What do you need to prepare for Fed Pivot and Severe Recession?

Looking on the horizon, it's hard to say what's next for markets or the Fed. For now, stocks are moving higher, seemingly ignoring signals of a slowing economy, but volatility is far from over. Is rate hiking season over? At least one thing is clear, however: the stock market and the Federal Reserve, they don't seem to be on the same page. I'm going to share my thoughts on what is likely to happen, along with some what-if scenarios that you might want to consider. Stay tuned for what you need to know.

Welcome to another edition of We're Talking Money. I'm Phil Clark, founder and CEO of OmniStar Financial Group, and today's show is all about the Federal Reserve's recent hike of a quarter point. Even though this hike was expected, stocks didn't like it. Of course, the market turned around on the following Thursday and Friday and basically shook off the rate hike. Now the question is, are we off to the races now that the Fed is showing signs of a pause? I don't think so.

Imagine for a minute the Fed meeting, the next Fed meeting: inflation has remained stubbornly high and rates need to be raised yet again. This is exactly what causes me concern. Credit markets actually are predicting a 60 percent chance or probability that rates will be unchanged. Even worse, credit markets are pricing a pivot as early as June. Suffice it to say, markets are in favor of the Fed not raising interest rates. From our perspective, this is a setup for major disappointment. What I mean by that is asset values are likely to move lower as inflation persists and credit tightens.

My expectation is further weakness regardless of the Fed's direction. Why? The economy is slowing, corporate profits are declining, credit markets are tightening, and consumers, we're all being forced to think more carefully before breaking out our wallet. Remember, inflation is still much higher than wage growth, so real wage growth is negative.

How will we know if the Fed plans to hike or pause or pivot? Well, no one has a crystal ball, but the Fed may offer some clues in a few weeks, and the next inflation report comes out April 12th, and that will certainly influence the Fed's decision. Now, if inflation is above five and a half percent, I think we'll have a good sense of what the Federal Reserve will do at this meeting: probably another 25 basis point hike, or quarter percent. If that happens, I fully expect the market to reach a tipping point. Higher rates threaten profits, and that threatens stock prices.

Also keep in mind, of late the S&P 500 has been held up only by a few big names: Apple, Microsoft, Nvidia, Meta, Tesla and Amazon. Remove those mega-cap companies and the S&P is in the red. Why does this matter? Breadth. Breadth is a very important measure of stock market momentum. As of this writing, the S&P 500 may look healthy on the surface, but let's take a closer look.

Now, we use the 20-day and the 50-day and the 200-day exponential moving averages, and we measure where each stock is relative to these averages. As of today's show, only 37 percent of the S&P stocks are trading above their 200-day moving average, and 30 percent are trading above their 50-day moving average, and just 35 percent are trading above their 20-day moving average. Now, this is hardly what I would call a sign of rising breadth. In fact, it's just the opposite.

The Federal Reserve is hoping, and when I say hoping, I'm saying that with great emphasis, they're hoping that inflation comes down on the April print. Getting inflation to move down from current levels is what we talked about several weeks ago. It's going to be difficult because the consumer is still spending, mostly using credit cards these days, and that is working against the Fed's best efforts. As markets rise, the wealth effect is giving consumers confidence, the very confidence they need to keep swiping those credit cards.

So if inflation comes down, everyone's asking, will the Fed start to reverse course sooner than originally expected? Of course, going on what we know, the Federal Reserve is saying rate cuts are not in the cards for 2023, yet the market is pricing a sixty percent probability of rates being at five percent or below by June, and more than a 50 percent probability of rates falling to 4.75 percent by as early as July. The Federal Reserve, Mr. Jerome Powell, he's signaling that in June interest rates will be five and a quarter percent, and that will likely last until the end of 2023.

In his words, either the market is getting ahead of itself or the Fed is lying. In my humble opinion, there's a little bit of both. Markets are overpriced, and the Fed is definitely not sharing with us the truth, or maybe they just don't know. So what are the implications? If you know these, at least I believe you can be better prepared.

Often the market will get ahead of itself, and this is one of those times. The market is pricing for a pivot as early as July, meaning that rates start going down, the Fed reverses course. The odds of this happening, according to the credit markets, those odds are growing. This idea that interest rates will be below five and a quarter percent come July, that's opposite of the Fed's signaling. Jerome Powell has said more than once, we will not pivot in 2023, that is, unless something else breaks.

Now you might be asking, what else could break? Well, let's see, I can think of a few things: more economic deterioration, more bank failures, a sovereign debt crisis, which by the way is out of our Fed's control, or even another European bank going under. And we saw a glimpse of these things happen with Silicon Valley Bank and other financial institutions in the last few weeks. Such events could cause the Fed to pivot much faster, and they might even turn on the printing presses once more. Neither would be good, but I believe that's where we're heading. If you've been thinking of raising cash, selling into these bear market rallies, that could be a very good idea.

