Stocks rose slightly last week despite the Federal Reserve sending a message that it is “nowhere near” done with its fight against inflation.
The reason for the Fed’s hawkish message is that although commodity prices have fallen, wage inflation continues to run hot.
The supply of workers has been reduced as a result of COVID-related retirements, disabilities and reduced immigration.
Thus, the unemployment rate in the US has fallen back to its pre-pandemic low of 3.5%, indicating an overheated labour market.
Stocks have rallied in the face of optimism that the worst for inflation is behind us and that the Federal Reserve can start cutting interest rates next year.
We remain skeptical. To bring wage inflation down, the labour market needs to weaken, which may require higher interest rates for longer. Purchasing Manager Indices are falling, the yield curve is inverted, profit margins are elevated and earnings estimates look overly optimistic.
The markets have now become short-term overbought, which so far this year was a signal that the end of a bear market rally was approaching.
We do not know if it will be the same this time, but since we do not see the risk-reward in stocks as being favourable over the next 9-12 months, we continue to hold a large cash position. We would change our view if leading economic indicators bottomed or if wage inflation moderated so that central banks could become more accommodative.
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To earn interest on the cash balance, we have initiated a position in $JPST . It is a money market ETF that pays about 2.5% interest annually. The interest rate will increase if the Federal Reserve hikes interest rates as expected. This is a CFD position, which we normally avoid because losses on CFD positions are not tax deductible in some jurisdictions. Due to its low-risk nature, this position is however unlikely to generate a significant loss (though it is, of course, not entirely impossible). For example, in the COVID crisis, the most this ETF fell was 3%, and it quickly recovered.