Why analysts are muttering against central banks
What analysts say and what central banks, in particular the Fed, will do. The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds
It is used to say that the sell side (financial intermediaries who offer operational ideas to end customers) is always positive (or constructive, as they say when one wants to be more elegant and moderate). That's often true. End customers don't like being told negative scenarios and reduce their operations when there is pessimism in the air. Bankers and consultants, for their part, do not like to report negative analyzes to customers that could lead them to take refuge in liquidity. Analysts, in this context, think twice before giving indications that are not reassuring.
Mind you, the work of sell side analysts is often of excellent quality and still has value. The user of their analyses, however, if he has some experience is aware of their positive inclination and tares with respect to their indications. Eventually the system is in balance and works.
After these premises, it is interesting to note that at the moment the tone of some of the most authoritative manufacturers is more cautious than that of the market. The SP 500 index is in fact above the target that some of the strategists who usually write opinions indicate not only for 2022, but also for 2023.
As is well known, the market does what it wants and in the end has the last word anyway, because it sets the prices. The market must therefore be respected even when it behaves in an apparently irrational way, if only because its irrationality can do a lot of damage not only to those who get too involved in enthusiasm or panic, but also to those who get in the way and risk to be overwhelmed.
It should also be noted that the market is often more agile than analysts and quicker to adapt to real or perceived changes. The indication of a price target for a stock index by a large house is something that must be carefully considered because it ends up in the media and can have a major impact on the markets and, through them, even on the economy. These price targets aren't set in stone, but they can't be changed too often or you'll lose credibility.
It is not the first time that this gap between markets and analysts has occurred. It had already happened in August, in an even more accentuated form, when the SP 500 index had exceeded 4300. At the time, however, the exclusively technical nature of the rise was clear, also favored by the rarefaction of trading in the summer. This time, however, the rise has at least one solid argument on its side, namely the sharp drop in inflation. It's a short step from this to thinking about the Fed's pivot.
In reading the market, almost all imaginable scenarios are positive in one way or another. If the economy continues to grow at the fairly strong pace it has shown over the past couple of months, that will be good for earnings and therefore support the stock market. If the economy grows between zero and one per cent we will have a Goldilocks scenario, which is always popular. And even if the slowdown over the next few months were to turn into a moderate recession, then the pivot will be anticipated and we will have an expansion of multiples driven by falling rates and therefore by bonds.
If then the Fed were to persist with the hard line, which Powell and some of the components of the Fomc seem to want to confirm, then it will be the sharp rise in long government bonds that will drag the stock market upwards.
At worst, the market is thinking at the moment, it will simply be a question of having a little patience and waiting for the Fed to be convinced of the seriousness of the disinflationary process. However, the happy ending is certain. In 2024 at the latest (but the market is already thinking of the second half of 2023) the Fed will start cutting rates. Since the market always tries to anticipate, waiting for the Fed risks having to buy higher levels. So it's worth buying now.
Analysts responded by pointing out that inflation has not yet fallen in a generalized way. Trimmed inflation, calculated by the Dallas Fed excluding tails in the distribution of price increases, is struggling to come down. In any case, even when all indicators have turned comfortable, the Fed will keep its foot on the brakes for some time to make sure it doesn't repeat the experience of the 1970s, when prices rebounded as the central bank started cutting rates .
Furthermore, according to the statements of Powell and Bullard, the Fed would have even added an increase, for next May, to those of January and February that the market has already discounted. And the more the market relaxes and anticipates the celebrations, the more confident the Fed feels about continuing with hikes.
The second order of reasons that lead analysts to be cautious is related to growth and earnings. Very few now predict earnings growth for 2023, while some estimate the possible contraction at 10-15 percent. With valuations that, with interest rates at these levels, do not appear to be sacrificed, there is very little room for price appreciation.
Even more radical is the voice of Zoltan Pozsar. Markets, he says, continue to think in terms of the normal succession of business cycles and don't see the elephant in the room, which is the war economy we've entered since February. The war economy means high public deficits, heavy expenditure on rearmament, on the reshoring of strategic industrial sectors such as semiconductors and on a complicated and costly energy transition. These deficits, if they are not to generate inflation, will have to be balanced by real rates much higher than those of the last decade.
Even if the global economy appears to have adapted to the war better than might have been thought, Pozsar's warning should still prompt markets to create a premium for the new structural risks that have begun to loom.
How to move between these two opposing impulses, the bullish one of the markets and the more cautious one of many analysts? A first consideration is that it seems justified to celebrate the transition from a situation in which everything was dark at the end of the tunnel to one in which light has appeared. A second consideration is that the tunnel risks being, however, still long and including a first semester in which rates will rise further and a second semester which will see a slowdown in the economy.
In practice this means that we have passed from a long phase in which the increases were to be sold to a new phase, which will last all next year, in which the decreases will be to be bought. And there will still be declines, if it is true that no one has abandoned the definition of bear market rally for what is happening. In other words, nobody is saying that a new bull market has already begun.
In summary, therefore, hold, buy on weakness and don't chase too much the ongoing rise except from a trading point of view between now and the end of the year.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-gli-analisti-borbottano-contro-le-banche-centrali/ on Sun, 27 Nov 2022 06:13:40 +0000.