The Federal Reserve (Fed) took the market by surprise at yesterday’s meeting. The Fed officials decided to have the most-doubted taper talk and more importantly, they said they would tighten the monetary conditions faster than previously thought. Two rate hikes could be coming by the end 2023, and inflation may be stickier than thought. Of course, there should still be a decent pullback from the actual 5% level in the coming months, but it looks like the Fed is now prepping for a period of higher inflation due to the post-pandemic boost in activity, and also the huge amount of liquidity it injected to the market to deal with the Covid pandemic.
The dot plot shows that most Fed members see no change until the end of 2022, but some still do. The median plot stands between 0.5% and 1% by the end of 2023, but two members already plot a rate above 1.5%. Then, the long-term rate is plotted between 2 and 3%, most members agreeing that 2.5% is a fair level. That is close to where the rates stood before the pandemic-led measures, and still halfway down compared to pre-2007/2008 subprime crisis. So, the financial conditions will be tightened, but they will remain relatively accommodative. Moreover, in case of a problem, the Fed could always take a step back and support the market. And also, Jay Powell is again on the cautious side of the play; he says that these dot projections could be taken with a big grain of salt and that these conversations would be highly premature. Well premature or not, it’s happening, Jay.
But if all goes well, the normalization should not be a massive problem for the stock markets as the increased economic activity should compensate for higher funding costs and lessened liquidity. The problem is, due to excess liquidity, the price-to-fundamental ratios have diverged significantly over the past couple of years. Today, the company fundamentals explain only a part of the S&P500 valuations. The excess liquidity explains the rest. Therefore, pulling away liquidity should lead to some price pullback in major indices, even though we don’t expect a rapid fall as the Fed won’t pull away the rug from under investors’ feet rapidly.
But given the actual circumstances, investors will be increasingly craving for inflation and reflation friendly stocks.
If there’s one place you wish you weren’t long, it’s well gold. Gold took a severe hit from yesterday’s Fed meeting. The price of an ounce tanked to $1803 as the US yields jumped on expectations of faster rate normalization. Higher yields increase the opportunity cost of holding the non-interest-bearing gold, and prospects of a further rise in yields should cap the upside potential in the yellow metal despite the rising inflationary pressures. A sustained positive pressure on yields could send the price of an ounce sustainably below the $1800 level.
On company news, General Motors boosts its investment plans for electric and self-driving vehicles from $8 to $35 billion. Two battery call manufacturing plants are on the horizon for GM in addition to the two already on their way. Electrification is the future, and all carmakers are now rolling up their sleeves to work as fast as possible to not miss the train.
The GM’s stock price was multiplied by more than 4.5 times since the March plunge and the price is almost double compared to the pre-pandemic levels. It’s much less than which saw its share price multiplied by more than ten during the same period, but we don’t have a massive pullback on GM’s price, as the one we have on Tesla’s.
Of course, the fierce competition will eat into carmakers’ profits. But if you don’t have an electric exposure in your portfolio just yet, or you put all your eggs in the same Tesla basket, you should think of adding some more names into the mix because the electric game has just started and it will only get bigger as all countries are looking to cut their CO2 emissions massively over the next couple of decades.
