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Stock market faces the most ‘massive misallocation’ of ‘capital in the history of mankind,’ says ARK’s Cathie Wood
Cross Currents
The move in the S&P 500 last week towards the lower end of the 4300-4800 year-to-date range was consistent with incoming inflation data, the marginal deterioration in liquidity, and increased risk of a Fed credibility crisis. In contrast, incoming macro growth and corporate data increased our confidence that the low end of the range will hold. The crisis in Ukraine risks disruptions in energy, metals and food supply, consequently, like China’s zero-Covid policy and the Omicron wave that is fading fast, Russian aggression is a greater inflation than growth risk.
“The staff continued to judge that the risks to the baseline projection for economic activity were skewed to the downside and that the risks to the inflation projection were skewed to the upside.” January FOMC Minutes
The Fed staff’s growth forecasts are marginally below street consensus. Their inflation forecasts are probably best described as hopeful and based on a disinflationary regime whose time has come and gone. St. Louis Fed President Bullard called their inflation forecast ‘optimistic’. Between now and the March FOMC meeting we expect their forecasts appear increasingly off base as the growth outlook improves with little or no loss of inflation momentum. The Fed staff and ‘Coastal Doves’ appear to be looking to 2Q22 for base effects to relieve pressure on the inflation measures, much as they were hoping to look through base effects in 2Q21. While a 2Q22 peak in goods prices continues to be a reasonable assumption, the thesis is devoid of any supporting evidence, with the possible exception of new car prices.
A year ago, the transitory narrative began to unravel in 2Q. In 2Q22 we expect the Fed’s forecast — that if they tighten to a neutral policy setting inflation will head back to target — to begin to crumble. While the release of the minutes offered no new details on balance sheet management, it appears the preference is to begin the rate process slowly and accelerate in 3Q if we are correct that the staff’s inflation forecast is too low. The Fed leadership has not made any attempt to increase policy optionality for the March meeting, consequently, they risk a credibility crisis if our inflation and growth forecasts are correct. The absence of a favorable equity market reaction to NY Fed President William’s not seeing a “compelling argument for big step in March” highlights the risk of a credibility crisis. So, what began as a Fed policy normalization correction has evolved into a series of concerns about geopolitics, growth, inflation and a Fed that will have a credibility issue if they don’t tighten aggressively. Despite the policy concerns, we expect an improving growth outlook will stabilize the equity market near the January low, and if you missed it the first time, we suggest adding exposure.