Much like 2007 and beyond, the markets have come to crave intervention from the Fed. Bailouts are not, however, how you build a solid economy. We're learning that right now. Think about how slow our economy has grown since the Great Recession back in '07 and '08. Money was cheap, the stock market continued setting new highs, yet GDP was anything but inspiring. Except for 2021, which was the reopening of many economies post-COVID, GDP really hasn't been that strong, relatively speaking.

Nevertheless, once again we're watching a market that is already betting on a reversal of higher interest rates even before the economy is remotely close to the Fed's mandate of a two percent inflation rate, and they're looking for higher employment. That has not occurred. If the Fed pivots now, a real risk of longer-term inflation would have to be considered. This seems to me we're setting the stage for stagflation.

At this juncture, the Fed is signaling that rates will remain high for the time being, with a small chance of one more increase. Hopefully I'm wrong, because this would be fuel for stagflation, in other words, if he didn't raise rates more. Think about it: our economy is contracting, inflation is stuck at elevated levels, it's been there for a while, and I told you several weeks ago, once we got into the five percent range, it's going to be really tough to get much lower. The only component missing is higher unemployment. Add that and you have the classic definition of stagflation. I imagine the media will start throwing this word around with a positive spin, if that's possible.

For now, I believe the stock market is overly optimistic, even exuberant. First quarter earnings will start showing up in just a few weeks, and I don't expect them to be great. The Consumer Price Index, or the inflation index, will also print in a few weeks, and that's going to provide yet additional clues about next steps for the Fed.

But what if there's another scenario that maybe no one is talking about? Things like headline inflation rising so quickly, it went from one or say two percent and it peaked above nine percent. The US dollar rose, commodity prices were also rising in a commodity inflationary cycle. This has never happened. How can the dollar go up, especially at a time of record money printing? What if global credit is slowing? In that case, the dollar would have every reason to rise.

And of course, the Federal Reserve raising rates 500 basis points, or 5 percent, after holding interest rates at near zero for 14 years, that has quickly caused a huge loss for many financial institutions. This was bound to break something, and it did. But almost like clockwork, officials stepped in to plug the hole. The FDIC, as they should, said all deposits are insured up to the two hundred fifty thousand dollar limit. Almost immediately the Fed stepped in and said, wait a minute, no one will suffer any loss, no one will lose a dime. Once again, federal government to the rescue.

Why is this such a problem? It's simple, in my opinion. If the rules are good, why would you start rewriting them to save mismanaged institutions, unless you know something is more ominous under the surface? I would say the fragility of the global economy was there; now it's showing. The cracks can be seen, and I believe they will develop in the coming months.

Given this backdrop, many people are wondering how to navigate what could be a very difficult period. Here's what our firm is doing. First, we have been increasing cash since late 2022. Next, our fixed income assets are mostly positioned on the short end of the yield curve for now. However, as things unfold, we will start to move towards the other end, probably stopping somewhere in the middle, simply to lock in some fixed rates that will likely be much better than anything else as rates get pushed further to the downside. And lastly, we increased our positions in precious metals. Our stock exposure is mostly dividend-paying positions with an overlay of covered calls or options for additional income and some downside protection.

Let me recap. I believe conditions are deteriorating faster than expected, and the Fed is going to be forced to pause on their rate hikes. It is also plausible that Jerome Powell will start lowering rates. That's right, I said lowering rates, before the end of 2023. Corporate profits are likely to continue their decline, P/E ratios are still elevated, and unemployment, it will rise, and GDP, I suspect it will continue to struggle. So I'm not saying that we might have a recession; I'm saying we will have a recession.

Remember, panic is not a strategy here, so be patient. Think through your strategy, what you're doing to weather the storm. As things unfold, I will keep you informed. If you need help with your investment strategy or wealth management, if you have questions, please reach out to one of our associates for a second opinion. We're not asking you to become a client; we're simply letting you know that resources are available if you're concerned, if you want a second opinion, you want confirmation that what you're doing is good, or maybe not so good. We're here to help.

Now, I hope this video has inspired you to look closer at your investment program. Remember, it is always a good idea to consult with professionals to ensure that you're taking appropriate steps for your situation, and they're all different. If you like this video, make sure to subscribe to our YouTube channel right now. Just click on the subscribe button below this video and give us a thumbs up. You can also follow us on Facebook and Instagram, LinkedIn and Twitter, and our website, omnistarfinancial.com. Thanks for watching. We'll see you next time on We're Talking Money.

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