@theMarket: Stocks Drop as Fed Delivers Same Dire Message
It was another "read my lips" moment for equity investors. Federal Reserve Chairman Jerome Powell out hawked the hawkish as he reiterated the Fed's tightening stance on monetary policy after the Federal Open Market Committee meeting on Sept. 21.
That should come as no surprise for those reading this column every week. A 75-basis-point hike, which was expected, was followed by a promise to continue raising interest rates higher, and longer than investors expected.
The eventual terminal rate where investors hope the tightening will be done, has now ratcheted higher to 4.6 percent. Expectations are now set for another 75-basis point increase in October, and 50-basis point hike by the end of the year. These actions have now forced most investors into a more defensive camp. The markets' actions reflect that.
And it is not only the U.S. central bank that is raising interest rates. It is almost as if bankers are outdoing themselves in their single-minded intent on seeing who can raise rates faster and further. After the Fed's actions on Wednesday, a half-dozen countries from Norway to Indonesia followed suit with hikes that were of similar size within hours.
Remember, too, that normally, as interest rates rise, so does a country's currency. The dollar is already at 20-year highs, which is crippling many countries ability to pay interest and principal on their U.S. dollar-denominated debt. Foreign governments need to at least keep exchange rates at their present levels. They do so by matching the Fed's rate hikes with those of their own.
One might wonder how all these frenzied rate hikes will impact the global economy. Not well, I suspect. The conversation here in the U.S. is now flipping from a focus on inflation to how much damage the Fed's action will inflict on the economy. It is no longer "if" we get a recession, but how deep and long will it be? The debate between the bulls and the bears centers on judging how badly the Fed will err on the side of tightening.
Naturally, equity investors are also concerned about how all of the above issues will impact corporate earnings. Over the last few months, I warned investors that at some point we will begin to hear corporate managements lower their outlooks for future sales and earnings. That is already happening.
Companies across the country are announcing layoffs, but the fall out is still uneven across many sectors.
Energy companies, for example, are still looking for workers, while many high-tech companies are reducing staff. I expect as recession begins to take hold, we will see more sectors succumb to this lethal dose of inflation, rising interest rates, and slowing economic growth.
As quarterly corporate guidance and results continue to decline, so does the "E" in the Price/Earnings Ratio (P/E). I have explained in the past that the P/E ratio for the overall market is a key metric when valuing the stock market. The average P/E of the markets is now hovering around 16, but there are many companies that are trading anywhere from 20 to 23 times earnings or more. Others are trading much, much lower.
Several of the high P/E stocks happen to be favored by investors, like the FANG stocks. The bears are betting that markets won't see a bottom until those high-valuation stocks catch-up to the rest of the market on the downside. That makes sense to me.
So where do we stand after this week's latest Fed disappointment? As of Friday morning, we are just a few points above my first target, which is the year's low (3,666) on the S&P 500 Index. We are at historical levels of pessimism, according to the sentiment readings of the American Association of Individual Investors (AAII). Only 17 percent of investors are bullish, while 61 percent are bearish. Presently, there is an inverse relationship between the U.S. dollar (up) and the S&P 500 Index (down). Both are at extreme levels right now.
Given the dire mood of most investors (except those readers who have followed my advice, and are either short, or in cash). As a contrarian investor, I expect we will get a countertrend bounce in the early part of next week before turning down again at quarter's end.
It remains to be seen whether we bottom at the lows or break lower. I'm leaning toward the 3,500 level on the S& P 500 Index. In either case, I am looking for another bear market relief rally starting in October through November 2022, but it may be led by precious metals and not equities. To me that simply gives investors another chance to reduce their stock exposure.
@theMarket: Consumer Price Index Triggers Market Decline
Sticky inflation, as represented by Tuesday's Consumer Price Index (CPI), caught most investors off guard. The resulting equity market rout drove the three main averages down over 4 percent. It was the worst market day in more than two years. Is the selling over?
I doubt it. The rampage lower spared few stocks. The dollar soared higher and most commodities as well as precious metals plummeted. That's what happens when you get everyone on one side of the rowboat.
Many analysts, traders, economists, and retail investors had bid up stocks in the days prior to the report in anticipation that the CPI would result in a cooler inflation print. The opposite happened and everyone headed for the exit at the same time. On Wednesday, Sept. 14, the Producer Price Index (PPI) was a bit better and came in at the consensus forecast.
It only required an hour or so before strategists were hiking their expectations for how long and how high the Fed will raise interest rates. At least one Wall Street analyst I follow raised his expectations for next week's FOMC meeting rate hike from 0.75 basis points to 100 — a full 1 percent.
I am sticking with a 0.75 basis points hike. And after this week's CPI, most of the financial community have given up on their mistaken notion that the Fed may be moving into a more dovish stance next week.
This week the Biden administration intervened to avoid a U.S. railroad strike that could have been a disaster for the economy. Aside from the backup in product shipments, the strike could have added a percentage or two to the inflation rate depending on the duration of the strike. However, the markets barely acknowledge the Biden "save."
