What Did We Learn This Week? (6/29)—Tim Pierotti, Chief Investment Strategist
Tim Pierotti, Chief Investment Strategist
The most important thing I learned this week (besides never grab hold of a skillet on a 500 degree grill) is that the people arguing that Fed will lose their nerve early and Fed Funds wont get over 3% are going to be wrong. I say that even in the context of observing commodity disinflation and continued leading indicator weakness that suggest we are sliding toward recession and curve inversion. Chairman Powell, Cleveland Fed's Mester as well as the Bank of International Settlements, which issued their annual economic report this week, are all singing from the same hymnal.
The BIS economists wrote, "The overriding near-term challenge is to prevent the global economy from shifting from a low- to a high-inflation regime. In doing so, policymakers will need to limit the costs to the economy as far as possible and to safeguard financial stability. Some pain, however, will be inevitable. As historical experience has shown time and again, the long-term costs of allowing inflation to become entrenched far outweigh the short-term ones of bringing it under control."
Mester said, "The more costly error is assuming inflation expectations are anchored when they are not."
Finally, and most importantly, Chairman Powell said, "Is there a risk we go too far, Certainly there is a risk. But the bigger risk is that we would fail to restore price stability."
I understand the Fed has a dual mandate but with US employment at historically tight levels, they are for now, singularly focused on price stability and their credibility and I would guess we will need to see a number of ugly employment prints before we hear any signaling of a pause.
Earnings season is soon upon us and like many others, I have been pointing out that Wall Street corporate earnings estimates remain ridiculously optimistic. That said, I was still surprised to hear the frankness of Morgan Stanley's Wealth Management CIO Lisa Shalett call out her compatriots on the sell-side as brutally as she did. In an interview this week with Bloomberg, Shalett said, "It is just horrifying that there is so little proactivity among the bottom-up analysts to go out on a limb and cut numbers without corporate managements telling them exactly what to do and that is problematic and it calls into question their value proposition because it's not very helpful".
The street consensus for the back half of the year is still over 10% EPS growth y/y. How exactly are earnings going to grow 10% in a world where financial conditions have gone from all-time accommodative to near all-time tights. C-suite and consumer confidence has gone from ebullient to historically fearful. Next twelve month earnings growth will very likely be negative so beware of anyone telling you the market looks cheap on forward earnings because that person has no idea where earnings are going to be.
In previous recessions, earnings have generally fallen more than 20% from peak to trough. Surely, equity markets will bottom before we get to the end of the negative revisions cycle but I certainly doubt they will bottom before the revision cycle even gets started. Patience is a virtue.
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