- Is the Fed about to do too much; or not enough?
- US 2-Year trades close to 4.00% and headed higher
- S&P 500 June lows likely to be re-tested
The bullish pivot we experienced last week proved to be short-lived.
Stocks worked their way lower this week – as markets priced in higher rates for longer.
None of this is surprising – given we are trading through a (clear) bear market.
And whilst at some point – a bullish market will return – it’s not here yet.
Therefore, the game plan is patience.
Put another way, we trade far less and focus on buying well.
I like to say your success will be mostly determined by how well you buy… less so what you buy.
Even investments in the highest quality companies can see you lose 30% or more in quick time.
Consider Adobe and FedEx.
These are two exceptional companies. Both are world-class businesses in their respective markets.
However, both these stocks lost ~25% this week.
In full disclosure I own Adobe from a level of $300, so that hurt. Admittedly the stock was overpriced above $500.
It was FedEx’s worst single day in its history – after citing significantly weaker global demand.
Question:
Is this a FedEx specific problem or something broader? That’s always hard to know. Let’s see what UPS has to say.
Tonight we start with the Fed… as another big rate hike awaits.
75 Bps Next Week – Too Much?
The market is concerned that Fed tightening runs the risk of going too far into what appears to be a rapidly slowing economy (further to FedEx’s dire macro warning).
The question is will the Fed go too far?
Pending on what you read – you will get a different view.
Some analysts (e.g. Bond King Jeff Gundlach) are calling for the Fed to pause from here and let their existing hikes start to take effect.
The investor told CNBC that while he believes the Fed will likely do a 75 basis point rate hike at its next meeting, he prefers 25 basis points because he is concerned the Fed might oversteer the economy and hasn’t paused long enough to see what effect the previous hikes have already had.
Barry Sternlicht, a billionaire investor and the CEO of Starwood Capital Group, told CNBC on Thursday that the Fed is “attacking the economy with a sledgehammer, and they don’t need to.”
Sternlicht is in real-estate so he is “talking his book”
Tell me a single person who invests in real-estate (investment or otherwise) that wants to see higher rates?
I don’t know many.
Sternlicht echoes Gundlach – saying the Fed’s hikes, along with healing supply chains and cooling commodity prices, have already done most of the work to control inflation.
The problem, he said, is the data central bank officials are using to back up their aggressive stance is just too old—and it’s distorting their understanding of economic reality.
Now it’s true the Fed can only look in the rear-view mirror whilst driving forward.
And sometimes that means they will career straight into a tree!
Probabilities (if nothing else) suggests they will.
And if I look at the severity of the inverted 2/10 yield curve… bonds suggest avoiding “the tree” is unlikely.
Others are saying inflation will be far more persistent than many think – citing ‘sticky’ wages and rents.
They make the case that hikes should continue until real rates are positive (similar to what Volcker did in the early 80s).
That could see rates as high as 5% next year (assuming inflation falls to below 5% at some point)
And based on the trend with the 2-year note – which traded as high as 3.92% today – it’s plausible.
Sept 16 2022
Unseen Consequences
“History records many, many instances when policy adjustments to inflation were excessively delayed and there were very substantial costs to that,” Summers told Bloomberg Television’s “Wall Street Week” with David Westin.
“I am aware of no major example in which the central bank reacted with excessive speed to inflation and a large cost was paid.”
Summers highlighted that even Paul Volcker “had a kind of false start,” as recounted in a recent opinion piece by former Fed Governor Frederic Mishkin.
In response to weakening economic data, Volcker relaxed the Fed’s stance in the spring of 1980, “which then had to be reversed” later, generating higher interest rates than would otherwise have been needed, he said.
And if we look at the Fed’s Jackson Hole speech – Powell warned against repeating the “stop-go” mistakes of the past:
“Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely against loosening policy”
“We’ve got a substantial underlying inflation problem — that doesn’t come out without very substantial monetary policy adjustment. And the market is waking up to that fact.”
“We’re more likely to end up above 4 1/2 than we are to end up below 4 1/2, and it certainly wouldn’t surprise me if that rate has to get above 5%
Whether the Fed is going to stay the course and do what’s necessary to contain inflation, we’re going to have to see how that plays down the road.”
Summers echoes what I suggested during the week.
But let’s check in with the weekly tape… and how markets are slowly “waking up” to the reality of Fed tightening.
S&P 500 Bear Market Continues
Last week the bulls were optimistic.
The bid prices sharply higher – perhaps thinking that a Fed “pause or pivot” was a possibility.
This week those hopes were vanquished – where Core PCE increased month on month – some 3x higher than the Fed’s 2.0% objective.
What’s more, CPI also showed sharp increases in rents and wages.
Sept 16 2022
First, let me apologize in advance for the repetition talking to this weekly chart for the past 6+ weeks.
I sound like a broken record…
And that’s the thing when you eliminate the noise and whiplash of short-term timeframes.
It means there’s far less to exciting things to talk about (that’s mainstream’s job) — however it means far more reliable (profitable) signals.
Here’s what matters:
- Our weekly trend remains bearish (i.e. expect lower prices)
- The price was firmly rejected around the 35-week EMA zone (i.e. strength is sold)
- Next likely test is support around 3600 (also 61.8% outside our distribution labelled A-B); and
- VIX remains complacent of the risks below 30
A quick word on the zone of 3600…
I would start building positions in quality names around this zone (as I’ve said before and what I did in June).
That’s not to say we don’t thunder down to 3200 (we could easily) – but that’s okay.
If we do – and assuming you have capital available – buy with more confidence in the same quality names (and/or Index) – taking a 3-year mindset.
I could be wrong – but I feel better about the 3-year risk/reward for the market around this zone.
Putting it All Together
There are no shortage of ‘economic forecasters’ willing to share the expert views on:
(a) what the Fed should or shouldn’t do; and
(b) what the appropriate level of interest rates should be?
I wish I knew…
But as I outlined in this post – I don’t know how anyone can accurately forecast all the permutations and combinations of risks.
Sadly I am neither an economist and/or a good macro forecaster.
All I know is the monetary environment feels more likely to be tighter (than looser) in the months ahead.
The Fed is likely to keep raising rates whilst running QT at $95B per month.
And if I look at the tape – it suggests there is likely to be downward pressure on risk assets.
Therefore, I’m likely to swing at less pitches.
But at some point, the market will throw us a “fat pitch” in our hit zone.
For example, 3600 will be a pitch I will swing at. And if we see 3200 I will take another (bigger) cut.
That means exercising further patience… but that’s okay.