Will The Fed Say Anything These Days?

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group

It was expected that markets would react negatively to the conflict in the Middle East and the potential for higher oil prices with increased volatility.  Instead, the markets seemed solely focused on the Fed and interest rates.  The Fed responded by providing more confusion than clarity - per usual.  The inspiration for this week's musings is the 1989 movie, "Say Anything."  The film is largely regarded as one of the definitive movies for Gen X (those born between 1965 and 1980).  The movie is generally thought of as a love story first, but if you dig a little further, it's also an "anti-establishment" film about growing up in the late '80s.  Here's some trivia about the movie:

• While the film was praised by critics (including Siskel & Ebert), audiences didn't exactly come out in droves to see it in theaters.  With a budget of $20 million, the worldwide gross for the film was only $21 million.  However, the film has achieved somewhat "cult" status over the years and is on several notable movie lists for its quotes and themes.
• This was the directorial debut for Cameron Crowe.  He would go on to direct famous films such as "Singles," "Jerry Maguire," and "Almost Famous."  Though raw in this film, his penchant for humor and interpersonal relationships are still on full display in this early film in his career.  
• The movie's soundtrack is impressive and even features Crowe's wife at the time, Nancy Wilson (of Heart) who sang, "All For Love" for the film.  Of course, the song "In Your Eyes" by Peter Gabriel is featured on the soundtrack, but was not originally considered for the film.  In fact, the famous scene where Lloyd Dobler holds the boom box outside of Diane Court's home was actually filmed with a different song playing "Turn The Other Way" by Fishbone.  "In Your Eyes" was added in post-production.
• The movie is littered with young, up-and-coming talent.
  • John Cusack
  • Eric Stoltz
  • Joan Cusack
  • Jeremy Piven
  • Loren Dean
  • Chynna Phillips (that's right, of the band Wilson Phillips)

Here's what we've seen so far this week...

Misdirection and Confusion.  One of the great scenes from "Say Anything" involves the typical question by Diane Court's father and his friends to Lloyd, "So, you've graduated.  What are you going to do now?"  The classic response is what follows:  "I don't want to sell anything, buy anything, or process anything as a career. I don't want to sell anything bought or processed, or buy anything sold or processed, or process anything sold, bought, or processed, or repair anything sold, bought, or processed. You know, as a career, I don't want to do that."  As hilarious and noble as that sounds, it's not exactly grounded in reality.  Neither is the Fed these days.  Like the movie title suggests, the Fed will say just about anything and most investors will buy it or be confused by it.  This week, while most of us expected the markets to react harshly to the conflict that began last weekend in the Middle East, it was comments from the Fed that seemed to move markets.  Early in the week, Atlanta Fed President stated that there was no need for the Fed to raise interest rates further and that the Fed does not see a recession on the immediate horizon.  Fed futures on the probability of no rate hike moved higher and now sit at 92%.  In addition, equities moved higher for 3 consecutive days.  Then, enter the other Fed speakers.  Fed members Collins, Waller, and Bowman created doubt later in the week by stating that the Fed was "near" peak rates or "may" need to raise further.  That sowed doubt on Thursday.  However, the jury is still out on the notion of "sticky" inflation.  While both PPI and CPI were slightly higher than expected for September, the readings were also lower than the previous month.  In fact, year-over-year, CPI for the month was flat.  If we take a deeper look at September's reading of CPI, Fuel was up 8.5%, while all other categories were up only a fourth as much, or lower.  If we strip out food & energy from CPI (also known as "Core CPI"), September's reading was only +0.3% and flat month-over-month.  One could argue that the concern over "sticky" inflation at these current levels is premature as little-to-no inflation would mean stagnant or no economic growth - which would be bad for equities.  At 3.7% CPI, we're trending right at about the historical norm.  If prices are moving up, that means there is demand.  Where there is consumer demand, there is economic growth.

Looks Can Be Deceiving.  The movie "Say Anything" is rife with ironies.  When Lloyd convinces Diane to go to the end-of-the-year party with him, one of the girls in the party asks, "How did that happen?"  Lloyd is the opposite of Diane - she is beautiful, smart, and classy; he is rough around the edges, certainly no scholar, and has little direction.  In another scene, after Diane has broken up with Lloyd, he is hanging out at the local convenience store with some guys receiving not-so-smart relationship advice.  Finally, Lloyd asks, "I got a question. If you guys know so much about women, how come you're here at like the Gas 'n' Sip on a Saturday night completely alone drinking beers with no women anywhere?"  To which one guy answers, "By choice, man."  We can either see things as they are or we can fool ourselves into thinking a situation exists when it clearly does not.  For many investors, sentiment is not red hot - and for good reason.  As clients look at their investment portfolios over the past two years, they will likely notice they are flat to only slightly higher.  In fact, the S&P 500 Index is up only 1.1% since September 30, 2021.  Why?  We all know that 2022 was a bear market, as equities lost more than 27% from peak-to-trough.  And yet, the full calendar year for 2022 saw a total return of down just a little more than 18%.  By most bear market standards, that's not bad.  In fact, going back to 1928, the S&P 500 Index has suffered only 11 calendar years with a double-digit loss.  Where does 2022 rank among them?  Right in the middle of the pack as the 6th lowest drop among double-digit losses.  This year, it's been a different story.  Markets are higher, but not across the board as breadth has been an issue.  The top 7 names in the S&P 500 Index are up an average of 100% over the last 200 days.  The more broad index is up only 13% over that same time period.  The average investor is likely to have a more diversified portfolio, which compared to the top 7 names previously mentioned, has not performed as well.  In 2022, at least, diversification has not served investors well.  Another element, especially for those investors will a lower risk tolerance, bonds have not participated.  The Barcap US Aggregate Bond Index is facing another down year, which would make the first time the Index has been down in back-to-back years since 1980.  These are difficult conversations to have with clients, but that doesn't mean diversification is dead.  It's just taking a nap.

Better Returns Ahead?  One final scene worth mentioning is when Diane breaks up with Lloyd (temporarily, for those of you who haven't seen the film).  At that point, Lloyd laments to his sister in the film (Joan Cusack, who is also his sister in real life), "I gave her my heart and she gave me a pen."  As previously mentioned, this is how some clients feel about their investments.  But, better times could be ahead - at least in the short-term.  We've discussed seasonality in previous posts over the past few weeks.  The 4th quarter seasonal returns are higher than any other quarter, except for the 2nd quarter.  In fact, the 4th quarter has a 69% probability of a positive return since 2004.  On top of that, the fundamental data remains solid.  This week the Fed revised their GDPNow estimate for the 3rd quarter back up to +5.1%, after dropping it a couple of weeks ago to +4.9%.  The Fed's National Financial Conditions Index and Financial Stress Index continue to show loose financial conditions.  This morning, the 3rd quarter earnings results came in from a few of the big banks & financial institutions - Wells Fargo, JP Morgan, Citigroup, PNC, and Blackrock.  All 5 beat earnings estimates for the 3rd quarter.  Redbook Sales on a year-over-year basis was +4.0%.  There are some headwinds, such as still high interest rates and credit card rates that have reached the highest levels in 38 years.  But, that is offset by the fact that jobs are plentiful and consumers have money in their pockets.  While the excess savings that mounted up during COVID has dwindled, there still remains an excess in the system.  At least for the short-term, equities could provide positive momentum - albeit, unbalanced.

Here's Lloyd Dobler trying to tell us what he wants to do with his life....

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The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

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