A ‘Very Dangerous’ Spot

(ReclaimingAmerica.net) – Contrary to what Joe Biden keeps trumpeting as he tries to convince Americans to vote for him this fall, the latest buzz from the financial world has American citizens perched on the edge of their seats because according to Cole Smead CEO of Smead Capital Management the U.S. stock market is in a “very dangerous” spot.

The reason is that the Federal Reserve’s series of interest rate hikes haven’t quite hit the mark especially when you look at the latest jobs numbers and wage growth data.

Let’s dive into the details. Last week, nonfarm payrolls blew past expectations with a 353,000 increase in January, leaving the Dow Jones’ 185,000 estimate in the dust. Also average hourly earnings jumped by 0.6% monthly which is double what the forecasters had on their bingo cards. Unemployment? It’s hanging tight at a historically low 3.7%.

Now, this comes right after Fed Chair Jerome Powell threw cold water on the idea of rate cuts in March, something many market watchers were crossing their fingers for. Smead, who’s been on point with his predictions about the U.S. consumer’s resilience amidst tighter monetary policy, shared his thoughts on CNBC’s “Squawk Box Europe.” He believes the real risk has always been the strength of the economy, even after a 500 basis point increase in interest rates.

But here’s the kicker: despite a banking scare last spring and some turbulence in the bond market, wage growth is still going strong. And while inflation has cooled down from its mid-2022 peak, December saw a 0.3% month-on-month increase in the consumer price index, pushing the annual rate to 3.4% above the Fed’s 2% target.

Smead argues that the dip in CPI is more about good fortune thanks to dropping energy prices among other factors rather than the Federal Reserve’s aggressive policy moves. If the job market, consumer sentiment and household balance sheets keep their footing we might see interest rates staying high for an extended period. This scenario could spell trouble for listed companies needing to refinance at higher rates potentially sidelining the stock market from the economic strength parade.

He even harked back to a period between 1964 and 1981, where a robust economy didn’t translate to stock market gains, thanks to inflationary pressures and tight money. Fast forward to today, and despite Powell’s hints at keeping rates up, the stock market had its 13th winning week out of the last 14, fueled by hefty earnings from U.S. tech giants like Meta.

Smead’s cautionary tale begs the question: why is the stock market priced as it is, given the economic backdrop and the Federal Reserve’s cornered stance on high rates? It’s a precarious position for stocks, he warns, especially when last year’s market valuations seemed disconnected from the actual economic growth.

But not everyone’s sounding the alarm. Some strategists are leaning into the optimism that the Fed’s handling might still achieve a “soft landing” for the economy, dodging a recession and limiting broader market downturns.

Richard Flynn from Charles Schwab U.K. notes that the recent strong jobs report hasn’t sparked the usual market panic, suggesting that both the markets and the economy might be more resilient to high rates than previously thought plus Daniel Casali of Evelyn Partners hints that investors are warming up to the idea that central banks might just strike the right balance between growth and inflation. This “benign macro backdrop” he believes could be a silver lining for stocks.