@theMarket: Recession: 'Certainly a Possibility'
"Certainly a Possibility."
Those were the words of Federal Reserve Chairman Jerome Powell during testimony to the U.S. Senate banking Committee on Wednesday, June 22. Investors took his warning in stride, instead of plummeting. That may indicate markets are ready for another relief rally.
Powell thought the U.S. economy was strong enough to roll with the Fed's punches of higher interest rates, and a shrinking balance sheet without too much trouble. It was the outside factors — the Ukrainian war, China's COVID-19 policy, and supply chain problems — that complicate the outlook. Avoiding the "R" word was largely out of the Fed's control, he said, "it's not our intended outcome at all, but it's certainly a possibility."
Granted, it wasn't as if fears of a recession were a new concept among investors. For the past few weeks, as the Fed made clear they were pursuing an even more aggressive series of interest rate hikes to combat inflation, investors began to worry that the Fed's action might tip the economy into recession.
This fear has weighed heavily on stocks in various hot sectors like energy and materials, which have fallen considerably in price. Oil has dropped from $123 a barrel to almost $100 in the last two weeks with energy stocks falling faster and further. Natural gas prices have also dropped substantially, despite the actions of Russia to cut off natural gas to the European Community.
Defensive stocks in areas like utilities, health care, consumer durables, and telecom were bought instead. As were U.S. bonds, which are sending yields lower. That makes sense. If the U.S. does slip into recession, there will be far less demand for energy and other commodity inputs to fuel economies. In recessions, investors usually hide out in higher yielding areas where hefty dividends support stock prices in areas which people need, (not want) to purchase.
I pay attention when investors receive bad news (such as a potential recession forecast from the Fed), and the markets hold in there as they did this week. After all, Chair Powell had two days of testimony in front of Congress and plenty of opportunities during the Q&A sessions to tank the markets, but that didn't happen, even though he was no less hawkish in his forecast. That leads me to believe that the markets may have discounted the worst — for now.
Rest assured, I still believe we have a lower low in front of us sometime before the end of September. But that does not mean we can't see a face-ripping rally of 10 percent in the short-term. As a contrarian indicator, the AAII Sentiment survey, which measures bullish/bearish sentiment among institutional investors, just registered the 25th lowest bullish and its sixth highest bearish sentiment reading in its history.
Many traders are expecting just that kind of event to occur over the next week or two. There are several technical reasons that make bounce higher a high probability. There is the rebalancing of funds by large institutions (bonds into equities) that occurs at the end of a quarter after severe selloffs. Many hedge funds are ending the quarter net short and will also need to rebalance.
There will also be the usual flow of new funds into pension plans that will need to be invested. Finally, a huge number of put options will expire at the end of the month. They will need to be either liquidated or rolled over to a future month. This could set the markets up for another oversold bounce.
We have had several of these rallies thus far in 2022. The S&P 500 Index gained 6 percent in four trading days, 11 percent in 11 days, and 8.7 percent in 9 days, while losing 19 percent overall. Bear market rallies typically get back 70 percent of the losses of the prior move lower with over a quarter of the rallies gaining back over 100 percent.
@theMarket: Inflation Shock Pummels Markets
The Consumer Price Index (CPI) surged in May 2022 as gas prices continued to run higher. These results came as a downside surprise to a stock market that has been falling most of the week.
Friday's CPI number for May 2022 reflected an increase of 1 percent, compared to "hot" estimates of 0.3 percent in April 2022. On a year-over-year basis, the gain was 8.6 percent, which is a 40-year high in the CPI. Gasoline prices were a key driver of inflation last month, although Owners' Equivalent Rent (OER), which accounts for about a third of the CPI, also gained. The problem going forward is that analysts expect gasoline prices will continue to rise in this summer's driving season. If oil continues to rise, the stickier inflation will be.
This strong inflation result sets the stage for next week's June 15 FOMC meeting. It will be the first 50 basis point increase in the Fed funds rate in decades. Investors have been fully informed of the coming rate hike (and another one in July 2022), as well as the on-going reduction in the Fed's balance sheet.
