Trading Desk: When The Double Negative Is A Positive

For over a year now, Wall Street has gotten itself so wrapped around the Fed that the usual signals get reversed. “Bad” news becomes good. People start hoping for a recession.

Who does that? A recession is a shock for the economy. Years of investment get washed out. The money is wasted. Great companies are forced into uncomfortable decisions. Careers end.

Stocks normally go down. And yet if you’ve spent the last year in a state of Fed Dread, every hint of the economy weakening comes as a relief. The world might be getting cold, but at least the suspense is over . . . and interest rates can start going down instead of up.

I don’t buy it. If you’re afraid of a recession, good news for the economy is still good news. People are working, corporations are making money. Every day we dodge a recession is another day of life.

But if you’re afraid of interest rates in themselves, bad news for the economy is actually bad news. These are mutually exclusive fear factors. The odds of them both playing out simultaneously are practically nonexistent.

So choose one. This week, the Fed suggested that interest rates are practically at their peak. They don’t get much higher. Wall Street is already eagerly banking on cuts between now and the end of the year.

Jay Powell says that’s not likely. But the Fed’s own projections show interest rates dropping about 0.75 point next year. They’re the ones that set rates. This is how they think they’ll vote.

Can we get that kind of rate relief without a recession? I don’t think so. But at this stage, people are so afraid of interest rates that they’ll embrace an economic slowdown just to get relief.

After all, a slowdown should hit the brake on inflation even if the Fed hasn’t been able to do much more than slow prices down. Inflation is the real threat. People are tired of working harder year after year just to keep up.

And inflation is a real and present threat. “Recession” has become a scary word in the wake of the 2008 crash, but that slowdown was so unusual that they called it the “great” recession for a good reason.

The Fed thinks we can get through the coming year with the unemployment rate only reverting to 4.5%. Believe it or not, that is not apocalyptic. We most recently lived through a period of 4.5% unemployment in 2017 and nobody thought it was scary or noteworthy.

In that word, real GDP growth might come in at 0.4%, which again is not apocalyptic. It’s slow and it’s a little stagnant, but real GDP dropped 0.2% in 2008. That’s a number that actually hurts . . . especially because we’re also looking at inflationary drag in both scenarios.

Believe it or not, inflation ran at a 3.3% rate in 2007. Historically, that’s practically normal. And the Fed is hoping that’s roughly where we’ll end this year.

If they’re right, I’d call that a soft landing. As bad as it gets. If you’re afraid of a recession, that’s when you can take a deep breath and get back to work.

And if it really is the interest rates that you’re afraid of, you can cheer up pretty soon. As long as inflation stays roughly where it is, the May policy meeting could be the last hike of the cycle.

We might not see active cuts at that stage. But we’ll know that this is as bad as it gets from a rate perspective. Banks that can manage this environment can keep managing. Those that can’t have already ruptured.

Remember, a slowing economy naturally depresses inflation. Demand for goods and services declines, taking pressure on prices with it. That’s why oil and oil stocks are down.

Inflation, in turn, is the only thing driving the Fed to keep rates where they are or even contemplate serious additional tightening. Get real. In 2018, Powell started cutting rates because he couldn’t see any inflation.

It took the excesses of the COVID economy to set prices on fire. As those excesses get cleaned up, inflation should weaken on its own.

You don’t need a crash. But if you’re expecting a crash, you’re going to take care of inflation. And that will take care of interest rates.

It’s just that a crash isn’t fun for shareholders, is it? Inflation is real right now. What’s in doubt is whether we can somehow achieve a soft landing and get back to work.

I think we can. Powell thinks we can. And the great thing about stocks is that there are always weaker ones to avoid and stronger ones to overweight. There’s a recession going on right now for the banks, for Amazon (AMZN), for a lot of little companies.

There’s no recession for growth stocks. Earnings are still moving the right way. The stocks themselves are often a whole lot cheaper than they were a year ago.

And a year from now, earnings will still be higher than they are now. Sooner or later, the stocks will respond. So it’s okay to be as nervous as you like about the economy as a whole . . . but there’s a reason to embrace the stocks that are growing fast enough to weather the storm.