Walking a Tight Rope as the Fed Faces a Stagflating Economy
The big question that’s been overhanging the market this week was cleared up yesterday when the Fed announced the next upward move in interest rates, something the stock market has been increasingly expecting over the last several weeks. In looking at the Fed’s new forecasts compared to those issued three months ago, there were no material changes in the outlook for GDP, the Unemployment Rate, on expected inflation.
We find the Fed’s action yesterday rather interesting against that backdrop, especially given its somewhat lousy track record when it comes to timing its rate increases — more often than not, the Fed tends to raise interest rates at the wrong time. This time around, however, it seems the Fed is somewhat hellbent on getting interest rates back to normalized levels from the artificially low levels they’ve been at for nearly a decade. Even the language with which they announced the rate hike — “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent” — makes one wonder exactly what data set they are using to base the decision.
The thing is, recent economic data hasn’t been all that robust. Yesterday morning, the Fed’s own Atlanta Fed once again slashed its GDPNow forecast for 1Q 2016 yesterday to 0.9 percent from 1.2 percent last week and more than 3.0 percent in January. That’s a big downtick from 1.9 percent GDP in 4Q 2016! Given the impact of winter storm Stella, particularly in the Northeast corridor, odds are GDP expectations will once again tick lower as consumer spending and brick & mortar retail sales were both disrupted. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out yesterday, real average hourly earnings decreased 0.3 percent, seasonally adjusted, year over year in February.
Despite that lack of wage growth, we have seen inflation pick up over the last several months inside the Purchasing Managers’ Indices published by Markit Economics and ISM for both the manufacturing and services economies as well as the Producer Price Index. Year over year in February, the Producer Price Index hit 2.2 percent, marking the largest 12-month increase since March 2012. Turning to the Consumer Price Index, the headline figure rose 2.7 percent this past February compared to a year ago, making it the 15th consecutive month the 12-month change for core CPI was between 2.1 percent and 2.3 percent. We’ve all witnessed the rise in gas prices, up some 18 percent compared to this time last year, and while there are adjustments to strip out food and energy from these inflation metrics, our view at Tematica is food and energy are costs that both businesses and individuals must bear. Rises prices for those items impact one’s ability to spend, especially if wages are not growing in tandem.
It would seem the Fed is caught once again between a rock and a hard place — the economy is slowing and inflation appears to be on the move. The economic term for such an environment is stagflation. In looking to get a handle on stagflation the Fed is walking a thin line between trying to get a handle on inflation while not throwing cold water on the economy as it continues to target two more rate hikes this year.
Once again, we find ourselves rather relieved that we don’t have Fed Chairwoman Janet Yellen’s job. We’re far more content to look at the intersecting and shifting landscapes around us to look for companies positioned to prosper from multi-year thematic tailwinds like those found on the Tematica Select List. Great examples include Buy rated Applied Materials (AMAT), Dycom Industries and Universal Display (OLED) among others. As we do this, we recognize the stock market is out over its ski tips and yet to fully bake in the current and likely near-term economic reality into its thinking especially as the likely timing on potential Trump economic policies look further out than previously thought. This is likely to offer the opportunity to find such thematic beneficiaries at better prices in the coming weeks compared to today.
While we may be a tad ahead of the herd on this, we’ll continue to be prudent investors and let the data, the hard data, talk to us as we navigate our next moves with the Tematica Select List.