Jeremy Siegel a renowned American economist and a professor of finance at the Wharton School of the University of Pennsylvania, also the author of the best-selling book, "Stocks for the Long Run” is out with a dire warning for investors in his recent commentary. He has declared that the US economy is on the verge of an economic downturn.
The Federal Reserve recently announced a quarter-point hike in the interest rate after the recent bank failures of Silicon Valley Bank, Signature Bank among others, much on expected lines. However, Fed Chair Jerome Powell’s tone during the press conference following the FOMC meeting was notably hawkish. The dot plot and Fed projections for the economy and inflation were quite concerning, as the Fed even revised its GDP projections for 2023 down to 0.4%, which indicates negative growth for the next three quarters unless there is a significant collapse in productivity, Siegel noted. This forecast suggests that the economy is headed for a recession, with negative job growth predicted for the next nine months and an increase in the unemployment rate to 4.6%.
‘Outlook worries’
Jeremy Siegel further said, “It is alarming that Powell stated that the Fed did not even discuss the possibility of rate cuts by the end of the year, despite these dire projections. The bond and Fed funds futures markets are predicting that the Fed will need to cut rates at least two to three times this year based on the Fed’s projections. Powell's denial of the potential for rate cuts is reminiscent of his previous comments when inflation was rapidly accelerating, and he stated that the Fed was not even “thinking about thinking about” raising rates.”
‘Fed's complacency alarming’
Moreover, Powell acknowledged that a tightening of financial conditions resulting from bank stress is equivalent to a Fed rate hike. The Fed only went for a 25bps hike when it could have chosen 50bps, but the current situation is reportedly more serious as per Siegel, and a bank lending contraction is expected to be equivalent to 50 to 150bps of hikes. The Fed's complacency about the lending contraction is alarming, and it needs to take a more forward-looking and cautious approach.
It was further contended by him that, “Powell's body language during the press conference was somewhat uncertain, and he seemed shaken and blindsided by the bank failures. Reporters asked numerous questions about the health of the banking system, and Powell repeatedly stated that Vice Chair Michael Barr would look into the collapse of SVB, refusing to comment further. He should have been better prepared to address the issue.”
Furthermore, it has been discussed by him that, the bank stress tests only "stressed" banks up to a 2% Fed funds rate, which is significantly lower than the Fed's projections of increases two to three times higher. This is another regulatory misstep by the Federal Reserve Bank of San Francisco, and it is almost as big of a mistake as not hiking rates in 2021 despite the explosion in the money supply. The economic data from last week was mixed, with initial jobless claims coming out on the strong side, below 200,000, but a weak durable goods report. The risk of recession hence on the publicly available data has clearly increased.
‘Stay calm and be conservative’
Given these developments, investors should be more cautious about equities, especially as recession risks rise and the Federal Reserve tightens its policy. Cyclical and value equities are likely to face more pressures in this environment. However, if the Fed adjusts its policy, we can avoid the worst-case scenarios. For now, hence Siegel has urged investors to stay calm and position themselves conservatively.
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