A few weeks ago, there were almost no positives to think of. Most investment advisors were bearish. Cash was sitting on the sidelines earning nothing. Short sellers were pressed. Russian invasion continued to look worse by the hour. Oil, wheat, natural gas and many other commodities spiked higher even after doubling since Covid. The most predictable of FANGMAN stocks were taking it on the chin. Half of all stocks were down 20% from their highs. Over 70% of the Nasdaq was in a bear market. Statistically, stocks were as oversold as any time in history, which leads us to a massive rally that continued yesterday.
The Nasdaq is now up 12% in just 10 days and the S&P is up 8%. The Ark Innovation fund is up a whopping 25%. This happened while crude and oil stocks kept making new highs as well. The 10-year Treasury yields are also up over 50bps this month, all the way back to early 2019 highs of 2.35%. Steel, copper, gold and aluminum stocks also made new highs, pressuring low-income balance sheets. Suffice it to say, this is not normal action!
High P/E stocks shouldn’t jump higher when rates rise. Spikes in interest rates shouldn’t cause a flow of funds into long duration stocks. Russian progression will fan fuel on the inflation front with no end in sight to sanctions. This will keep restricting the flow of fuel which has tremendous ancillary effects to prices across the globe in numerous commodities. Russia may not matter much from a direct GDP metric, but they supply too much energy to not matter. Nitrogen is in short supply, causing fertilizer prices to skyrocket. This precedes a critical planting season where corn and wheat farms are in dismay due to geopolitical events. One commodity supply chain disruption leads to others.
All of this leads to a very confusing market for everyone involved. Range bound action tends to do that. Stocks deserved to take a breather after doubling in just two years. Many high flyers carried momentum into the stratosphere and will not reach 2021 prices in quite some time, if ever. However, bad news got priced in. Facebook# went from nearly $400 to $185, causing its P/E to drop from 31 to 14. With an expected growth rate in the mid-teens, there are signs of real value. Zoom went from $406 to $94. Their P/E went from 100 to 25. That still may or may not be cheap enough, but it is a real business whose fair value is closer to $100 than $400. Fundamental investors start to come back.
This leads to a relief rally. Shorts get covered. Cash from the sidelines roars back into stocks for fear of missing the next rally. Buy the dip mentality is still here. Over the near term, that’s a positive. Over the long haul, it’s questionable. Markets don’t make solid bottoms until froth is completely washed out, which doesn’t happen overnight. Sometimes bottoms are a long, drawn-out process. Just as we do not get more bearish after sizable drops in stocks, there isn’t much reason to flip over to full-blown bullish either.
Inflation remains enemy #1 and every day Russia continues to keep Putin in power equals another day of higher commodity prices. Russia can divert some of their oil and gas to other Asian countries but not all of it. Europe is finally getting religion and will invest more towards their infrastructure to help get alternative sources of energy. Neither situation is going to help the cost of fuel, which is tied to nearly all goods produced at some point in the supply chain. Taking one step further, I see only one way that sanctions and corporate actions will stop with respect to Russia and that entails Putin being ousted. There is simply no other reason to allow Russia back into the global picture. This keeps oil prices elevated for quite some time…and fertilizer…and wheat….and corn…and aluminum…and copper…etc.
As inflation stays elevated for much longer than many expected, the Fed will react even more aggressively. Chairman Powell, not even a week away from his last conference, is already hinting at 50bps for May’s meeting. That will do nothing to inflation right now. Much more will need to be done. Balance sheet reduction should be pulled forward, meaning by summertime, maturing bonds will not be reinvested. A gradually slowing global economy will help some, but not nearly enough to quell the commodity spikes which are turning into the new norm as opposed to coming back to earth.
Granted there are plenty of signs already pointing to a gradual slowdown that will actually help inflation in the coming months. Mortgage refinancing is all but over. When 30-year mortgage rates almost double, there is sure to be less action. No more using home equity as an ATM. Manufacturing indices keep showing slowness, albeit still positive on a forward looking basis. Atlanta Fed’s GDPNow model is pointing to 0.9% growth in Q1, a far cry from yesteryear. Recent earnings reports have been good, not great. Europe is going to be close to a recession in the near future. Russia almost assuredly will be. Global GDP is coming down.
That being said, history notes that stocks don’t peak until earnings do. Even though the Fed is pulling the punch bowl, the train is still moving forward. Earnings should expand 5% – 8% this year, lower than the 10% economists expected at the onset of 2022. Many consumers are still flush with cash. Savings accounts are full for higher income earners. Home values remain elevated. Investment accounts are only 5% – 10% off recent highs, following a three-year run of 27% annually. Lastly, no bull market has peaked before the first rate hike. As always, past performance is no guarantee of future results.
Don’t fight the Fed works in both directions. An overly aggressive Fed will lead to an inverted yield curve at some point. This may even be necessary to get us out of this inflation rut. In the 70s, Chairman Volcker caused a lot of short-term pain fighting inflation that eventually yielded a massive bull market for the United States. Soft landings are quite rare, but not impossible.
More range-bound action is likely with 4,000 as a floor and 4,800 a ceiling for the S&P 500. Actively managed accounts might be well served to reduce beta at the upper ends and buy beaten down leaders towards the bottom. It could take a while before enough economic data emerges and geopolitical hostilities are squashed, giving investors more questions than answers. After a huge run for stocks, that is perfectly acceptable.
Nancy Pelosi is 82. A creative arts kind of day with musicians Dian Ross turning 78, Steven Tyler 74 and Kenny Chesney 54 and for actors/actresses: Keira Knightley 37, Leslie Mann 50, Jennifer Grey 62, Martin Short 72, James Caan 82.
James Vogt, 610-260-2214