After a brutal year in 2022, the S&P 500 rose over 6% in Januaryto the surprise of many Wall Street analysts. But Wharton Professor Jeremy Siegel warned on Monday that the good times may not last.
After the Federal Reserve raised interest rates seven times to fight the rise of inflation last year, Siegel said that investors are betting that their tactics have worked, inflation has peaked, and rate hikes will slow or even stop in the coming months, leading the stock market to rise.
Economists and investors are optimistic, and expect the Fed to raise rates by just 25 basis points (bps) on Wednesday after the latest Federal Open Market Committee (FOMC)where a group of officials meets eight times a year to decide interest rate policyconcludes. But Siegel warned that if chairman Powell choses to raise interest rates by 50 basis points instead, as he did in December, it could be a disaster for investors.
There will be tremendous selling pressure for the risk markets, and we could easily see a 1,000-point drop in the Dow immediately, he wrote in weekly market commentary, adding that even a 25 basis point rate hike doesnt mean stocks are all clear.
Siegel said he will be carefully watching Chair Powells post-FOMC press conference tomorrow, where Powell delivered hawkish remarks that sent markets lower in the past. And he added that even with a 25 basis point hike, Powells tone will be crucial.
Does Powell concede there has been much progress on the battle over inflation or will he maintain a stubborn view that tightening must continue for much longer. The markets clearly want this to be the end or very near the end of the tightening cycle.but is Powell paying attention?
Siegel has argued for months now that Fed officials are being overly aggressive in their inflation-fight because they are relying on old data. In December, he said that inflation is basically over and Fed officials are making a terrible mistake by continuing to raise interest rates.
The professor points to data that shows rent and home prices are falling, despite the supposed housing market inflation seen in the Feds inflation gauges. He also said on Wednesday that overall consumer demand is now quite weak, and economic growth is fading.
But Siegel wasnt all doom and gloom. He struck a more positive tone when discussing the latest earnings season this week.
As fourth quarter earnings continue to come in, they are largely showing ok results, with a nod towards guiding lower for 2023, he wrote. I still hold out hope that productivity growth can rebound and support corporate profits.
Siegel said 2023 earnings estimates from Wall Street are conservative and that firms will get rid of unproductive workers to help maintain profitability. That means, as long as the Fed doesnt push the economy into a recession with aggressive rate hikes, stocks could rise.
We can have a positive backdrop for the markets, he wrote. But we are reliant on the Fed pivot. All eyes are on you, Powell.
Jeffrey Roach, chief economist for LPL Financial, told Fortune that he believes the good news is that the Fed will eventually be forced to address both sides of its dual mandateinflation and employmentby pausing rate hikes as inflation convincingly decelerates.
The Fed cannot ignore the fact that the economy is slowing and recession risks are rising, he said.
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