The overall macroeconomic data still points to an economy that is chugging along, especially the labor market that still appears to be growing and with it, rising wages. That is bad news for the markets, but good news for the economy. The Fed needs to see demand start to slow and the labor market cool off before they even think of pausing in their tightening policies.
That means the stock market will continue to be pressured downward by higher interest rates and further quantitative tightening. As markets tend to do, everyone is now crowding to the other side of the rowboat. From expecting easing earlier this week, investors are suddenly convinced that the Fed's tightening is going to cause a deep recession. You can't make this stuff up!
If you are looking for proof that the Fed will over tighten and cause a disastrous decline in economic growth, look no further than Friday, Sept. 16.
Some companies are sounding warnings on the future health of U.S. and global economies. In just one day, FedEx issued a profit warning due to declining package delivery volumes around the world. International Paper said it was being hurt by decelerating orders and an inventory glut. And General Electric revealed that the company's cash flow remained under pressure as supply chain issues continued to impact their ability to deliver products.
FedEx dropped more than 20 percent on the news taking the entire transportation sector down with it, since the company is a leading indicator on the future health of economic growth.
In my opinion, the strong CPI number has stretched out the duration of the Fed's tightening regime by a quarter or two. The big money in the market believe that the Fed has lost its way and that remaining "data dependent" suggests the Fed does not know what it is doing.
I am still expecting that this next week's FOMC meeting will deliver bad news — more hawkish statements — which allow investor hysteria to expand. But maybe, just maybe, Fed Chairman Jerome Powell may try to restore some of the Fed's credibility by offering a target terminal Fed funds interest rate for this tightening regime. The historical average of the Fed funds rate is 4.25 percent, and assurances that it won't go higher could help markets recover.
As I said last week (and many weeks before that) "a retest of the year's lows in the weeks ahead," was, and still is, my call. If we break the year's lows my terminal value on the S&P 500 Index is 3,500. It doesn't have to go straight down, however. We could see bounces that could take that index up 100 points or more, and then down again.
@theMarket: September Is Tough Month for Equities
Since 1928, the S&P 500 Index has lost ground in September more than 55 percent of the time. It looks like this year will be true to form.
It is called "The September Effect" and no one market or news event has been responsible for this anomaly. Some attribute the negative results to seasonal behavior bias. After a good summer of gains, like this summer’s bear market rally, investors make portfolio changes and cash in on their gains.
Since 1950, the Dow Jones Industrial Average has booked a decline of 0.8 percent on average. If we go back further in history (since 1928), the S&P 500 Index has averaged a 1 percent decline during September. However, over the last 25 years those losses have more than halved to only minus-0.4 percent.
Those declines seem almost laughable today in a market where stocks go up or down by that much in less than an hour.
You may have noticed that investors' attention has become laser-focused on the jobs data. Unemployment claims, continuing claims, job gains, non-farm payrolls and anything else that smacks of employment or the lack thereof is moving markets dramatically. As you might have guessed, this is the data the Federal Reserve Bank is carefully scanning in order to determine how far the monetary belt needs to be tightened.
Strong labor markets mean higher wage growth in a jobs market where supply and demand are out of balance. Wages are far stickier and therefore more important to the long-term rate of inflation than what gasoline or food prices happen to do this month or next. And since the Fed is data-driven, so are investors.
Of course, no single week or month's data point will move the Fed to cinch or uncinch their tightening belt — that is not the case with the stock and bond markets. From my point of view, it is ludicrous to move stocks up or down 2 or 3 percent a day based on a Thursday or a Fridays' report. The stock market prop desks and algo traders obviously disagree.
What's worse, the numbers are highly inaccurate, according to the federal government's own labor department, since data collection has been hit or miss ever since the pandemic. It is also subject to large revisions sometimes weeks and months afterwards, but no one ever trades on the revisions.
A case in point was the jobless claims for the week of Aug. 27. They came in at 232,000, which was below the estimates for 245,000. Therefore, fewer workers applied for unemployment insurance. That was great for the economy, but terrible for the stock market since it indicated a growing economy and more reason for the Fed to tighten.
Even worse, unit labor costs (think inflation) increased 9.3 percent over the last four quarters, the highest level since the first quarter of 1982. An hour later, stocks dropped more than 1 percent, interest rates spiked and so did the dollar.
On Friday, Sept. 2, at 8:30 a.m., the non-farm payrolls report beat estimates slightly (315,000 jobs gained in August), while the unemployment rate ticked up from 3.7 percent versus the expected 3.5 percent. Average hourly earnings month-over-month dropped, as did average hourly earnings, year-over-year came in at 5.2 percent versus 5.3 percent expected. Downward revisions from prior months labor gains helped improve the mood as well.
The markets deemed this a "goldilocks" report, so the algos bid up stocks and bonds, sold the U.S. dollar and interest rates fell; all in the pre-market. I wouldn't take any of these gyrations seriously. I put it down to traders looking for any excuse on a slow week before a major holiday to improve their trading profits.
