Similar to July, markets are starting to react to a potential Fed pivot and rallied hard earlier this week. An eventual pivot paired with extremely negative sentiment, retail investors throwing in the towel, valuations getting back to normal and a significant drop in rates following the Bank of England’s about face and you get a 6% pop in just two trading days to start the 4th quarter. A minor pullback ensued yesterday as investors do not want to be over exposed prior to data due out this morning.
Clearly, this morning’s employment report will drive stocks and bonds alike. Again, good news is bad and vice versa. For the Fed to actually pivot, they need to see pressure on the employed and even more pressure on wage gains. There were some real positives from that standpoint earlier this week as well. US Job openings posted their 2nd largest monthly decline on record, only bested by April 2020 which followed the pandemic lockdowns. Job openings were 1.1 million lower, falling to a still very-strong 10.05 million openings. We have been noting that leading indicators are pointing to a softening labor market, albeit not quick enough for economic tightening to stop. Even with the drop, job postings are still 50% higher than pre-pandemic. One data point will not change anything, but it is a good start.
Wages and newly employed will be key to watch today, but they are still lagging indicators. The Fed could do nothing from here and more jobs would be lost. Our, and the market’s fear, is that another strong payroll number today will make the Fed keep its brake pedal to the floor, bringing the economy to a screeching stop and causing a deeper recession.
Stock and bond markets may be anticipating a dovish shift over the coming quarters, but it is unlikely to come from Fed speeches in the near-term. Chairman Powell’s hawkish speech at Jackson Hole was only a little over one month ago. He and his team have referenced Volcker on numerous occasions. They realize tough talk is necessary to keep inflation “expectations” in check. One or two months of preferably slower economic data will not end their newfound mantra of not just fighting, but beating, inflation for good. Fed history shows inflation must be brought down before any change occurs.
While the headlines will not be great from the Fed in the near-term, stocks look out further than what is going to be posted in the Wall Street Journal this weekend. Damage has already been done to consumer balance sheets. Home prices have peaked. Getting a loan is very costly today. Stocks and bonds have been crushed. What is more important, is what can we expect conditions to look like next Summer/Fall? It is that notion which drives moves like what we saw this week. The Fed can banter all they want about not raising rates next year; in reality, they have no clue. Truthfully, they should stop saying they know what will happen in 2023 as history shows their prognostication powers are no better than a roll of the dice. More data pointing to a slowing economy, declining inflation and a weaker jobs market will finally slow/halt this record-breaking tightening phase.
Markets Have Always Roared Back
The most important question we get these days from clients is what to do now. Elevated cash levels have helped investors throughout 2022, so has owning oil companies. Every other S&P sector is down, even previous safety areas like Utilities and Consumer Staples. Going to cash in January and paying Uncle Sam his share of realized profits would have been crazy at the time, but would have alleviated a lot of stress. Hindsight is always 20/20. However, what happens from here is the critical investment question.
There are no DeLorean time machines. Every investment holding needs to be scrutinized for what will happen, not what has already occurred. While the absolute lows may or may not have been confirmed, it is quite clear that stocks are pricing in a lot of negative news and many are now offering decent, long-term values.
Case in point, when looking at the S&P 500, there are 114 stocks trading at a single digit price-to- earnings ratio. That is 23% of the market, trading well below historic norms and levels not seen since the depths of the Great Financial Crisis in 2009. These names are well known too (to name a few): Nucor, PNC Financial Services, FedEx#, Chevron#, JP Morgan#, DaVita, eBay, Bristol-Myers Squibb#, Comcast#, Altria Group, AIG, Prudential, Verizon, Whirlpool, Lennar, Toll Brothers and Warner Brothers Discovery. For those that prefer income as a measure, nearly 30% of the S&P now sports a dividend yield over 3% as well!
It’s obvious, but worth stating: every bear market has led to better entry points. So far, every bear market has been followed by a strong bull market too. Hindsight will show if September was the exact low, but when looking out over the coming decade, it should not matter too much. What matters is getting/staying invested when values appear. Over time, stocks (and bonds at 5% – 6% coupons) will give investors respectable gains. Here is a good graphic showing the advances relative to drops going back to the 1950’s:
Over previous inflationary periods, stocks did not regain their footing until it was clear that inflation turned the corner and started to drop precipitously. Dating back to 1929, the average gain following an inflation peak was 14% over the following year. Taking out the housing bubble period and those gains jump to 17%. When inflation clearly shows signs of dissipating, the Fed will stop their aggressive monetary tightening plans. “Don’t Fight the Fed” has worked since its inception. When they stop, stocks will rise.
Bounces during bear markets, especially near the lows, are also the most impressive times to recoup previous losses. Again, no one will know if ~3,600 is the ultimate low for the S&P 500. What we do know, is a bounce like what we saw this week (6% in two days) is quite normal during the bottoming process. So far, previous bounces have proven to be good times to get defensive and reduce exposure to those high multiple, debt-dependent companies, so investors should still proceed cautiously. However, now is not the time to get overly defensive either. Eventually, the huge bounce following a 25% drawdown proves fruitful and is a clear sign of a change in tone.
Source: @jessefelder, The Daily Shot
Economic data will get worse from here. Headlines will be overly negative. That is all well known. While there is no all-clear signal quite yet, plenty of world-class companies are offering substantial discounts to fair value. Things could get worse, but we expect the most painful portion of this bear market is behind us.
In that regard, AMD could be an interesting name to watch today. They preannounced earnings last night and lowered their revenue for the quarter by an eye-opening 17%. Even worse, earnings per share are down by 35% from their guidance a few months ago. This mega drop happened in just one quarter. A year ago, the stock would be down similar to the EPS drop, or 35%. So far, pre-market action shows a modest, albeit not great, 5% decline. The brunt of negative forward news has already been built in to the stock price.
Simon Cowell is 63 today. Vladimir Putin turns 70. Singers Toni Braxton and John Mellencamp are now 55 and 71, respectively. Alice Walton, daughter of Sam Walton, founder of Walmart, is now 73. Finally, the Philadelphia Phillies are back in the playoffs. If they advance, they could be playing the Los Angeles Dodgers in the NLCS. One of their many stars, Mookie Betts, turns 30 today.
James Vogt, 610-260-2214