The Fed held its usual post-FOMC meeting news conference last Wednesday. The main points, as I see them, were that:
–the economy is at least as good as expected,
–inflation is stronger than expected, therefore
–the Fed is going to move more quickly than previously thought to raise short-term rates and to shut down its bond-buying program
–the number, size and frequency of rate rises will depend on how effective the first few rate rises are.
What was news, other than the Fed understands the current economic situation and has lost its previous reluctance to act (for fear of slowing economic activity too much)? Who didn’t know this already?
The bond market was fine with this (yields rose a few basis points and gave most of that back the next day). So, too, were currencies and commodities. But stocks, which had been falling all month, dropped sharply, although they, too, are starting to gain back these losses. The thing I noticed is that the financial press was immediate, and very sharp, in its criticism of the Fed. I’m interpreting the stock drop as the effect of AI reading overblown press accounts and selling on them. Why not the same reaction in other markets? I don’t know, but my guess is that the other markets are harder for short-term speculators to move, either because they’re bigger or more under the control of big international banks.
On the other hand, it’s never one-and-done with important news being discounted in the market. Investors replay the same ideas multiple times until one day the “news” ceases to have any effect. For a head-scratching optimist like myself, last week means we’re another step closer to having rising interest rates baked into prices.
The end game for the Fed: it’s to return to non-emergency conditions by establishing positive real yields for fixed income instruments. If there’s any news from last week it’s that the Fed may have decided that, as some commentators have been suggesting for a while, that the trend rate of inflation that’s now acceptable for the Fed is 2.5% – 3.0%. That would imply eventual (meaning a year or so in the future) 10-year Treasuries at a yield of 3.5% – 4.0%. That suggests a PE for stocks on earnings of 25x – 28x in 2023. The S&P 500 is now trading on about 20x 2022 estimated earnings and on 22x 2023 earnings. This suggests there’s still upside from here, whatever day-to-day volatility there may be.
One other thing–bonds yielding something like 4% would seem to me to provide an attractive alternative to stocks for income-oriented investors for the first time in years. Arguably, this would suggest a slightly lower PE on stocks. We’ll see.