Supposedly, the markets have fully discounted this event, but there is always a risk that during the Q&A session with Fed Chairman Jerome Powell after the meeting, he says something more hawkish than investors expect. I am betting that he will do nothing to add risk (more downside) to an already skittish market. If so, that could give markets a lift.
Throughout the week, central banks around the world continued to raise interest rates and telegraph their plans to tighten even more as global inflation climbs. Christine Lagarde, the president of the European Central Bank (ECB), joined the crowd on Thursday indicating that the ECB plans to raise interest rates above zero for the first time in a decade by September 2022.
The ECB will raise rates by half a percentage point, followed by a planned quarter-point rise in July 2022, which is a bigger increase than expected. ECB officials are becoming increasingly concerned that higher wages, higher oil prices, and supply chain issues could lead inflation to become entrenched. Sound familiar?
Most of Wall Street expected that inflation may have peaked (and it still may in the months ahead), but the CPI threw a monkey wrench into this theory. The U.S. dollar has reversed course as a result and climbed higher over the last few days. I have advised readers to keep an eye on the greenback as an indication of where stocks might go. Right now, the two have an inverse relationship, so dollar up, stocks down.
I was dead wrong in my expectations that we could see a substantial rally in the stock market. Instead, we have dropped throughout the week as a barrage of interest rate hikes by central bankers throughout the world pressured stocks lower and the U.S. dollar higher. And now we face the Fed next week.
As I write this (Friday morning, June 10), the S&P 500 Index has tested and held at 3,900. If we break this level by more than 20 points, we could see a re-test of the lows (3,810). I suspect that we will bounce today instead. From a technician's point of view, into next week, depending on how the market closes for the week, we may see a down Monday to re-test the lows we put in today and a rebound on Tuesday into Wednesday. At that point it is up to the Fed, which way the markets go. I am hoping the direction is up.
I wanted to give readers a heads-up that I am taking the latter part of next week off, so there will not be a column next week. I'll be back at my post the following week for sure.
@theMarket: June Still Looks Good for the Markets
Thus far, the markets in June seem poised for a further bounce higher. That does not mean we are in the clear throughout the summer, but let's take it one month at a time. Here is what I see.
Between now and June 17, 2022, I am betting for another move up in the equity indexes. We could see a rally that takes us up to the 4,300 -4,400 level on the S&P 500 Index. It will likely be the kind of surge that floats all boats higher as it rises.
The stocks that have been hurt the most this year would be prime candidates to outperform. China, emerging markets, energy, materials, retail, transportation, small caps, tech, mines, metals and even the Kathy Wood stocks will benefit. I have been predicting this move higher since early April 2022. I believe it has become the consensus view.
The energy for such a move is based on the mistaken belief that the Fed will prove to be less hawkish than the Federal Open Market Committee (FOMC) statements have led us to believe. To me, that argument is as wobbly as a three-legged chair. It is also why I don't expect that we are up, up and away for the rest of the summer. At best, the months of July 2022 through August 2022 should exhibit some sideway actions. However, I don't see the markets making a lower low (3,500 on the S&P 500 Index) until sometime in September 2022.
On June 1, quantitative easing (QT) began. The process of draining off some of the Federal Reserves Banks' $9 trillion balance sheet will take months to accomplish. Remember, this is in addition to the Feds' plan to raise interest rates by 50 basis points in June 2022 and again in July 2022. Some analysts believe QT could be equal to raising interest rates by another 100-basis points or more.
I believe investors have yet to discount this new and unique tranche of monetary tightening. You see, hiking interest rates is tangible, quantifiable and has happened many times before. It is an event that is visible and is almost immediately will be translated into a higher prime rate, followed by a rise in mortgage rates.
QT is less visible, a stealth tightening if you like, that will work though the credit system withdrawing liquidity as it travels and builds throughout the economy in various ways during the next few months.
I expect investors will only realize its impact when they see the effect it will have on housing, economic growth, consumer spending, and corporate earnings. That data will be apparent by late June, or early July, and buttressed by the second quarter corporate earnings season.
