The Fed will hike, and the odds are rising

Outlook

In reviewing the upcoming Fed meeting, the WSJ chose one of the many ways to fiddle with statistics— “consumer prices rose at a 3.7% annualized rate over the three months through October, up from a 1.6% rate for the three months through July.” This version is as good as any other.

The Fed will hike on Dec 9, and the odds are rising it will hike again in Q1. Note that Dallas Fed Logan joined Waller yesterday and thinks the Fed needs two more hikes, implicitly rejecting one 50 bp “jumbo” hike.

We had a ton of commentary from analysts about the CPI data and whether it means a 50 bp hike in Dec The consensus is no, the Fed will stick to 25 bp. First, the Fed is conservative. Only if they get a scary high advance copy of the Nov numbers (or their economists deliver one) would others join Waller. Even then, it would not be unanimous. Mr. Warsh wants unanimity.

In addition, the Fed doesn’t like to surprise markets, which reacts badly to the unexpected. Now that we no longer have forward guidance and are supposed to read the tea leaves by observing market prices, we don’t know if this orientation remains. We might add that Trump would be furious and threaten to fire Warsh, but Warsh is protected by the Supreme Court now and doesn’t need Trump’s approval.

Second, stickiness is an issue. The Atlanta Fed “sticky price” judgment indicates stickiness is not going away. “The Atlanta Fed's sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 4.7 percent (on an annualized basis) in October, following a 3.4 percent increase in September.

“On a year-over-year basis, the series is up 3.1 percent. On a core basis (excluding food and energy), the sticky-price index rose 4.7 percent (annualized) in October, and its 12-month percent change was 3.1 percent.”

See the Atlanta Fed chart, which contains the pandemic inflation Two things: the sticky price measure has been rising since before the 2024 election and accelerated after Trump and his tariffs. But second, notice that when the pandemic ended, it fell dramatically and in about one year. The decline started in March 2022, even though the WHO didn’t declare the pandemic over until in May ’23. It’s a little interesting that we didn’t get the vaccine until July ’22. Remember, this is about stickiness, not overall inflation. 

Finally, the falling price of oil will lower inflation going forward. Let’s jump off the cliff and say Trump is deliberately stalling the war process in order to get falling energy prices and recover some credibility among his traditional voters who smacked him down in the midterms. We don’t know why he would do that since he can’t run again and doesn’t give a fig about the party, but it might soothe his ego to get praise for doing it instead of the barrage of disdain.

Note that plenty of price rises can be blamed on increased costs of shipping and insurance, secondary to the price of oil itself.

Forecast

Note that today is Veterans Day in the US and the bond market is closed (equites are open). It’s also Remembrance Day in Canada.

We are back to the connection between yields and the dollar. See the chart from Bloomberg. It looks a lot like ours in the Chart Package. It never did make sense for yields to have corrected downward under the circs—inflation was never going to be substantially better, although we admit it was worse than anyone had forecast. The excuse for the yield drop was risk aversion, a weak story., but pretty much all we had.

Beware. If hedge funds and others are confused, they can respond to fresh news by overreacting. We think the world has returned to the standard model—the supremacy of the “institutional” argument: institutions are far more influential than anything else and it’s the Fed now.

Other central banks will be hiking, too, but they are expected to stop after one and done. The consensus is building that Dallas Fed Logan is right and it will be two for the Fed, to the dollar’s advantage. The CME Fed funds betting concurs—44% see one more hike after Dec and 6.7% see two for a combined 50.7%. These numbers are flighty but interesting.

Stock Market: The BOA/ML “spotlight” calls for the traditional Santa Claus rally, and not just on a single catalyst. “Rather, several pieces of the investment mosaic are beginning to align—a meaningful valuation reset, healthy earnings growth that is becoming increasingly broad-based, improving market breadth, more cautious investor positioning, and the potential for investors to refocus on fundamentals as some of the concerns that dominated September begin to recede.”

“Valuation has quietly become considerably more compelling. The S&P 500 Index price/ earning-to-growth ratio based on FY1 consensus estimates recently fell to its lowest level since the Q1 2009 Global Financial Crisis (GFC), according to FactSet. March 2009, of course, subsequently proved to be an exceptionally attractive time to be bullish on U.S. Equities. We are not suggesting that today's economic or market environment resembles the GFC. Rather, the historical comparison illustrates just how significant the current valuation reset has become when prices are considered relative to expected earnings growth. “

So, earnings to growth, not earnings per share, or the price/earnings ratio, or EBITDA, and no mention of price-to-book or debt-to-equity. It seems reasonable under these circs to view earnings to growth the new top valuation method. After all, this is electricity and railroads.

We worry a little about valuations based on earnings guesses. According to Schwab, “While it's not as popular as its P/E relative, the price/earnings-to-growth (PEG) ratio can provide a more comprehensive and clearer picture of a stock's future growth prospects. This financial ratio compares the P/E to analysts' consensus estimate of projected earnings, which typically look forward as soon as the next quarter to as long as five years. 

“The PEG is derived by dividing the P/E ratio by projected EPS growth. For example, a stock with a P/E of 18 and an estimated EPS growth rate of 15% would carry a PEG of 18/15, or 1.2. So, how should you read this number? Typically, stocks with a PEG ratio of less than 1 are considered undervalued. 

“The growth component is important because investors don't want to buy something that isn't going to increase in value. What investors tend to look for when using a low PEG ratio in their analysis is a history of growth in combination with projected growth.”

We do not pretend to be an equity analyst, just a lowly economist. One of the components of the ratio is “projected EPS growth.” So you are projecting a stock price on the basis of projected earning per share, assuming no change in the number of shares. But projected by whom? This leaves the ratio in the hands of the very people being judged.

We like the growth aspect but if activity and earnings decelerate because of regulation or other headwinds, the slowing rate of change would take the PEG down a peg, right?  Still, we would buy Anthropic if we could.