Morning Note | June 16, 2022

Good Morning!

Futures are sharply lower as the post-Fed euphoric rally is proving to be short-lived as the markets are opening at 52-wk lows. The May FOMC saw stocks rally Monday - Wednesday by 4.0% and then fell 7.3% over the next three sessions. This time, the setup was less constructive but we also have reset expectations to be more hawkish with uncertainty surrounding July/Sept meetings. Further, consensus FY2023 EPS ~$250 and many client conversations point to that number likely moving lower. Most investors point to June 30’s PCE print as the catalyst since the Fed is wholly focused on inflation; but, we have PMI next week which may prove to be irrelevant.

The Fed may exert downward pressure on stocks over the near-term. By their own projections, another 175bps in rate hikes is coming this year while the market is pricing in 200bps (75bps in July, 50bps in Sept/Nov, and 25bps in Dec). For fundamental investors, the question is valuation and a) where are FY2023 EPS estimates and b) what is the appropriate multiple?   The S&P P/E ratio is plotted below and you can see that index has spent little time below 15x this century and had a pandemic low ~14.7x. Hypothetically, if you cut consensus FY2023 EPS estimates by 20% ($250 to $200) and apply a 15x multiple you get to 3,000 in S&P.  

The market conclusion is 75 bps in July seems most likely unless the July 13 CPI prints above 9.5% (go 100 bps), between 7-8% (go 50 bps), or below 7.0% (go 25 bps). Ultimately, we learned that CPI + Univ. of Michigan (Consumer expectations) were the game changing data.

The Fed plans to raise rates to 3.4% by the end of this year and 3.8% by the end of 2023.  That's approximately 100 bps above the neutral rate indicating a significantly hawkish tilt.  And all members are behind this plan.  This gets them to their core inflation forecast of +2.7% by the end of next year.  

So the Fed is no longer playing around and they even flagged the employment strength as giving them flexibility around going well above the neutral rate.  In other words, they are ok creating a mild recession (and the likely higher unemployment rate that comes with it) in order to squash inflation.

And we are increasingly likely already in a recession.