Hanging on Every Word

 

Federal Reserve Chairman Jerome Powell

Fed Chairman Jerome Powell appeared on 60 Minutes Sunday night, saying nothing really different from what he had to say after the Fed's meeting last week. The markets Monday are acting as though he had said that the Fed would sell short every stock in the S&P 500. As I wrote in this space in December, the big news about the Fed's so-called pivot is that they are likely done raising rates, and that the next move would likely be to lower them. Some investors in wishful-thinking land got the idea that this would happen in March. I never thought a lowering of rates would happen in March, but the more realistic thinking is that this will happen sometime in 2024.

Stock prices, broadly speaking, are determined by a combination of two factors. First, expectations of future earnings. Second, the interest rate at which those future earnings are discounted to a present value. For a number of years investors enjoyed a magical situation where the economy was strong enough to produce good earnings for companies, while interest rates were at historic lows. Economic reality is not that magical, at least not over long periods of time. A strengthening economy typically puts upward pressure on interest rates, while at the same time enhancing the chances that companies will realize greater earnings. That results in a sort of tug-of-war between the two forces. What investors hope for is that earnings will be powerful enough to overwhelm the pressure on valuations from higher rates. When that happens, stock prices likely rise.

The numbers that came out last week show a strong economy with robust jobs growth, not a situation where the Fed would be eager to cut rates. Normally the Fed would wait for at least a whiff of weakness before taking action to stimulate the economy, to stave off a recession. It just does not make sense for the Fed to cut interest rates anytime soon. That could change at any time, and when it does, that is when we will likely see an interest rate cut.

As for investing and stock-picking, the same old rules apply--there's really nothing radically new here. I prefer companies that have strong earnings growth prospects from a meaningful secular tailwind. That is why the AI companies have been so strong. Over the past year alone, Nvidia (NVDA, $690) is up some 227%. With a strengthening economy, economically-sensitive (cyclical) stocks have the potential to outperform, along with consumer discretionary companies that benefit from a strong labor market. Historically, though, consumer staples stocks, such as Procter and Gamble (PG, $159), tend to lag in such an environment. People don't buy more Charmin and Bounty just because they have more money.

It looks as if the Fed has engineered the so-called "soft landing" that everyone thought was so elusive. They have dampened inflation without killing the economy, and that is no small feat. Some commentators are suggesting that this is a "no landing" economy now, where growth keeps chugging along without persistent inflation. It has to land sometime, though, but for now I'll enjoy the flight.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I hold shares of NVDA and PG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright 2024 James Brinkley Taylor, Jr.

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