Recovery Room: Stocks Rebound Overnight Following Wednesday's Fed-Related Plunge

(Thursday Market Open) The big question today is which Wall Street shows up: the one that rallied yesterday immediately after the Federal Reserve raised rates and indicated it was close to a pause, or the one that cratered later in the day after hearing that a rate cut might not be in the Fed’s 2023 datebook.

So far, it looks like a more positive day, as stock index futures spent much of the overnight session in recovery mode. Stocks plunged late Wednesday after Fed Chairman Jerome Powell suggested a rate cut would be unlikely this year and Treasury Secretary Janet Yellen told lawmakers that the government wasn’t considering “blanket” deposit insurance to stabilize U.S. lenders. Bank shares led the selling.

The Fed continues to walk a tightrope following yesterday’s as-expected 25-basis-point rate increase. On the one hand, Powell stressed his continued commitment to the inflation fight. On the other, he noted that tightening credit conditions might do some of the heavy lifting, and that higher rates aren’t written in stone given the concerns about banking stability.

For the last year, the Fed’s been on cruise control raising rates to fight inflation—and staying in the far-left lane. Now maybe it’s changing course and could be slowing down, but it’s not making a quick move toward the off-ramp. This tightening cycle may be coming to an end, but the Fed is leaving itself optionality, stressing its data dependence. 

As Schwab Chief Investment Strategist Liz Ann Sonders told CNBC yesterday, ”[Powell] definitely left the door open for a pause rather than a hike next time.”

Eye on the Fed

Yesterday’s quarter-point interest rate increase by the Federal Open Market Committee (FOMC) came as expected by most market participants but raises questions about what’s next. The FOMC still pencils in at least one more 25 basis-point hike this year, but will that occur at the May meeting or later? It expects rates to fall in 2024, but when will the cuts begin? It’s too soon to tell, and much depends on the course of inflation and possible credit tightening in coming months.

• One possible takeaway from the FOMC’s decision is that the Fed is less worried about banking stability than it is about inflation. Many analysts argued the Fed could have paused its rate increases in the wake of the recent banking turmoil, but apparently Fed Chairman Jerome Powell and company wanted to send a message that they remain committed to bringing down price growth. The Fed now sees core Personal Consumption Expenditures (PCE) prices rising 3.6% this year, up from its previous 3.5% estimate and well above its 2% goal.
• On the other hand, the Fed changed language about the future rate path, saying “some additional policy firming may be appropriate” and striking previous wording about “ongoing increases.” The old language sounded rather open-ended, as if rate increases could continue for quite a while. The new language is more nuanced, suggesting the Fed might be close to a pause.
• Whether that pause comes in May or later, the Fed’s terminal, or peak, rate expectation of between 5% and 5.25%—unchanged from its December projection and up from the current range of 4.7% to 5%— signals that at this point the FOMC doesn’t see the need to go much higher.
• In his press conference, Powell connected the banking situation to the FOMC’s decision to change the language about “ongoing” rate increases in its statement. “We believe events in the banking system over the last two weeks are likely to result in tighter credit conditions for households and businesses, meaning monetary policy may have less work to do,” Powell explained. The impact could eventually be seen in the labor market and on inflation. That’s why the Fed changed the language from “ongoing” to “additional firming,” he added.
• The Fed’s “dot plot” of the anticipated path of rates—which, as Powell said, only represents projections, not a plan—shows the average FOMC member now expects a rate of 4.3% for the end of 2024, versus their projection of 4.1% back in December. That’s not a huge shift, but it also doesn’t indicate that anyone at the Fed expects an economic dive in coming months. Instead, the path they forecast implies one more hike sometime this year followed by at least two rate cuts sometime in 2024.

Powell added that reducing inflation is likely to require a period of below-trend growth and a softer labor market. The FOMC forecasts weak Gross Domestic Product (GDP) growth of 0.4% this year, 1.2% next year, and 1.9% in 2025. The first two of those projections were below the FOMC’s December estimates.

Morning rush

• The 10-year Treasury note yield (TNX) fell 1 basis point to 3.48%.
• The U.S. Dollar Index ($DXY) was nearly flat at 102.24.
• The Cboe Volatility Index® (VIX) futures eased to 21.36 after a move above 22 yesterday.
• WTI Crude Oil (/CL) continued to recover from recent 15-month lows, trading at $70.56 per barrel 

Just In

As expected, the Bank of England (BoE) raised interest rates by 25 basis points this morning. It was a 7-2 split decision. The BoE said the U.K.’s banking industry is resilient, but more hikes could be necessary if inflation persists.

Back home,  weekly initial jobless claims came in at 191,000, remaining stubbornly low as the Fed looks for labor market tightening.

What to Watch

New home sales for February are expected soon after the open, with consensus for a 4.5% drop from January to a seasonally adjusted 640,000, according to Trading Economics. This comes after Tuesday’s surprising report of a 14.5% monthly jump in February existing home sales.

February Durable Goods Orders are due before Friday’s open, and consensus is for a 0.7% monthly rise overall and 0.4% excluding transportation, according to Trading Economics. This would be a sharp improvement following January’s 4.5% monthly decline that was driven by falling demand for non-defense transportation equipment, particularly aircraft and parts.

That drop masked a 0.8% January rise in non-defense capital goods excluding aircraft, often seen as a proxy for business spending. Investors will likely watch that aspect of tomorrow’s report closely to gauge whether businesses are pulling back. Economists expect a 0.3% rise in that category for February, Trading Economics says.

