Traders expect the U.S. Fed to soften as Chairman Powell suggested they have reached a neutral rate with the last rate increase. The US stock markets started an upward trend after the last 75bp rate increase – expecting the U.S. Fed to move toward a more data-driven rate adjustment.
My research suggests the U.S. Federal Reserve has a much more difficult battle ahead related to inflation, global market concerns, and underlying global monetary function.
Simply put, global central banks have printed too much money over the past 7+ years, and the eventual unwinding of this excess capital may take aggressive controls to tame.
Real Estate Data Shows A Sudden Shift In Forward Expectations
The US housing market is one of the first things I look at in terms of consumer demand, home-building expectations, and overall confidence for consumers to engage in Big Ticket spending. Look at how the US Real Estate sector has changed over the past five years.
The data comparison chart below, originating from September 2017, shows how the US Real Estate sector went from moderately hot in late 2017 to early 2018; stalled from July 2018 to May 2019; then got super-heated in late 2019 as extremely low-interest rates drove buyers into a feeding frenzy.
As the COVID-19 virus initiated the US lockdowns in March/April 2020, you can see the buying frenzy ground to a halt. Between March 2020 and July 2020, Average Days On Market shot up from -8 to +17 (YoY) – showing people stopped buying homes. At this same time, home prices continued to rise, moving from +3.3% to +14% (YoY) by the end of 2020. Continue reading "Should We Prepare For An Aggressive U.S. Fed?"→
It may be time to start thinking that this recent bout of high inflation won’t really last as long as we thought.
Right now the outlook is starting to look fairly positive: Oil prices are coming down, the chip crisis seems to be over — the shortage has quickly turned into a glut — supply chain problems have eased.
At the same time, technology will continue to make things more efficient, just as it did before the Covid-19 lockdown, thus easing price pressures.
Retailers are overloaded with inventory and are already unloading it at steep discounts. And stores can only raise prices so much before consumers say no. Do I really need that $6 box of cereal? Probably not.
Does this mean the Federal Reserve won't need to be as aggressive in raising rates as we thought? Was the Fed - dare I say it — correct after all in believing that inflation was transitory, and the only thing they got wrong was how long that temporary period would be and how high inflation would rise?
Maybe it won't be as long as most everyone thinks. Like most things lately in the U.S. — climate, Covid, the economy — crises never turn out to be as bad as the panic-mongers would have us believe.
Indeed, consumers don’t appear as worried about inflation as most people think. Consumer confidence numbers have dropped sharply, it’s true, but retail sales have held up, witness the 1.0% rebound in June after falling 0.1% the prior month, according to last Friday’s report.
That’s mainly because we still have a robust job market and incomes continue to rise, maybe not at the same rate as inflation but not far behind. The economy added 372,000 jobs in June, down slightly from May’s gain of 384,000 but 100,000+ more than forecasts.
The unemployment rate remained near the 50-year low of 3.6% and about where it was before the pandemic. Most importantly, perhaps, average hourly earnings rose 5.1% in June from a year earlier, not far below the core inflation rate of 5.9%.
Does this mean we’re out of the inflationary woods that our monetary and fiscal authorities have largely created by flooding the economy with money when it wasn’t totally necessary? I wouldn’t go that far.
While income gains seem to be running only a little behind the rate of inflation, the same can’t be said for interest rates. On Friday the yield on the U.S. Treasury’s benchmark 10-year note had fallen below 3.0%. Can the Fed realistically get inflation down to its target rate of 2% if inflation is double that on long-term bond yields? It doesn’t seem possible.
However, it’s useful to note that other bellwether rates have risen closer to the rate of inflation, thanks to the threat/promise of more Fed rate hikes. Specifically, the average rate on a 30-year fixed-rate mortgage in June hit 5.52%, according to Freddie Mac, more than 200 basis points above where it stood at the beginning of the year.
That’s certainly not good news if you’re planning to finance the purchase of a house soon, but it does stand the possibility of removing some of the froth from the housing market — both purchases and rentals — that is keeping many young people from starting out on their own. Long term, that’s a good thing.
More than any other statistic, perhaps, housing costs were an area where the Fed proved woefully inept in measuring inflation over the past decade or so.
Ever since the global financial crisis of 2008, the Fed banged its collective head against the wall trying to raise the inflation rate to 2%, while all along inflation was running well above that, if only the Fed’s army of Ivy League-trained economists had paid attention to what was going on around them in home prices and rents.
So where does that leave us? Is the Fed going to stop tightening because inflation may appear to be under control? No, nor should it.
For the past 15 years or so, ever since the end of the global financial crisis in 2008, we’ve heard constant pleas (including from yours truly) that monetary policy needs to “normalize,” meaning to some traditional, pre-2008 level of interest rates. Alas, it never came to pass.
