Investors scramble to figure out impact of the Fed's big change in tone this week, how to trade it

Published Thu, Apr 7 202210:18 AM EDTUpdated Thu, Apr 7 202210:36 AM EDT

The market is slowly getting the message that the Federal Reserve is going to be very aggressive in raising rates. For stocks, this means that the name of the game will be monitoring growth. If you want to see the complicated intersection of growth and inflation, look at food products maker Conagra . They reported earnings in line with expectations, but lowered estimates for the current quarter, citing higher transportation expenses and raw material costs that are cutting into margins. Most interesting was the organic sales, which were up an impressive 6%. But why were sales up? Because prices were higher. Conagra: prices up, volume down Organic sales: up 6% Price/mix: up 8.6% Volume: down 2.6% A 6% increase in organic sales was driven by higher prices, and volumes were down. Why? "The volume decrease was primarily a result of the elasticity impact from inflation-driven pricing actions; however, the elasticity impact was favorable to expectations," the company said. In plain English: They raised prices, and some consumers declined to pay the higher prices. But, the number of people who declined to pay wasn't as bad as we feared. So we not only have to worry about a growth slowdown; we also have to worry about the immediate impact of inflation. This will have a profound impact on earnings estimates: My sense is that the first quarter will be fine. The second quarter may also be OK because corporate America will still (mostly) have pricing power without large demand destruction. However, third and fourth-quarter estimates — which are at historic highs — will likely be coming down soon. What does this all mean? The market is trading like the economy is in a late-stage cycle. This is the last stage before an economy falls into a recession. It is characterized by rising wages, higher inflation, decelerating economic growth and peaks in profit margins and stock multiples. The market reacts by selling cyclical stocks that turn down when the economy turns down, which is what we are seeing: Transports, home builders, and retail are all down roughly 10% since the S & P 500 hit a peak on March 29. At the same time, commodity stocks like energy and metals are holding up, as are defensive sectors like health care and consumer staples. Again, this is all classic late-cycle activity.

Traders on the floor of the NYSE, March 31, 2022.

Source: NYSE

The market is slowly getting the message that the Federal Reserve is going to be very aggressive in raising rates. For stocks, this means that the name of the game will be monitoring growth.