Stocks in Spotlight

Wall Street’s gone to the dogs this week, with earnings reports from Petco (WOOF) and Chewy (CHWY) yesterday. CHWY shares plunged after the company reported a drop in active customers.

WOOF was flying high last spring, but its shares fell 16% Wednesday following earnings. Guidance appeared to disappoint investors, as an increase in projected interest expenses weighed on the company’s earnings per share (EPS) forecast. The company’s “Supplies and Companion Animals” business continues to suffer, perhaps suggesting that in the aftermath of COVID-19 fewer of us are bringing home new furry friends.

KB Home (KBH) shares rose in premarket trading after the homebuilding company reported sales and earnings that beat analysts’ estimates and said it’s seeing improved demand.

Nike (NKE) shares struggled yesterday despite strong earnings, dragged down by margin worries linked to supply chain issues, analysts said. Inventory could continue to weigh on gross margins, and investors appear less forgiving of this, Barron’s noted Wednesday.

Market minutes

Here’s how the major indexes performed Wednesday:

• The Dow Jones Industrial Average® ($DJI) dropped 530 points, or 1.63%, to 32,030.
• The Nasdaq 100® (NDX) fell 1.37% to 12,567.
• The Russell 2000® (RUT) dropped 2.56% to 1,731.
• The S&P 500® index (SPX) fell 66 points, or 1.65% to 3,936, just about at the 200-day moving average.

Major stock indexes initially wavered and then cratered after the Fed decision to raise rates 25 basis points. The initial reaction was lower, followed by a sharp move higher, especially by the NDX, which is more rate-sensitive than some other indexes.

About a half-hour into Powell’s press conference, however, indexes lost ground as Powell stressed the Fed’s ongoing battle against inflation and that rates may have to keep going up. Inflation is “way above” the Fed’s long-term target of 2%, he said, and the path toward it could be “bumpy.” For more perspective on the Fed, check this podcast from Schwab’s Liz Ann Sonders.

The real cratering came in the final half-hour yesterday as investors considered Powell’s statement that a rate cut isn’t part of the Fed’s “baseline expectation” for 2023—basically deflating bullish investor hopes that rates might begin to drop this summer. This battle between what the Fed says (typically a hawkish take) and what the market expects (more dovish) has been raging all year and appears to be far from over. Stay tuned.

CHART OF THE DAY: WAVER, THEN CRATER. Yesterday saw the S&P 500 index (SPX—candlesticks) take a brief dip, then climb, then dive sharply as Fed Chairman Powell conducted his press conference following the Fed’s rate hike. As it became clear the Fed wasn’t promising rate cuts anytime soon, the dollar index ($DXY—purple line) recovered some lost ground. Data sources: S&P Dow Jones Indices, ICE. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Call for speakers: With the FOMC meeting over, it’s back to watching the Fed speaker schedule. It starts this morning with a speech from St. Louis Fed President James Bullard, who is often considered a “hawk” on interest rate policy. His remarks offer investors a perspective from someone at the Fed other than Powell—though Bullard’s not a voting member of the FOMC this year. The market, judging by the CME FedWatch Tool, remains more dovish than the Fed about the path of rates, calculating a more than 95% probability of rate cuts happening before the end of this year. This likely implies that investors expect the economy to slow.

That time again: Earnings season is less than a month away and becomes the major focus now that the FOMC meeting is over. One number to keep in mind: 17. That’s the forward price-to-earnings ratio (P/E) of the SPX—near the 10-year average—according to research firm FactSet. While that may sound comforting to bulls, any slip in the “E” could make stocks look pricey. Analysts aren’t too fired up about Q1 earnings prospects, judging by the average estimate for an overall Q1 S&P 500 decline of 6.1%, according to FactSet. It doesn’t improve much for the full year, with FactSet projecting a 1.9% rise versus 2022. Seven of 11 S&P 500 sectors are expected to see earnings fall year-over-year in Q1, according to research firm CFRA, with the worst losses coming from materials, real estate, and communication services. Consumer discretionary, industrials, and energy all could see better than 15% year-over-year EPS gain in Q1, CFRA forecasts.

Down, not out: Drilling deeper into expected earnings by sector, it’s useful to compare quarterly forecasts to full year. Some sectors struggling early on might revive, while others seen impressing in Q1 could end up disappointing when the books close on 2023. Take energy, a sector that’s expected by CFRA to report 15.5% EPS growth in Q1 but then go downhill after that. Energy sector EPS is seen falling 19% this year, not necessarily because of anything these companies are doing wrong, but because most face tough comparisons against eye-popping 2022 results. While energy earnings can be volatile due to the turmoil of global oil markets, some other sectors also may climb on the teeter-totter this year. Communication services Q1 EPS is expected to fall 16.8% and then rise 5.7% for the full year, CFRA says.  The firm sees info tech earnings falling 11.5% in Q1 but rising 0.1% in 2023. Interesting things to keep in mind, because sometimes frogs can turn into princes.

Calendar

March 24: February Durable Goods Orders.

March 27: Expected earnings from Carnival Corp. (CCL).

March 28: March Consumer Confidence and expected earnings from McCormick (MKC) and Walgreens Boots Alliance (WBA).

March 29: February Pending Home Sales.

March 30: Q4 GDP-third estimate.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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