The post-crisis economic growth rate was never strong enough to persuade the Fed to ease monetary policy and raise interest rates significantly. Then we had the pandemic, which moved everything back to square one, with Fed policy going well beyond where it had ever gone before.
Now, with the economy still growing fairly strongly despite multiple obstacles — supply chain disruptions, war in Ukraine, inflation — that should give the Fed comfort to continue to raise rates and reduce its balance sheet without overly disrupting consumers, who continue to travel, eat at restaurants, and go to ballgames.
Let’s hope it doesn’t lose its nerve as it has multiple times before. That should be a boon to stocks, which could certainly use a lift.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
On Tuesday, July 5th, Crude Oil collapsed very sharply, down over 10% near the lows, in an aggressive breakdown of the price. The $97.43 lows reached that day were more than -14% from recent highs (set on June 29, 2022) and more than -21% from highs set on June 14, 2022.
Consumer Discretionary Spending Likely To Fall Further
Recently, I shared a similar breakdown that took place in Crude Oil in 2009 and how tightening consumer spending often correlates with peaks in Crude Oil when crisis events happen.
Within that research article, I shared this chart highlighting the collapse in the Consumer Discretionary sector that preceded the downward collapse in Crude Oil. The interesting facet of this chart is we can see the inflationary price pressure in Crude Oil (and the general economy) countered by pressures put on consumers in the lower IYC price chart.
Consumers Lead The Global Economy – Watch IYC Closely
As prices rise, consumers are put under extreme pressure to keep their normal standard of living. As inflationary pressures continue, consumers make necessary sacrifices to manage their budgets – often going into debt in the process.
Eventually, this cycle breaks, and inflationary trends end. This is clearly evident on the chart below in July 2008 – as IYC, the Consumer Discretionary sector, collapsed by more than 27% before Crude Oil finally peaked and broke downward.
Since November 2021, IYC Has Fallen More Than -37%
This current Weekly Crude Oil & IYC Chart shows IYC has collapsed by more than -37% from the November 2021 highs – well beyond the -27% collapse in 2008 that preceded the 2008-09 Global Financial Crisis event. Is the current collapse in IYC a sign that a broad global crisis event has already begun to unfold beneath all the news and hype? Will Crude Oil collapse below $75ppb as the global economy shifts away from inflationary price trends and bubbles burst?
The Deflationary Price Cycle Is Not Over Yet
If IYC falls below $55 in an aggressive downward price move, I would state the risks of a global deflationary price cycle (or extended recession) are still quite elevated. Currently, the $55 price level in IYC aligns with early 2019 price highs and reflects an extended price advance from the $12~$15 IYC price levels in 2008-09.
If the $55 IYC price level is breached to the downside, I expect the $37.50~$40.00 price level to become future support – as that price level reflects the COVID-19 event lows.
Still, these lower price targets represent an additional -32% decline in IYC and reflect a total of a -57% collapse in the Consumer Discretionary sector from the November 2021 peak levels. The potential target range of $37.50~$40.00 correlates with the 2008-09 GFC collapse range when IYC fell from $18 to lows near $8 (nearly -57%).
We are still very early in the shifting deflationary cycle phase after the US Fed started raising interest rates. Learn to protect and profit from this global event with my specialized investment solutions.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation for their opinion.
This has been the stock market’s worst first-half in over 50 years with inflation serving as the main culprit and a slew of ancillary pressures from China’s Covid lockdowns and the Ukraine/Russia conflict.
Through the first six months, no sector has been immune from the breath and reach of this bear market. The S&P 500, Nasdaq and Russell 2000 are well in bear market territory at June’s end.
Risk appetite across the spectrum has been eroded. The crypto market has collapsed, traditional IPOs and SPACs have dried up and several commodities have collapsed as of late.
Despite this massive wealth destruction, strategists from major Wall Street firms are forecasting that stocks will recapture most of their losses in the back half of the year.
The S&P 500 is expected to finish the year more than 20% higher from the end of June’s levels per the average year-end target derived from the top 15 Wall Street strategists. This forecast translates into the market recapturing most of the year’s losses, albeit finishing the year with a negative return of ~3%.
During bear markets or an extended period of a market-wide bear backdrop, investors have the unique opportunity to purchase heavily discounted stocks at a fraction of the price when compared to their peaks.
As history indicates, establishing long-term positions during corrections can lead to outsized gains over the intermediate and long term. As the selling pressure abates and the macroeconomic backdrop resolves, building equity stakes in high-quality companies bodes well for long term investors.
As the macro issues resolve over time, the markets will regain their footing and appreciate higher. The current market backdrop is the exact scenario where investors should be deploying cash on-hand to snap up heavily discounted merchandise in a diversified and dollar cost averaging manner.
