The U.S. Federal Reserve Destroys All Hopes for Slower Rising Interest Rates

Chart of the week

The chart shows the breakdown of U.S. gross domestic product and S&P 500 earnings by goods and services. It is immediately noticeable that the two indicators are structured differently.economic growth is mainly dominated by the services sector, but the profits of the broad market index are dominated by the goods sector.

Why this is important

When economic figures are published, the press usually only mentions the total figure (the so-called headline figure). Here it is always important to look closely. Is the current economic slowdown more in the goods or in the services sector? Depending on this, it will influence the stock market to a greater or lesser extent.

The U.S. Federal Reserve Destroys All Hopes for Slower Rising Interest Rates

Many of the economic data published in recent weeks (restaurant chain profit reports, private income and consumer spending, construction activity, etc.) clearly indicate that the economy is cooling noticeably.

The chart shows the development of house prices (according to the Case-Shiller Index) and an indicator derived from various sub-indicators from the house sector, such as the demand for new mortgages or construction activity. This indicator usually has good forecasting power. It currently points to a massive slowdown in the housing sector and lower house prices.

The chart shows the probability with which market participants currently expect a recession. This probability can be calculated depending on the position of the yield curve.

The publication of recent weeks, which point to an economic slowdown, have increased the likelihood of a recession.

Therefore, many market participants came up with hopes that the U.S. Federal Reserve could slightly lower the interest rate hikes.At a speech at the Jackson Hole meeting, where all central bankers of rank, meet every year, Jerome Powell, the head of the U.S. Federal Reserve, made it clear in a speech on Friday that there will be no tapering of interest rate hikes.

Many stock market watchers remember a similar situation in 2008, when a speech by the Fed chief triggered a mini-crash and the stock market plunged 15%. We do not currently believe in such a scenario, but currently the markets are very nervous and high daily fluctuations often occur. At the moment, you need strong nerves and a clear long-term investment strategy in order not to buy or sell at the dumbest moment.

We have already pointed out several times in our blog that usually after the 2-3rd interest rate hike of the US Federal Reserve, there is a trend reversal in capitalization. At that point, the returns of small-cap stocks start to outperform those of the well-known large-cap stocks. So far, there is no sign of this trend reversal. As before, the large known stocks deliver a better return or decline less than the stocks of smaller companies. We have therefore not yet made any reallocations in the portfolios, as we first want to see proof of our theory.

The chart shows the USD index calculated by BCA Research and the deviation from the intrinsic parity to the fair valuation. The deviation is as large as it was last time in 1980. In the last blog article, we pointed out that most institutional investors consider the USD to be overvalued. Currently, USD strength is based primarily on the war in Ukraine and the flight to the world currency (which the USD still is).

The far greater interest rate hikes in the US than in Europe further contribute to this.It should be noted here that the slightest glimmer of hope that the war in Ukraine may soon be over can lead to a very strong and rapid reversal.

The chart shows how strong countermovements in a downtrend (so-called bear market rallies) have been in the period since 1929. The S&P 500 has recovered 53% of its decline, and that is the maximum of a bear market rally. We then also see the current market correction as a normal countermovement and not as the start of a major new downward movement.