Fact or Fiction? Addressing Popular Market Proclamations

After a year (2022) in which nothing seemed to go investors' way, 2023 has so far been the polar opposite. Stocks are up handsomely while interest rates are down. Last week brought a heavy dose of fresh information on what we'd consider to be the two critical drivers for the market this year: the Fed and the labor market. The outcome was another up week for the market – its fourth in the first five weeks of 2023.

While this recent rally is both welcome and reasonable, we don't think it should be viewed as confirmation that the coast is clear.?Given what we learned last week, here are our latest thoughts on several popular takes that prevailed heading into this year:

The Fed is overdoing it with rate hikes.

• Fact and Fiction.?The distinction lies in the context of necessity and broader outcome.?In our view, it's been necessary for the Fed to take aggressive action to combat high inflation.?Has it tightened (raised rates) to a point that threatens to undermine economic growth? We think so. Monetary policy acts with a lag, so we have yet to see the full impact of the Fed's actions.
• So should the Fed have stopped earlier to prevent a slowdown??No. While we certainly would prefer monetary conditions that are accommodative to robust GDP growth, underdoing it runs the risk of reigniting inflation that would pose greater structural threats to the economy. Put simply, we think the Fed is willing to exert some near- and short-term pain on the economy in exchange for avoiding a scenario like we experienced in the early-'80s.?
• Stocks rallied last week following the Fed's latest meeting in which it announced a 25-basis-point (0.25%) rate hike. Markets found comfort in a few elements of the announcement:

1. This marked a downshift in the pace of rate hikes, with the previous six hikes being 0.5% or larger.??
2. The Fed acknowledged that disinflationary forces are taking shape, suggesting it feels it's making progress.
3. The Fed did not make special or dramatic efforts to push back against the recent evidence of easing financial conditions (which include measures such as access to, and cost of, credit).

Overall, our takeaways from the Fed's announcement are:

• This phase of rate hikes is nearing an end; and
• We suspect the Fed will first move to the sidelines, pausing after one or two quarter-point hikes, and then begin to acknowledge a more accommodative shift later this year. The markets appear at the moment to be slightly too optimistic towards the expectation for multiple rate cuts in 2023. We think the conversation around easing policy will pick up in earnest at some point in 2023, but the actual implementation of material rate cuts will be fully dependent upon a material and sustained drop in inflation back toward the Fed's 2% target.

Just look at the price of eggs. Inflation is still out of control.?

• Fact and Fiction. Admittedly, if you're making an omelet, prices still appear to be skyrocketing.?However, a broader look at consumer prices reveals a much more favorable trend. It's a fact that overall inflation is still elevated, but it's fallen markedly from its peak and should continue to decline toward a more manageable level ahead.???
• Several key elements of inflation that drove last year's spike have reversed course, setting the stage for further moderation in consumer prices. Oil is down 40% from its peak last year. Used-auto prices are contracting after an unprecedented surge. Supply-chain bottlenecks are clearing, driving a significant drop in goods inflation. And importantly, shelter costs are softening as the housing market cools (This has masked the underlying decline in inflation recently, as shelter prices are slower to recede. Excluding shelter, the core consumer price index has seen an outright decline for three straight months).
• Inflation is far from a nonissue at this stage, but an analysis of underlying factors gives us confidence that it is poised to moderate rather materially ahead. Falling inflation also boosts real wages (adjusted for inflation), offering support to consumer spending and helping soften an economic slowdown.

Layoffs are just getting started, and spiking unemployment will bring a recession.

• Fiction, though some qualification is required here.?While several underpinnings of the economy are contracting or trending toward that, nobody told the labor market. The January employment report released on Friday showed that the economy added a whopping 517,000 jobs last month, more than double the consensus forecast. Payroll gains were broad-based, with healthy additions across the leisure and hospitality, retail, manufacturing, health care and construction sectors.
• The unemployment rate fell to 3.4%, a number last seen in 1969.?1951-1953 is the only post-war period in which unemployment was lower.?This was particularly positive given an increase in the labor force, which signals that more people are joining the workforce and finding jobs when they get there. Further, average hours worked moved higher, which, when coupled with separate data showing job openings increased to 11 million, offers additional signs of ongoing robust demand for labor.
• Perhaps the most important figure from this report, however, was the latest read on wages. Average hourly earnings growth slowed again in January, to an annualized pace of 4.4%, down from 4.8% in December. While any moderation in wages may not sound like a positive thing, this should offer some comfort to the Fed that wages are not exerting upward pressure on inflation.
• The bottom line: This latest read on the labor market is categorically positive for consumers and the economy. However, we think it's premature to consider a potential recession canceled.?We're not sure that this sweet spot of strong job gains and historically low unemployment, alongside moderating wage growth, can persist indefinitely.?We suspect the former will give and we'll see some softening of the labor market ahead.

All that said, we think the foundation of a new bull market and economic expansion will take shape as we advance through the coming year. With cash and CD yields having risen to their most attractive levels in some time, we think a systematic strategy to put excess cash and maturing CDs to work within long-term equity and bond portfolio allocations will be rewarding, allowing you to benefit from a broader recovery as well as any short-term pullbacks that emerge along the way.

For this week's full Weekly Wrap, please visit: ?https://www.edwardjones.com/us-en/market-news-insights/stock-market-news/stock-market-weekly-update