And just like that it's time for the September edition of Adding Alpha -- the start of my favorite season: pumpkin spice lattes, the leaves beginning to change, and of course college football season.
But before we get to all of that fun, today, I wanted to share with you some updated thoughts on market action following Chair Powell's Jackson Hole speech.
In the weeks leading up to the Jackson Hole speech, the market really went through a bit of an evolution.
Powell turned out to be much more hawkish than markets expected, and in just a few short minutes managed to walk back any hint of dovishness that was, in our view, really responsible for driving the mid-summer market rally.
He talked about needing to take forceful steps to bring down inflation, and that it might also bring along some pain for the economy and to the labor market.
The market interpreted that message as the Fed might not be able to engineer a soft landing after all.
But believe it or not, following Powell's comments, market-based expectations for interest rate increases really didn't move all that much.
It may no longer be July, but I'm still hoping for my Christmas wish for a Fed pause.
I don't think we need a policy pivot for the markets to find solid footing here.
And whether a 50 or 75 basis point increase ultimately occurs in September, it's not as critical for the market's path forward as what happens to the expected terminal rate.
If we get faster and more front-end loaded rate hikes, but the final destination is roughly the same, we think the market can live with that at these valuation levels.
But I think a key question is, what will happen in 2023?
Powell basically told markets, "don't expect any interest rate cuts," and yet the market has already priced in 50 basis points worth of cuts beginning in May or June of 2023.
The final destination of Fed policy is not a no-brainer: is it gonna be 3.5%; is it going to be above 4%; is 4% the right answer?
Policy actually is very much data-dependent -- when is the right moment to slow down and move in smaller increments without the Fed promising markets that a pause or a pivot
After the sell-off following the Jackson Hole speech, the stock market is no longer in overbought territory, and September and October are notoriously challenging months from a seasonality perspective, so investors might want to buckle up: we're expecting some more choppiness ahead.
By mid-August, the rally had driven valuations into the 18 times forward P/E range for the S&P 500, but we're back down in a trading range of 15-17 times -- in our view, that's about fair value, assuming we continue along in a slowing, but still positive, phase of growth.
On a hopeful note, we've started to see sentiment indicators finally begin to grind higher.
If this trend holds, we don't expect the market to retest the mid-June lows, because, back then, sentiment was effectively in a crisis of confidence at record low levels.
The recent University of Michigan consumer sentiment survey showed sentiment went up and inflation expectations went down; not only that, but the rolling six-month average for inflation expectations is now all the way back to November 2020 levels.
Both data points may be moving in different directions, but both are moving in the right direction.
And the recent Conference Board data also reinforced an uptick and inflection point in sentiment.
At the end of the day, we believe the market still only cares about two things as it relates to the market's path forward: the first is inflation peaking and/or rolling over; and the second is the Fed to complete its tightening of financial conditions.
We're starting to gather some data points to confirm the peak in inflation, but the jury is still very much out on the Fed's policy path.
So stay tuned.