After seven straight negative days, the Nasdaq finally bounced higher on Wednesday with a substantial rally. Oversold conditions were ripe, but paired with falling energy prices and moderation in Treasury yields led to a risk-on rally. The small-cap index led the way with a 2.2% advance and held important support levels. The S&P was up 1.8%. Nearly 95% of the stocks in the S&P finished higher, an impressive feat. Around half of the index is back to trading above its 50 day moving averages. On the flip side, hardly any are above their 200 day moving averages. End result, bears are still in charge.
Thursday brought continued volatility with major averages flipping back and forth from down ~1% to up 1% before finally settling modestly higher. The equal weight S&P finished up nearly 1% but mega caps lagged, with the S&P behind that. Following a profit warning from McCormick (anyone see how expensive spices are these days?!) led to a decline in the Consumer Staples sector while Health Care and Financial stocks finished ~1.8% higher.
There were nearly a dozen Fed governors, voting and non-voting, speaking this week at various conferences. Chairman Powell continued his mantra that we must get inflation under control and avoid what occurred during the 70s. Again, during the 70s, the Fed continued to make a now obvious mistake of cutting rates too soon only to see inflation flare back up over and over. He specifically noted, again, inflation during the period “followed several failed attempts to bring inflation under control.” Powell is undoubtedly intending to beat inflation by keeping rates higher for longer, impacting the jobs market and awaiting clear signs of CPI falling back to 2% from 8%+ today.
Here is what 70s investors had to deal with (CPI went from 6% in 1970, 2.5% in 1972, back up to 12% in 1975, another drop to 5% in 1977 then 15% in 1980 before finally taking their medicine and dramatically raising Fed Funds to an overly critical level under Chairman Volcker). A CPI chart from that timeframe shows massive high and low waves. This is not constructive for business planners.
Source: Evercore ISI
Federal Reserve Vice Chair Lael Brainard had a similar sentiment, noting “While the moderation in monthly inflation is welcome, it will be necessary to see several months of low monthly inflation readings to be confident that inflation is moving back down to 2 percent.” Fed officials are attempting to erase decades of the proverbial Fed Put where any inkling of slowing jobs, GDP or even a declining stock market resulted in turning on the printing presses. Inflation “expectations” are critically important. We shall see how long this lasts but do not expect any change in tone unless something dramatic happens.
Jim and I have noted on numerous occasions the jobs and CPI data are backward looking, aka lagging indicators. Many changes in market pricing takes time to filter into the economy and show up on economic reports. Making policy decisions without looking forward has been a century long problem for the Federal Reserve.
A list of items yet to hit CPI and Jobs:
- Surging US Dollar (commodities are priced in dollars so there is a strong inverse relationship).
- Easing supply chains as factories reopen (outside of lockdowns in select China provinces).
- Global recession is all but a foregone conclusion with Europe leading the way this winter when electric/gas bills are going to skyrocket.
- Money supply plunging.
- Future basis effects – we are about to start lapping 2021s inflation spikes. Year over year CPI comparisons could even be negative by late 2023.
- Commodity prices collapsing. Even energy declined over 30% the last few months and is entering a seasonally weak period. The proverbial death cross (50 day moving averages going below the 200-day moving average) occurred this week as well.
- Effective rents have clearly topped.
- Used car prices are falling ~2%/per month.
- Gold, an inflation hedge through centuries, is down ~20% since March.
- According to surveys, 90%+ of corporate executives think we are in or will be in a recession.
- Trucking and shipping freight rates getting back to normal.
- Lastly, CPI/PCE inflation expectations are falling like a rock:
The future looks bleak for inflation bulls. However, a Fed focusing on the past is more likely than not to make yet another policy mistake by going too far in this battle. Recall, they did not see inflation coming at this point last year either!
Inverted Yield Curve:
Here are current US Treasury Interest Rates:
7 of the past 7 recessions followed an inversion of the 10 year & 3-month Treasury. Currently, that spread is still a positive 21bps. Futures are pricing in an 82% chance for another 75bps rise at the Fed’s September 21st meeting, putting Fed Funds in the 3.00% – 3.25% target range. Subsequent meetings are also “live” and suggest another 50 – 75bps tacked on.
If executed, those rate hikes will all but guarantee an inversion across the entire yield curve. History would say that gives an economy another 9 – 18 months before a real recession hits. This entails not just two negative GDP quarters, but substantial job losses, lower incomes, a significant decline in economic activity across multiple industries, declining industrial production and a drop in real personal consumption expenditures. This has not happened in 2022. Jobs, industrial production and consumer spending are still in bull market territory today, albeit down from last year’s highs. The future looks bleaker, which is part of why equities have collapsed so much this year.
In conclusion, we have a Fed hell bent on “winning” this battle that they helped create. They are backward looking and unlikely to see an incoming freight train of slower growth. Policy mistakes are commonplace, meaning a soft landing is unlikely. On the flip side, stocks have priced in a lot of bad news already. 3800 and 3600 are obvious support levels for the S&P 500 and 4400 is resistance. Technicians, including black box computer programs, will hit stocks hard on a breakout in either direction.
Markets will react positively to any semblance of an end to this rate hiking cycle. Next week’s CPI data could be another important piece to the Fed’s puzzle. Inflation is coming down, but maybe not quickly enough to halt this Federal Reserve. Overnight, inflation reports internationally came in lower than expected. This is driving market futures strongly higher this morning.
Again, going back to the 70s, when CPI peaked, stocks took off. When markets decide inflation is finally beaten, a tradable rally will ensue. History does not repeat exactly, but often rhymes. This Fed will keep rates higher for longer than what occurred in the 70s so any stock rally based on hope for lower rates could prove costly. Stick to high free cash flow companies, leading businesses and those who can control costs in either rate environment.
Source: Evercore ISI
SNL alum, Adam Sandler is 56 today. Grammy award-winning jazz singer, Michael Bublé turns 47. Hugh Grant is 62 and Eric Stonestreet, of Modern Family, is 51.
James Vogt, 610-260-2214