The problem I see is that all of the above areas are already slowing. And while inflation may have peaked, it is still high and will continue to be so. It's already stressing consumers. QT will stress them further. This will raise the risk in investors' minds that the Fed "has gone too far."
Investors are laser-focused right now on inflation slowing and potentially hoping for a "two and done" interest rate scenario from the Fed. As such, I see the next few weeks as a sweet spot. A time before investors realize what is ahead of them.
This week, J.P. Morgan CEO, Jamie Dimon, announced that he is preparing this largest of U.S. banks for an economic hurricane, which he sees on the horizon caused by the Fed and the Ukraine War. He then advised that investors should do the same. And yet, the same company's Head of Global Research, Marko Kolanovic, is bullish and thinks that his boss is wrong. Who is right?
My answer is both. Short term, Marko can see the S&P 500 Index hit the 4,300-4,400 level. After that, Jamie carries the day.
@theMarket: Corporate Earnings, the Dollar, and the 'W'
In case after case, corporate earnings guidance was at best disappointing. Those companies that disappointed saw their stocks plummet, which took the markets down with them. But earnings season is almost over. Now what?
This past week we saw some stocks fall 30-40 and even 50 percent in one day on disappointing results. The volatility on individual stocks has been extraordinary. Many companies who beat on the top and bottom line and gave good guidance saw their stocks climb 15 percent or more in an hour or two, but the overall markets ignored that.
Time was that investors shunned Bitcoin because the crypto currency could move a percent or two a day. Nowadays, the cryptocurrency is less volatile than most equites and bonds! One wonders what would happen if the fear index called the VIX were to move higher? Fortunately, over the last week VIX dropped to below 30. That was a good sign.
There is precious little I can add to the topics I have covered that have bedeviled inventors for most of the year — the Fed, inflation, rising rates, supply chains, slower growth in China, the U.S. and Europe. To be honest, no one knows whether the U.S. will fall into recession, or stagflation, or simply continue to grow. You would have better luck betting on the ponies than predicting where inflation will be at the end of the year, or if another strain of COVID-19 will pop up.
In times like this about the best one can do if trying to navigate the financial markets is to focus on price. The price investors are willing to pay for the stock and bond markets, the U.S. dollar, cryptos, commodities and so on. Some of these instrument's lead and others follow price movements. So far this year many of those price movements have been down. Few have been up.
Notice, for example, that the U.S. dollar is up about 8 percent, so far this year. That is a spectacular, out-sized move for the world's reserve currency. It has had an inverse effect on stocks and bond prices. The higher it goes, the lower they go.
Inflation, however, seems to track the U.S. dollar, as do most commodity prices. That makes some sense, since the dollar needs to strengthen in order to preserve purchasing power in an inflationary environment where commodities like oil are soaring. Can the greenback give us a clue to where stocks are likely to go? I believe so.
I have noticed that over the last week, the U.S. dollar has fallen, while other currencies like the Euro and yen have strengthened. Could that give us a reason to be bullish on stocks, at least until the dollar reverses course? Currency traders will give you all sorts of reasons why the dollar dropped.
Leading the list is the European Central Banks slightly more hawkish attitude toward monetary tightening. Higher interest rates in Europe would attract more investors to the Euro and away from the dollar. Global interest rates are a key ingredient on where investors decide to put their money. Given the same risk profile, the currency with the highest interest rates attracts the most capital.
However, I am guessing that the sudden dollar weakness has more to do with inflation expectations. Readers may recall that in the beginning of this year I expected inflation would begin to peak in the Spring. Friday's Personal Consumption Expenditure Index PCE), which is a measure of the prices that people in the U.S. pay for goods and services. The Fed pays close attention to this measure since it captures a wide range of consumer expenses and reflects changes in consumer behavior.
The PCE showed inflation rose 4.9 percent in April from a year ago. It was below expectations and seemed to indicate that inflation was slowing from 5.2 percent reported in March 2022. That data could indicate that my peaking prediction was right on track. If inflation were to flat line (albeit at a rate higher than anyone is comfortable with), the U.S. dollar should flat line as well, at least for now.
