From Cathie to The Fed, Recession, and Earnings

Cathie Wood’s open letter to the Fed.

The CEO, and CIO of investment firm ARK Invest, Cathie Wood, wrote an open letter to Fed officials on Monday, October 10, 2022. The letter expresses the Feds risking an economic ‘deflationary bust’ and concern that the central bank is making a policy error with its rapid rate hikes.


What is a deflationary bust? It is a situation where people do not spend their money due to high inflation rates. Investment, consumption, and goods demand rates will decline, and cash circulation will also decrease due to weakening purchasing power. It is common during a recession or economic crisis.


Consumers spend less money because they think the prices will be lower tomorrow, so why spent today?


Fed’s Mistake — only taking the employment and price indexes into consideration. According to Cathie, The Fed should focus on commodity prices, which indicate an economic risk of deflation, not inflation. On the bright side, the unemployment rate fell by 3.5% this year, with more than 263K people being employed. However, the prices of lumber, copper, and housing commodities are decreasing, which could lead to the risk of a deflationary bust.


In Wood’s letter, addressing — “The Fed seems focused on two variables that, in our view, are lagging indicators — downstream inflation and employment — both of which have been sending conflicting signals and should be calling into question the Fed’s unanimous call for higher interest rates.”


Following the US Fed’s decision, almost 40 central banks around the world appointed the same remedy of rate increases during September. This will result in a global deflationary bust.


Recession — from Europe to the US.

Last Monday, October 10, 2022 — World Bank President David Malpass and International Monetary Fund Managing Director Kristalina Georgieva warned about the growing risk of global recession and said inflation remained a problem after Russia invaded Ukraine.



Jamie Dimon, the JP Morgan CEO, has been kept warning about a U.S. recession throughout this year, and now he’s putting a timeline on it.


As quoted by Dimon, “These are very, very serious things which I think are likely to push the U.S. and the world — I mean, Europe is already in recession — and they’re likely to put the U.S. in some kind of recession six to nine months from now”.


Reuters and CNBC report indicated the S&P 500 index has lost about 24% with all three major U.S. indices trading in the bear market momentum and supported by Dimon, “another easy 20%” of market slip is likely to happen. Along with JP Morgan, last June, Goldman Sachs had predicted a 30% chance of the U.S. market being in recession. Morgan Stanley also predicted a 35% chance of recession taking place in the next 12 months.


“Some parts of the U.S. economy have moved into recession,” Jonathan Garner, chief Asia and emerging market strategist at Morgan Stanley said, emphasizing the dangers the U.S. tech industry faces.



Tech companies had the worst hit when the stock market took a plunge earlier this year as Netflix, and Meta has already been putting layoffs into action, while companies like Google extending their hiring freeze.



A brutal third-quarter earnings season could push the stock market even lower

Energy companies driving the strong performance of the last quarter. If putting the sector off the hook, S&P 500 earnings declined, and most analysts expect that trend to continue. Last August, S&P 500 was down more than 12% in the past 30 days alone. Not only that, but many investment banks also slashed their earnings forecasts for the third quarter in recent months.


According to Bank of America, earnings per share estimates are down 7% since July for S&P 500 companies, with nine of 11 sectors seeing downward revisions. Adding to the estimation, Bank of America is now forecasting a 9% earnings decline in 2023.



Effect of the rise of USD

The increase in the U.S. dollar will put pressure on many U.S. companies with significant overseas revenues. Rising in the dollar can cost serious foreign exchange losses when cash flow is brought back to the home country.


Roughly 30% of U.S. companies’ revenues are generated overseas. For example, Philip Morris International is an American cigarette and tobacco company with a foreign presence in 180 countries outside the United States. With products exclusively overseas, they will probably experience harsh foreign exchange losses.



Bottom Line


Investors fear that the Federal Reserve won’t back off its interest rate hikes, even in the face of a slowing economy. The rise of interest rates, continuous recession across the globe, and weakening performance of stocks and products demands. Companies can hardly achieve their forecast revenue made months ago, let alone deliver promising dividends.



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