Behind the Inflation Curve
The Federal Reserve has fallen far behind the inflation curve, putting through reactive interest rate hikes of 1.5 percentage points, with more to come throughout 2022.
Many politicians and executives have been sounding the inflation alarm since Q4 of 2021 to no avail while the Fed continued to buy bonds and pump liquidity into the system.
The latest inflation numbers by the Labor Department came in at 8.6%, the highest since December 1981. The reactionary Fed and runaway inflation have caused havoc on Wall Street while the Fed attempts to slam the breaks on the economy.
Second Half Bounce?
Although the first half of this year ranks among the worst in history, the selling may ease in the second half if history is any guide.
When the S&P 500 plunged 21% in the first half of 1970, it promptly reversed those losses to gain 26.5% in the second half and post a slight gain for the year. 1932, 1940, 1962 and 1970 saw first half decimation on par with 2022 however every one of those years saw a second half rebound.
Only one year saw the market recover the losses it incurred during the first half, in 1970 (Figure 1).
Figure 1 – Historical perspective of worst first half market performances and the respective full year outcomes when factoring in the second half of the year
Recession Possibility and Type
With the possibility of recession, there’s different underpinnings of a bear market that are broken out into cyclical-driven, structural-driven and “event-driven” stock declines of 20% or more.
Goldman Sachs (GS) holds the position that investors are experiencing a cyclical bear market which is marked by high inflation and rising interest rates. This combination results in price-to-earnings multiple contraction and thus a reduction in valuations.
The current climate is buffered against a structural bear market that is buoyed by strong corporate and household balance sheets. The positive side is that the average cyclical bear market lasts two years, far shorter than the average three in half years for a structural bear market. The average price decline during a cyclical bear market is only about 31% versus 57% during a structural one per Goldman.
Deploying cash into an environment where the selling is relentless and indiscriminate can be a daunting task. However, for any portfolio structure, having cash on-hand is essential and in these environments is where this cash should be deployed in equities.
This cash position provides investors with flexibility and agility when faced with market corrections. Cash enables investors to be opportunistic and capitalize on stocks that have sold off and have become de-risked.
Initiating new positions and dollar cost averaging during these extended periods of weakness are great long-term drivers of portfolio appreciation. Absent of any systemic risk, there’s a lot of fantastic entry points for many high-quality large cap companies. Investors should not remiss and capitalize on this buying opportunity because it may not last too long.
Anchoring and Dollar Cost Averaging
Purchasing stocks at the exact bottom is nearly impossible however purchasing stocks at attractive valuations in a disciplined manner over time is possible.
Dollar cost averaging is a great strategy to use when anchoring down into a position with an initial sum of capital and following through with additional incremental purchases as the stock declines further. The net benefit is reducing the average purchase price per share in a sequential fashion (i.e., reducing cost basis). An example of building out a high-quality portfolio with subsequent dollar cost averaging throughput this market weakness can be seen in Figure 2.
Figure 2 – Initiating positions in high quality companies with subsequent dollar cost averaging to build out a well-diversified portfolio. These long equity trades along with options-based trades can be found via the Trade Notification service.
This has been the stock market’s worst first-half in over 50 years where no sector has been immune from the breath and reach of this bear market. The S&P 500, Nasdaq and Russell 2000 are well in bear market territory at June’s end.
Despite this massive wealth destruction, strategists from major Wall Street firms are forecasting that stocks will recapture most of their losses in the back half of the year. The S&P 500 is expected to finish the year more than 20% higher from the end of June’s levels per top Wall Street strategists.
Purchasing stocks at the exact bottom is nearly impossible however purchasing stocks at attractive valuations in a disciplined manner over time is possible. During bear markets, investors have the unique opportunity to purchase heavily discounted stocks at a fraction of the price when compared to their peaks.
As history indicates, establishing long-term positions during corrections can lead to outsized gains over the intermediate and long term. As the selling pressure abates and the macroeconomic backdrop resolves, building equity stakes in high-quality companies bodes well for investors. The current market backdrop is the exact scenario where investors should be deploying cash on-hand to snap up heavily discounted merchandise.
Disclosure: Stock Options Dad LLC is a Registered Investment Adviser (RIA) firm specializing in options-based services and education. There are no business relationships with any companies mentioned in this article. This article reflects the opinions of the RIA. Any recommendation contained in this article is subject to change at any time. No recommendation is intended to constitute an entire portfolio. The author encourages all investors to conduct their own research and due diligence prior to investing or taking any actions in options trading. Please feel free to comment and provide feedback; the author values all responses. The author is the founder and Managing Member of Stock Options Dad LLC – A Registered Investment Adviser (RIA) firm www.stockoptionsdad.com defining risk, leveraging a minimal amount of capital and maximizing return on investment. For more engaging, short-duration options-based content, visit Stock Options Dad LLC’s YouTube channel. Please direct all inquires to [email protected]. The author holds shares of AAPL, ACN, ADBE, AMD, AMZN, ARKK, AXP, BA, BBY, C, CMG, COST, CRM, DIA, DIS, EW, FB, FDX, FXI, GOOGL, GS, HD, HON, IBB, INTC, IWM, JPM, LULU, MA, MS, MSFT, NKE, NVDA, PYPL, QCOM, QQQ, SBUX, SPY, SQ, TMO, UNH and V.
