The Great Investor Awakening: Overoptimism Meets the Looming Reality of Risk-Off Conditions
Blind Optimism Could Trigger a Market Wake-Up Call
Investors remain overoptimistic about the current state of both the markets and economic conditions. That will leave them vulnerable to a sudden shift to real risk-off conditions that could be coming soon. The weaker-than-expected CPI and PPI readings, which were the economic data highlights of the week, are no doubt providing some short-term relief for consumers and businesses, but it also emphasizes that deflation sometime in the next 12 months is a real risk. Gradually slowing inflation is a good thing. Large declines in a single month, such as the one we just saw with the PPI, run the risk of swinging too far in the other direction. The Fed may continue to raise the Fed Funds rate again next month even after these readings, which suggests there’s a high likelihood they’ll overtighten if they haven’t already.
Next week kicks off Q1 earnings season and this could be the point where we start getting downward forward-looking revisions based on weakening conditions. The big banks report next week and should be in relatively good shape as higher interest rates boost interest margins and profitability. Plus, they’re likely to say they’re not experiencing any liquidity issues, which could provide another short-term sentiment boost. The retailers and manufacturers are the ones I’m worried about. Target and Walmart have already warned of consumer weakness. Industrial supplier Fastenal reported this past Thursday and was downbeat on conditions for manufacturing for the remainder of 2023. Some of the early warning signs are already there. This could be a catalyst for an April downturn for risk assets. With the S&P 500 trading at 19 times forward earnings, there’s not a whole lot of room for error.
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