The 1994 Fed hiking cycle is often mentioned as a very unusual period, but in 2022 the FOMC has increased interest rates faster and more than during the 1994 episode, and the FOMC expects this to be the biggest percentage point increase in the Fed funds rate in recent history, see chart below. Inflation is 8.3% and the FOMC’s inflation target is 2%. The Fed is trying to cool down the economy by tightening financial conditions, i.e. by pushing rates higher, credit spreads wider, and stocks lower. Investors should be positioned accordingly.
The 60/40 Portfolio is Down 20% in 2022
If you had entered 2022 with a portfolio of 60% stocks and 40% fixed income, you would be down 20% so far, see chart below. With inflation still at more than 8% in the US, EU, and the UK, central banks will continue to push rates higher and stocks lower to cool down the economy and slow down earnings growth until inflation moves closer to the central banks’ 2% inflation target.
Fed Withdrawing Liquidity
Monetary theory points to a sharp decline in inflation over the coming months, see chart below.
US Macro: It is All About the Service Sector
The FedEx results don’t tell us much about the broader economy because goods only make up 18% of GDP, and consumer services such as air travel, hotels, restaurants, sporting events, and concerts are not slowing down. The bottom line is that the goods sector in the economy continues to cool down, and consumer services continue to overheat, see chart below. For markets, the implication is that the Fed will continue to slow down the interest-rate sensitive goods sector, including housing and autos, while we wait for the service sector to show signs of cooling down.
S&P500 Similarity with 2008
Last week, the S&P500 continued to follow the pattern seen in 2008, see chart below.
A Rising Fed Funds Rate
At last week’s FOMC meeting, the Federal Reserve announced that they were raising interest rates by 75 basis points. They also reinforced the message that we can expect additional rate hikes until inflation starts to come closer in line with their 2% target. In a relatively short amount of time, the Fed has significantly changed their expectations on interest rates and the economic outlook. FOMC forecasts are now predicting that the Fed funds rate will hit 4.5% by the end of next year. Not so long ago, they had forecasted that the same rate would be zero at that point in time. Given this dramatic shift, it’s not surprising that assets like equities and credit continue to see spreads widening.
This presentation may not be distributed, transmitted or otherwise communicated to others in whole or in part without the express consent of Apollo Global Management, Inc. (together with its subsidiaries, “Apollo”).
Apollo makes no representation or warranty, expressed or implied, with respect to the accuracy, reasonableness, or completeness of any of the statements made during this presentation, including, but not limited to, statements obtained from third parties. Opinions, estimates and projections constitute the current judgment of the speaker as of the date indicated. They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice. Apollo does not have any responsibility to update this presentation to account for such changes. There can be no assurance that any trends discussed during this presentation will continue.
Statements made throughout this presentation are not intended to provide, and should not be relied upon for, accounting, legal or tax advice and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed during this presentation, including consulting their tax, legal, accounting or other advisors about such information. Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients. This presentation does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product or service, including interest in any investment product or fund or account managed or advised by Apollo.
Certain statements made throughout this presentation may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.
Weekend Reading
Quantifying the Role of Interest Rates, the Dollar and Covid in Oil Prices
https://www.bis.org/publ/work1040.pdf
Labor Force Exiters around Recessions: Who Are They?
https://s3.amazonaws.com/real.stlouisfed.org/wp/2022/2022-027.pdf
Dollar Reserves and U.S. Yields: Identifying the Price Impact of Official Flows
Fed Expectations Changing
In March 2021, the FOMC thought the Fed funds rate would be zero at the end of 2023. Now they think the Fed funds rate at the end of next year will be 4.5%, see chart below.
Our attached Slowdown Watch PDF shows that the US economy is still overheating, with unemployment at 3.7% and inflation at 8.3%.
Recession in Germany
The consensus is now expecting a recession in Germany in 2023, see chart below.
Inventories Normalizing
Although services make up 80% of GDP, fluctuations in the goods sector are still important. Inventory levels are normalizing as a result of the supply chain improving and the goods sector of the economy slowing down, see chart below. Inventories for wholesalers are back to pre-pandemic levels, but inventories for retailers are still substantially below 2019 levels.