, the barges are not highly maneuverable and take a bit of foresight on the helmsman’s part in order to avoid calamity. First off, there are no brakes! In order to stop, ships’ pilots are likely to put the propellers into neutral long before the barge’s stopping point. Of course, the propellers can be reversed, but that is extreme and can cause the boat to shift even further off course. Turning the boat takes similar care, requiring not only prudence but also skill on the rudder. If you look carefully at the water, you will see treacherous currents that shift as the tides ebb and flow. Looking up at the many colorful flags or, perhaps, the streams of steam that float off the tops of the skyscrapers, you will notice that there is often a brisk breeze present. Those too make piloting a boat down the congested Hudson no easy task.

When it comes to the US economy, the Fed is the closest thing we have to a ship’s pilot. Its hands rest on the tiller and throttle of the economy. There are headwinds, cross currents, reefs, hidden rocks, and even other economies to contend with. If the Fed anticipates the need to slow the economy due to rising inflation, it must, like our tugboat captain, pull back on the throttle well before it is too late. In the case of our current challenge with inflation, many feel that the Fed pulled back too late, leaving it to scramble in order to avoid ending up on the rocks. Even if a boat’s propellers are stopped, it still moves forward due to momentum, which can be made worse by currents and the wind. This occurred, and is still to some extent, occurring with the economy. The Fed was forced to not only put the props in reverse, but also apply the throttle (push on the gas in car terms) in a frantic attempt to slow inflation down. Similar to our ships, those maneuvers take time to take effect. There is a lagged response. The Fed raised interest rates from effectively 0% to 4% in 7 months! Though the ship is far from stopped, there are some signs that it is indeed, starting to slow. Drivers of inflation are starting to fade as companies are beginning to see reduced consumer demand. Indeed, inflation itself, while it is still gaining, is losing momentum, as evidenced by the latest prints of the Consumer Price Index / CPI and the Producer Price Index / PPI. In the past few weeks, we have heard a lot from Fed officials, who are clear that they are far from putting the now reversed propellers back into neutral. However, in the last few days, some of the more careful FOMC members have been carefully hinting that the time for neutral may be soon… after perhaps another +75 to +100 basis points. The market agrees, wagering, based on Fed Funds Futures, that those rates will top off at around 5% sometime in May or June of next year. Those Fed officials thinking about that endpoint are likely to be joined by more and more colleagues after the new year, as even the most weathered old salts don’t want to end up on the rocks.

If you have been following my maritime fantasy and you have any experience with seamanship, you may also know that a ship cannot turn while in neutral. In other words, the gears must be engaged. The equivalent to that would be rate cuts in order to once again gain forward momentum on economic growth. Wouldn’t you know it, futures expect rates to be around 4.5% by the end of 2023. However, that is a ways up the river, even beyond eyeshot. Enroute, there are likely to be plenty of wind shifts, other boats, and jagged rocks to contend with. It’s not time to celebrate yet, but it is time to keep a close eye on market conditions, because they will shift, and we wouldn’t want to be caught off guard.

WHAT’S SHAKIN’

Medtronic PLC (MDT) shares are lower by -2.53% in the premarket after it announced that it missed Revenue targets by -1.72% while beating EPS expectations. The company lowered its full year guidance due to slower than expected demand for procedures. They pledged “decisive” actions to streamline the company, which is code for layoffs (ship’s captains, pay attention). Dividend yield: 3.30%. Potential average analyst target upside: +20.5%.

Best Buy Co Inc (BBY) shares are higher by +7.21% in the premarket after it announced that it beat EPS and Revenue estimates by +30.86% and +2.68% respectively. The company raised its full year guidance, maintained its current quarter guidance, authorized an $0.88 / share dividend, and resumed share repurchases, which are expected to reach around $1 billion for the year. Dividend yield: 4.97%. Potential average analyst target upside: +13.1%.

YESTERDAY’S MARKETS

Stocks slipped yesterday on news of Chinese lockdown fears in the wake of 2 reported COVID deaths, the first in months. The S&P500 fell by -0.39%, the Dow Jones Industrial Average slipped by -0.13%, the Nasdaq Composite Index dropped by -1.09%, and the Russell 2000 Index declined by -0.57%. Bonds inched higher and 10-year Treasury Note yields were flat at 3.82%. Cryptos dropped by -7.10 as further industry bankruptcies may be imminent while Bitcoin slid by -3.82%.

NEXT UP

• Richmond Fed Manufacturing Index (Nov) is expected to have improved to -8 from -10.
• Today’s Fed, ship pilot speakers: Mester, George, and Bullard.
• Earnings after the closing bell: HP Inc, Autodesk, Nordstrom, and VMware.