Investors cheered Apple’s latest earnings report and welcomed a strong jobs report, which suggested the U.S. economy remained robust despite banking uncertainty and rising interest rates. Friday’s gains were not enough to wipe out weekly losses for the S&P 500 and Dow Jones indexes, which fell 0.8% and 1.2% respectively, while the Nasdaq Composite eked out a 0.1% weekly gain.
The economic outlook and health of the global financial system is either stable or scary—depending on who you ask and where you live. Earlier this week, US Federal Reserve Chairman Jerome Powell said this week that the possibility of avoiding a recession is “more likely than that of having a recession.” He also opened the door to pausing interest rate hikes following 10 straight increases. “We may not be far off” the level that’s sufficiently restrictive to squash persistent inflation, he said.
Future Wealth’s View
So the question now is, if the Fed is in pause mode when it comes to changing interest rates, how long will that pause last? We, at Future Wealth LLC, project that the strong jobs report will increase the chances the Federal Reserve will hold interest rates high for longer—and potentially keep the door open to an 11th straight hike in June. Despite the Fed’s desire to cause some pain in the economy, the unemployment rate fell to half-century low of 3.4%.
The stock market wants to believe that inflation will continue to drop from current levels of 5% to possibly 3% level by Fall 2023 even as the unemployment rate stays low and interest rates remain elevated. Such a scenario would go against the fundamentals of economic theory – known as the Phillips Curve that states that inflation and unemployment have an inverse relationship. Higher inflation is associated with lower unemployment and vice versa. But, stagflation in the 1970s caused stagnant economic growth, high unemployment and high price inflation. And in the decade following the financial crisis in 2008, we had low inflation and low unemployment for a long period of time.
It would be easy to dismiss the Phillips Curve as an archaic theory that is no longer relevant but what if economic decline is yet to come and is yet to really impact unemployment rates? The lag impact of interest rates is largely unknown – it could be anywhere from six months to eighteen months. The credit crunch, weakness in housing, layoffs in tech could all be a sign of things to come in the 2nd half of 2023, in our view.
Investors would be wise to remember that trying to play a game of chicken with the market could have disastrous consequences to one’s portfolio.