Stocks ended on a high note Friday with a furious late rally to wrap up a roller-coaster week, as the swings indicate the challenge the market now faces, which is that financial conditions are going to be tightening, and Wall Street is ramping up expectations of how many times the Federal Reserve will raise rates this year.

At the Fed meeting on Wednesday, it was clear that they plan to raise interest rates in March on the assumption the U.S. economy will largely steer clear of fallout from the Omicron variant of the coronavirus and keep growing at a healthy clip. We ask, what if it doesn’t?

The more nuanced discussion is whether Powell would stop his inflation fighting hikes if the economy were to slump, and how stocks would fare. With the flattening of the yield curve — the gap between the 10-year and the 2-year yields the lowest in more than a year — the bond market is making precisely that bet. 

Future Wealth’s View

The stock market over the past month has done what the Fed should have done late last year – bring down expectations of growth when supplies were tight and goverment stimulus was going to end. But, the Fed labeled inflation as “transitory” early in the year, recanted that word in later part of the year and eventually accepted that they had misread the signs of inflation this week. The problem is that not the Fed is lacking in intellectual power and wisdom. It is that they rely on actual on-the-ground data before making decisions. Of course, by the time they look at the data and make decisions, it is too late. With clear signs of retail slowdown in January precipitated by high inflation and the end of the fiscal stimulus party, our fear is that the Fed is now going to resort to raising rates and run the risk of further slowing down economic growth that already appears to be waning. 

In our article on Dec 12, 2021, we had stated that “the inflation storm will batter American families for at least another six months”. Link to the article is here – For investors, it is important to look at the fundamentals once again. The U.S. economy grew better than expected in the final months of 2021, fueled by growing inventories and rising consumer spending. Quarterly GDP growth was the strongest in more than a year with jobless claims  declining for the first time in four weeks and unemployment at pre-pandemic levels. Global economic growth this year looks intact. Putting aside the impact of Fed policies, we view the stock market correction this month as a valuation compression and not a sign of an economic compression.

With the days of the Fed being preemptive, no longer the case, it is now more important than ever to pay attention to economic signals and adjust portfolio positions accordingly ahead of Fed’s moves. That’s what the stock market is doing and you should do it too.