Whether He Meant To Or Not, Powell Just Cleared The Way For Stock Prices To Move Higher

Both the stock and bond markets have largely rejected Powell's hawkish overtones.

Admittedly, I’ve been pretty bearish about the state of the economy over the past six months. There’s been a pretty strong case for it though. The manufacturing sector has been deteriorating pretty quickly. Consumer spending is drying up. Retail sales are down. The services sector had been propping the economy up for a while, but even that has started to buckle. The housing market has been in steady decline.

But being a market watcher requires a high degree of objectivity. You can’t talk yourself into something being true just because you want it to be true. Yes, I’ve been beating the recession drum for a while, but I have to admit it at this point.

Things look pretty good right now.

It’s actually been a remarkable change of conditions and I’m honestly a little surprised that the U.S. economy has been as resilient as it has. My base case scenario coming into 2023 was that we’d see a rally somewhere during the 1st half of the year centered around the Fed pivot and the loosening of financial conditions before trending towards recession in the 2nd half of the year.

We’re kinda, sorta, maybe entering the early stages of the Fed pivot (the market seems to think so; I’m not so sure), but it’s fairly easy to see the confluence of events that have triggered the rally that’s kicked off this year.

• The European energy crisis has almost turned into a non-event and economic expectations have improved greatly.
• The COVID reopening in China happened earlier than expected and has offered hope that it could be the catalyst that kicks off another growth cycle.
• The U.S. labor market remains strong, as evidenced by last Friday’s jobs report.

Based on these factors, I have less conviction today that we’ll see a recession in 2023 and believe it’s now more likely that it won’t come until 2024. I still believe that it’s more likely than not we’ll get a hard landing, especially if the Fed insists on keeping rates higher for longer, but I have to acknowledge that the soft landing scenario does seem to be a possibility.

Powell’s Mixed Statements

The statement coming from Powell last week that kicked off the bullish sentiment was this one…

“We can now say I think for the first time that the disinflationary process has started.”

Investors then connected the dots - disinflation means rate hikes are ending. But it’s interesting that equity investors seemingly ignored the statements that traditionally would have resulted in selling off risk assets.

“…ongoing increases in the target range will be appropriate.”

“We will need substantially more evidence to be confident that inflation is on a long, sustained downward path.”

“We’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive.”

Some of those statements are essentially carryovers from the December meeting, but they all reiterate the same point. The Fed isn’t done yet and they may be ready to continue raising rates beyond what the market expects.

The Fed Funds futures market had previously forecast one more quarter-point hike beyond this past one. It adjusted forecasts higher by roughly another quarter-point, but still priced in at least one rate cut before the end of 2023. Still, the equity markets rallied following the meeting and, so far, haven’t looked back.

I think Powell intended the markets to focus on the statement about needing more rate hikes to get to an appropriately restrictive level. Whether he intended it or not (probably not), investors feasted off of the “disinflation” comment instead.

Like it or not, that probably clears the deck for equities to maintain their bullish sentiment through the March meeting. Earnings could add some volatility to the equation, but I don’t believe we’ll get anything that will cause a material shift in sentiment until then (unless we get an unforeseen geopolitical event or something like that). Powell’s statement next month along with the revised dot plot will be key in setting expectations for the rest of the 1st half and beyond.

ETFs in Focus

Here’s a look at the weekly net flows/RSI matrix, where I try to get a sense of what the markets are doing relative to what investors are doing to see if there are disconnects.

© Provided by ETF Focus on The Street

Note: Most ETFs will fall above the 0% flows/AUM line because, well, ETFs take in hundreds of billions of dollar annually. So I’m looking at 1-month flows to focus on the short-term (1-week flows are too choppy to have high confidence in the results). Upper-left quadrant would identify ETFs that are performing poorly but are seeing investor money moving in. The lower-right quadrant would be ETFs that are performing well, but seeing money leaving. Both could provide contrarian opportunities. I wouldn’t call them buys or sells. Just more of a way of potentially identifying trends.

ETFs have collectively taken in more than $56 billion so far in 2023, so it appears as if it could be another huge year. That puts many of these ETFs in the upper half of this grid, but it’s still interesting to see where some of them are landing.

Emerging markets (IEMG) and value stocks (VTV) are still seeing some of the best short-term relative flows, but both groups have certainly cooled off over the past couple of weeks. Emerging markets, in particular, have seen strong inflows across the board so far this year, so I suspect we’ll be seeing this trend continue for at least a little while longer.

The one that sticks out to me is tech (XLK). Granted, flow behaviors can take a little while to turn, but this sector is up 14% year-to-date and XLK is still looking at net outflows of nearly $1 billion in 2023. ETF flows tend to follow returns in most cases and I expect this number to turn green, but I am a little surprised that it’s taking a while to get there.

Instagram Post of the Week

I did a brief post on the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) over the weekend. It’s a great fund for dividend growth investors because it offers exposure to more than 60 didn’t large-caps with long dividend growth histories.

© Provided by ETF Focus on The Street

Overbought & Oversold

Overbought: IWC, VOX, BITO, ROBO, IWM, KBE, XHB, BJK, QQQS, GREK

Near Overbought: SPY, QQQ, MGC, XLY, XLF, XLK, PFF, SPYD, SPHB, RPV, ARKK, ARKF, IPAY, XRT, JETS, EWQ, EWG, EWP

Near Oversold: XLU, SHV, SLV, USO, DBC, PALL

Oversold: INDA, UNG, BDRY

Note: Oversold/Overbought developed using a combination of RSI and Longbow dashboard.