Powell Is A Bull In Bear’s Clothing

The intellectual tug of war between bulls and bears continues with market performance ultimately determining the winner. The bulls clearly have the advantage year-to-date, but the bear camp had a big opportunity yesterday to bring an end to the party that started last October with Chairman Powell’s appearance at an event in Washington DC. The expectation was that his tone would change from dovish to hawkish after the huge rally that followed his press conference last week, as well as a jobs report that was much stronger than expected. It didn’t happen. Instead, he reiterated that he expects “significant declines” in inflation in 2023, which led to a sharp spike in the major market indexes. He did add that more interest-rate increases will be appropriate, which temporarily reversed the rally, but followed that with the assertion that the Fed will remain data dependent from month to month. The rally resumed and stocks finished at their highs for the day.

I am sure the bears were hoping for more follow through from the post-jobs report sell off, but I think they continue to operate on a false set of assumptions. Powell is not looking to instigate a market decline or a recession. In fact, just the opposite. He is targeting a soft landing for the economy, and the jobs report showed him that he is right on track. He stated that the strength of last week’s jobs number was a good thing, because “inflation has started to come down, not at the cost of a strong labor market.” Powell’s language is as balanced as he hopes the economic data to be in terms of not too hot and not too cold. He is not a hawk or a bear, but a bull who sometimes poses as a hawk or bear to keep managing inflation expectations and the Fed’s credibility. I think the biggest mistake the bear camp keeps making is taking what Powell or any other Fed official says literally rather than focusing on the incoming data that they will use to make their decisions. As Powell stated, last week’s jobs number was good news and it came with another decline in wage growth.

Powell acknowledged that the process of bringing inflation down will not happen overnight, indicating that “we think that we’ll need to hold policy at a restrictive level for a period of time.” How long is a “period of time?” I think it is intentionally nondescript. It leaves the door open for rate cuts later this year, but it could also mean that we have none at all. This is consistent with being data dependent, as he doesn’t know for sure how rapidly inflation will come down, but he gave us clues about what he thinks by saying he sees a “significant decline” from a core personal consumption expenditures (PCE) price index that finished last year at 4.4%. While he said that goods inflation is coming down rapidly, his concern is that services inflation has yet to see a meaningful reduction, but since the largest component of inflation for service sector companies is wages, last week’s jobs report probably puts his mind at ease.

Given the growth in lower wage jobs, while higher paid white-collar positions are being shed, I expect average hourly earnings growth to continue declining to a range of 3-4% during the second half of this year, if not sooner. I think Powell does too, which is giving him confidence that services inflation will follow what we have already seen in goods inflation. Powell is not going to lay all of his cards on the table, because he doesn’t want financial conditions to loosen further until he has more confidence in his outlook. Besides, he can send foot soldiers like Neil Kashkari out to do his dirty work when he wants to contain the enthusiasm for risk assets with some hawkish rhetoric.

As for the ongoing tug of war, bulls have another strong tailwind that bears have probably not recognized. Perhaps the greatest bear of them all in Jeremy Grantham noted this tailwind in his latest write up at GMO. The Presidential Cycle is the 7-month period from October of the second year of a presidential term through April of the third. The returns for the S&P 500 during that 7-month period equal that of the remaining 41 months during a 4-year term in data going back to 1932, which is why the annualized numbers are so much higher for the 7-month period, as shown below.

We are in the middle of the Presidential Cycle right now, and when you combine it with all of the bullish developments I have discussed over the past six weeks, including the Santa Claus rally, the first five trading days of this year, the January effect, and the triggering of three different breadth indicators, you have one hell of a tailwind. I am not suggesting that stocks shoot to the moon, but to be a bear in the short-to-intermediate term looks like an uphill battle.