by Jurrien Timmer, Director of Global Macro, Fidelity Investments
Key takeaways
- While many market participants continue to focus on the exact size of the Fed's incremental rate hikes, I still believe these are less important than exactly how high rates ultimately go.
- One silver lining is that inflation expectations have started to fall, which may reduce the likelihood that the Fed needs to shift to an even tighter course.
- Despite the recent choppiness in the stock market, it's possible we haven't yet seen the top of this long-term bull market.
The market has been undeniably choppy in recent days and weeks. Last week, the S&P 500® rallied 3% on Wednesday—probably on relief, after remarks by Fed Chair Jerome Powell that the Fed is not considering any 0.75 percentage-point hikes. But the following day, the index gave up that and more, dropping 3.6% in a single day.
Last week's rally seemed silly at the time, and it seems especially silly in hindsight. As I have said before, whether we see hikes of 0.50 or 0.75 percentage points at a time is irrelevant in my view, since it's the ending rate of this rate-hike cycle that really matters. Based on interest-rate expectations implied by yield curves, the market is currently expecting a 3.25% ending, or "terminal," fed funds rate in 2023. That, by definition, means several more 0.50 percentage-point moves in a row.
But with the choppiness creating a certain level of uncertainty, let's look at some silver linings that can currently be found in the market.
Inflation expectations are falling
Based on expectations implied by yields on Treasury Inflation-Protected Securities (TIPS), anticipated annual inflation over the next 5 years peaked at a high of about 3.73% in March, and has since fallen to about 3.23%. As I have written before, inflation expectations are important because when they get out of hand, they can threaten to cause spiraling inflation (with workers and businesses demanding ever-higher wages and prices).
Another benefit is that falling inflation expectations could help the Fed reach its finish line faster (without taking rates as high as they otherwise might need to go). All we need is for the rate of change on the consumer price index to start improving, and we could be at the point where the market is not constantly fearing another ratcheting up of Fed tightening.
We may still be in a long-term bull market
With the S&P solidly into correction territory this year (but still shy of bear-market territory), the big question is whether the long-term bull market is over, or just taking a breather.
The answer is unknowable in real time, but the historical analogies continue to suggest that the long-term bull trend remains intact. Based on the long-term bull markets of 1949–1968 and 1982–2000, I think we may not yet have seen the high-water mark for stocks for this bull market, even if the rate of stock gains has already peaked.
Earnings estimates are still holding up this year, which also supports this thesis. Analysts continue to expect about 10% growth in earnings-per-share for 2022, although operating margins seem to have peaked, which makes sense if growth is decelerating and inflation has been rising.
More potential fuel for the bull's tank
Looking at the long-term bull market of the last 13 years, it's important to note the profound impact that financial engineering—primarily in the form of share buybacks—has had on the market's supply-demand dynamic. (When corporations buy back their own shares, their profits are then spread out over a smaller total number of shares, which increases earnings per share and can thereby boost stock prices.)
This potential bull-market fuel shows no signs of running dry yet. On a year-to-date basis, share buybacks are still running strong, and in line with recent years.
As the chart below shows, the cumulative impact since 2009 of both share buybacks and merger-and-acquisition activities (which has the same effect in terms of reducing the outstanding shares) has totally overwhelmed any supply increase from initial public offerings (IPOs) and follow-on offerings.
If this trend continues, it could well provide some of the fuel that's needed to propel this bull into the final legs of its journey.
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
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