That does not mean that our inflation problem will be solved. We are a long way from that, but it may not get too much worse. In other words, I do not see a period of hyper-inflation like we experienced in the 1970s, instead we may have plateaued on the inflation front.
It also does not mean that the Fed is going to soften its stance anytime soon on raising interest rates. Far from it, but peaking inflation could give the markets a needed boost higher, which brings me to my "W."
Readers may recall that I described this month's market action as a sloppy "W" formation. The month is almost gone, and we have entered the last part of the W, which should give us more upside from here. Make no mistake; there has been no bullish buying in this rally. Markets have been pushed up by traders' short covering. Stocks are over extended, and I expect profit-taking kicks in next week. I would buy that dip.
The good news is that I believe we are building a base that could be able to give us a tradeable bounce for a few weeks beginning in June into July.
@theMarket: Look Out for a Bounce in the Stock Market
The bears are prowling the corroders of Wall Street. No one questions that, but rallies in downtrends can be breath-taking. Look for one of those short covering relief rallies in the coming week.
Do I know that will happen? Of course not, but when we get as oversold as we are now, the chances are high. If we do bounce in a relief rally it would trace out the first up to the center of my "W" pattern. The bounce won't last long, maybe for a few days or, at best, next week. And then down again. For those readers who may be hoping that at some point we will resume the bull markets of the last decade, give up that notion.
I fully expect another low that may match or break the year's low of S&P 500 Index of 3,877 made this week. Readers were forewarned last week that the index could (and did) break my 4,000 targets. There were several reasons for this bearish behavior.
The inflation numbers were the key trigger. On Wednesday May 11, 2022, the Consumer Price Index came in hotter than expected at 8.3 percent. For the month, the index gained 0.6 percent. The data disappointed traders who were gambling on a cooler set of numbers that might confirm that inflation was peaking. But instead of carrying the market up 5 percent, or more, the opposite occurred.
The Producer Price Index, which was reported the following day, did come in a bit weaker at a11 percent increase year-over-year, and 0.5 percent for the month. The lack of "inflation peaking" evidence squashed hopes that the Fed might be tempted to go easier in their hawkish policy plans, so markets tumbled.
For many investors a bearish assault on the market's "Generals" was of far more concern. The bears have torn apart the Meme stocks, the Cathy Wood stocks, and every other high-priced, no earnings, kind of security they could sell or short. However, this week traders came after the Generals — Apple, Microsoft, Meta, Amazon, Google and even Tesla.
As company after company during the last quarter's earnings season provided poor future guidance in sales and earnings, investors are wondering how long it will take for the Generals to add their voices to this growing chorus. Many investors are not waiting around to find out. Price declines in these individual stocks has had a knock-on effect in the market, since they comprise such a large weighting in the overall investments of so many mutual funds and exchange traded funds. As such, the further they decline, so goes the stock market.
I have been waiting for this kind of behavior, because without it there is no hope that we can find a bottom in the stock market. The problem is that this selling has only just begun for many of these stocks. remember that in many cases, the more speculative stocks are down 60-80 percent from their highs.
The Generals are nowhere near this kind of decline. Do I think we will see the price of Apple, for example, cut in half or more? Doubtful, but another 10-15 percent might be a real possibility. That is important since Apple is about 7 percent of the S&P 500 Index, and 13 percent of the NASDAQ Index.
As I said, I am expecting a relief bounce this week. It is just another bear market bounce, one of many we can expect as markets search for a bottom. Readers may ask where do I see that bottom? This week we briefly touched my target of 20 percent on the S&P 500 Index at 3,858. The NASDAQ hit my targets weeks ago and has suffered further declines.
I expect we will need to retest that 3,858 level on the S&P 500 Index level. If it holds, I might feel confident that we have made an interim low that could last out to September. That said, May, I believe, is the month to pick up some good bargains as we continue to dip and bounce in this "W" formation. I am hoping that by June, we can see a better market with some hope of putting together a string of higher highs for two months or so.