Fed gives early Christmas present, labor report steals it

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It’s been a wild week.

On Wednesday, Federal Reserve Chair Jerome Powell, in a prepared speech, hinted that the Fed was likely to start easing rate hikes soon, thanks to falling inflation.

As lower interest rates are good for stocks, the market rejoiced. In one day, the S&P 500 was up 3.1%, the Dow Jones Industrial Average was up 2.2%, and the Nasdaq Composite was up 4.4%. European and Asian stocks followed suit, adding billions more in market value to stocks worldwide.

On Friday, the monthly labor market report then showed that the inflationary war is not over yet.

The hope was that job and wage growth would slow, further justifying lower interest rates. Instead, more jobs were created than expected and average hourly wages increased more than expected. Result? Prices rose, markets fell.

This inflation/recession/interest rate rollercoaster has been going on for many months now. When there’s an indication of lower interest rates, stocks rise. When interest rates rise or the recession rears its ugly head, stocks go down.

Until this tug of war is resolved, don’t expect sustained market moves either way.

As I said in my Nov. 11 column “Beware of the Recent Rally”:

“When it closed on November 11th, the S&P 500 was at 3,993 points. While the rally could continue for a while, I don’t expect the S&P to get much past 4100-4200.”

As I write this three weeks later, the S&P is practically unchanged at around 4,000.

Below are some predictions for the next few months, along with my advice.

Long-term rates down, short-term rates up

The Federal Reserve has a direct impact on short-term interest rates because it essentially sets the rate at which banks lend each other money overnight, known as the Federal Funds Rate. This rate affects many consumer tariffs, from credit cards to savings accounts.

The Fed has raised its target range for the federal funds rate from 0% to 0.25% earlier in the year to 3.75% to 4% today in a bid to crush inflation by slowing the economy. It is likely to raise rates further with another half-point hike on December 15th.

But the Federal Reserve doesn’t set long-term interest rates. These prices are set by the market, much like stock prices, based on supply and demand.

The 10-year Treasury rate is now around 3.5%, below the 2-year Treasury rate, which is currently around 4.3%. That’s unusual. Long-term interest rates are typically higher than short-term rates, reflecting the added risk of lending for longer periods.

So what are lower long-term interest rates telling us? They tell us that market participants believe that long-term interest rates will fall because the economy will slow down. When short-term interest rates are significantly higher than long-term rates for an extended period of time — known as an inverted yield curve — it is often an indicator of an imminent recession.

Why …

The bear market may not be over yet

While it’s good news that rate hikes may be easing soon, the problem is why they’re easing. The reason the Fed can slow rate hikes is because the economy is slowing and possibly headed for a recession.

If this happens, many companies will earn less and their share prices could fall accordingly. My prediction is that the market will drop about 15% sometime in the next six months.

This gives you another opportunity to bag bargain stocks before the next bull market hits.

My advice

Right or wrong on the market’s direction in the coming weeks, my advice is the same: own quality companies like Apple, Alphabet, Microsoft, and others that are profitable and have strong businesses. When the market falls, buy more.

As I have said in the past, the stock market trades based on what will happen in the future, not what is happening now. If you wait until you see solid evidence that the worst is over, you’ll miss the first phase of the next bull market.

It’s better to buy too early and suffer short-term pain than to buy too late and miss out on a big profit.

In summary, don’t sell stocks unless you absolutely need money within the next six months. (And if you need money in the next six months, it shouldn’t be in stocks anyway.) However, brace yourself for lower markets in the coming weeks. Use weakness to add to your positions in quality stocks.

As for bonds, long-term bond rates should continue to fall as the economy weakens. So now could be a good time to hedge interest rates with longer-dated bonds, bond funds, or ETFs. It might also be a good time to consider retirement, as I did in October’s “Considering Retirement? Now is the time to act.”

And now for my standard disclosure: These columns are written to tell you what I think and do, not to tell you what you should do. In short, they are not investment advice. I’ve been doing this for a long time, but I’m definitely not always right. Do your own research, make your own decisions and take responsibility for your own money.

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About me

I founded Money Talks News in 1991. I am a Chartered Accountant and have also licensed stocks, commodities, option capital, mutual funds, life insurance, securities regulation and real estate.