I get the distinct feeling that a lot of investors are feeling like the action last week in the equity markets may be a harbinger of good things to come. In other words, we might be out of the woods.
As much as I’d like to believe that I can’t jump on board. I still feel there’s more downside pain to come for stocks, tech, and other risky assets like Bitcoin (BTC) and crypto. But before I tell you why, let’s take a win, no matter how ugly it is.
Fact is, across the board last week equity markets were up. See for yourself…
As you can see from this collection of multiple weekly charts, stocks booked a win last week. The Dow was up 5.4% and the S&P 500 - a good proxy for the broader stock market - was up 6.4%. Meanwhile, the Russell 2000 - a good gauge of all stocks - was up 6%. And probably most surprising of all, the tech-heavy Nasdaq was up 7.5%.
In addition, last week’s action in all four the indexes reversed multi-week slides. It was the first positive week in four weeks for the Dow, the S&P, and the Nasdaq. For the Russell 2000 it was the first up week in the last three weeks.
But as you can see from the above charts, last week’s action was an anomaly compared to the action we’ve been seeing over the recent past. In fact, if you take the above charts and drill out to what’s been happening over the past year, it’s clear the overall trend in all these markets is bearish. No ifs, ands, or buts.
As I warned about in my article at the beginning of June, the scant positive weekly action in these markets is now confirmed as little more than a series of “dead cat bounces.”
If you remember, a dead cat bounce can masquerade as a reversal to the upside. But it’s only a temporary reprieve and quickly resumes its prior downtrend. Unfortunately, that’s what we’ve been seeing in all these stocks markets. And while I’d love to be wrong on this point, the numbers don’t lie.
Stubborn Inflation Means More Downside
But it’s not just these technical patterns that tell me the markets have more downside pain to come. The other huge factor pressuring stock prices: Inflation and what it will take to bring it under control. Here’s what I mean.
In general inflation can drive investors to sell stocks. And that because inflation wears away at the value of invested dollars. If your money is worth 8.6% less this year that it was last year, nobody is happy.
But the biggest reason inflation drives investors to sell stocks is that that the “medicine” that’s needed to bring inflation down - higher interest rates - can have unpleasant side effects.
Fact is if higher rates do their jobs and bring prices down, companies have less money to do the things that investors want, like sell more goods, expand operations, and develop new products. And if companies aren’t doing what investors want, those investors sell their shares.
Result: A bear market like we’re seeing right now.
But as unpleasant as that is, not bringing inflation down is much, much worse. In fact, inflation can decimate entire economies. The last thing we want is to look in the rear-view mirror and see the current inflation rate of 8.6% as “the good old days.”
That’s why as unpleasant as the side effects of higher interest rates can be, the Fed must do everything in its power to get inflation under control. But don’t take my word for it: Here’s what Fed chairman Jerome Powell told Congress last week in his testimony and semiannual monetary policy report:
I will begin with one overarching message. At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all.Source
So far, so good. What exactly are they going to do about it?
Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy. We will make our decisions meeting by meeting, and we will continue to communicate our thinking as clearly as possible. Our overarching focus is using our tools to bring inflation back down to our 2 percent goal and to keep longer-term inflation expectations well anchored.Source
So, what does this tell me? With benchmark target fed funds rate now at a range of 1.5% to 1.75%, it’s clear that that’s just the beginning. More interest rate increases are coming. In fact, I think the Fed won’t slow down until it hits 3.5% and higher.
In addition, I now think the Fed is willing to take on a higher risk of recession in exchange for lower inflation. In fact, during his testimony Powell said that a recession could be in the cards: “It’s not our intended outcome at all, but it’s certainly a possibility … we are not trying to provoke and do not think we will need to provoke a recession, but we do think it’s absolutely essential” that prices come down. Source
Here's What to Do
There’s no doubt about it: Until inflation gets under control, rates will continue to go up. The Fed is making it clear that they’re going to do everything in their power to control rising prices.
And that means that there’s likely more downside to stocks as well as other risky assets like Bitcoin (BTC) and other cryptocurrencies. So, I wouldn’t be adding to any positions right now. And as always, don’t devote any more than 1% to 2% of your portfolio to crypto of any kind, including BTC.
Disclosure: This contributor may own cryptocurrencies, stocks, or other assets mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.