As predicted, the S&P 500 Index hit 3,900 this week. That was the upper end of my target range. I was looking for a decline with a range of 3,800 to 3,900. I had been warning investors that the bear market rally we had enjoyed since June 2022 was ending. I expected that we would give back most, if not all, of that rally in the September into October timeframe. We are right on schedule. Now what?
Expect a bounce to as high as 4,030 in the first half of next week, and then a further decline to the low 3,800s. The stairstep of lower highs on rallies, and lower lows on declines is playing out just the way I expected. The question I have been asking myself is will stocks hold those levels, or are we destined to re-test or possibly break the June lows. Stay tuned for next week's columns, and in the meantime enjoy the three-day weekend that marks the unofficial end of summer.
@theMarket: Bad News from Jackson Hole
Federal Reserve Bank Chairman Jerome Powell set investors straight at the Fed's annual Jackson Hole symposium. He said the job of lowering inflation is not done, and that the Fed will continue to raise interest rates in order to slow the economy.
"We must keep at it until the job is done," Powell said, during his speech.
That was enough to send stocks lower after a few days of gains. At the same time, the U.S. dollar fell, as did interest rate yields, which is somewhat counter intuitive given Powell's hawkish statement. The inflation data released on Friday morning showed a little progress on the fight against inflation. The Personal Consumption Expenditure Price Index, (PCE), a closely watched indicator, eased to 4.7 percent, slightly below forecasts of 4.8 percent.
Month-over-month, the PCE index increased by 0.2 percent in April, which was much lower than the 0.9 percent rise in March 2022. Lower inflation in investors' minds means the Fed does not need to tighten monetary policy as much. That would translate into less downward pressure on the economy and better corporate earnings. Powell said we are not at that stage quite yet.
On the economic front, the data continues to conflict. U.S. second quarter GDP was revised upward this week from minus-0.08 percent to minus-0.06 percent. As readers may know, Gross Domestic Product measures the value of goods and services. Another data point the Fed follows closely is a subset of GDP called Global Domestic Income (GDI). GDI measures the progress of labor income. That number gained plus-1.4 percent in the second quarter of 2022.
Most economists tend to average these two variables together in order to get a better picture on how the economy is really fairing. If we do that, GDP in the first quarter 2022 would have been a gain of plus-0.1 percent and a positive 0.4 percent in the second quarter, instead of two negative quarters in a row, according to headline GDP. Granted, both quarters would still be below the long-term trend of GDP, but not quite recessionary just yet.
However, rising interest rates are impacting economic growth. The latest Job Openings and Labor Turnover Survey (JOLTS) report, for example, showed that job openings have fallen by 1.1 million between March and June 2022.
Indexes based on online job listings, compiled by two job search engines, Indeed and LinkUp, suggest that the trend in job openings continued to decline in July and August. Other economic data that shows a decline is pending home sales, that are now down 22.5 percent, versus last year, and durable goods orders are flat to down. That data should encourage the Fed in their efforts to slow the growth in the economy.
The gains in the market this past week were expected. Stocks lost 2.4 percent in three days and then bounced. Gains pushed the S&P 500 Index up to the 4,200 level before rolling over. The way things are set up right now, we should see the market bounce up somewhat for a day or so next week, but I expect a series of lower lows by the end of next week. The bounces we get will disappoint and fail to make higher highs. That is my best case. If things get out of hand, we could just continue to drop down to 3,900 on the S&P 500 Index. In any case, my playbook for September into October 2022 is down.
@theMarket: Markets Gain Back Half This Year's Losses
This week's decline in two key inflation indicators gave investors an excuse to buy stocks. At this point, we have retraced 50 percent of the losses from the beginning of the year. The thinking behind this recent move higher is that inflation is coming down, and the Fed no longer needs to maintain its super tight monetary policy stance. Is that a good bet?
That is not the case, according to several talking Fed heads that were trotted out by the U.S. central bank to address the markets on almost a daily basis this week. Even the most dovish of members continued to stress that nothing has changed in their thinking. To a person, each Federal Reserve member stressed that the market should expect another interest rate hike in their September 2022 FOMC meeting. In addition, the reduction in their balance sheet will continue unabated.
Clearly, investors do not believe these warnings. The bulls are confident that inflation will continue to decline to the point that the Fed will change its mind. As such, that belief is enough to support if not justify further purchases. It certainly is an enticing story considering the data.
Everyone should have been pleased with the inflation data. It points to a peak in inflation. Both the Consumer Price Index CPI), and the Producer Price Index (PPI) came in lower than expected. However, both the CPI rate of plus-8.5 percent, and the PPI gain of 9.8 percent are still a long, long way from the Fed's official target of 2 percent inflation. Even if we had zero additional inflation for the remainder of the year we would not reach the Fed's 2 percent target.
Some bullish investors may also be betting that since we won't know what the Fed is going to do until September, markets can continue to rock and roll at least for another week or two. As it is, the bond vigilantes have already reduced their expectations of how much the Fed will raise rates from 75 to 50 basis points at that meeting.
Most of the decline in both the CPI and PPI can be credited to the price decline in energy. Nationwide, we are seeing gasoline prices below $4 a gallon, while oil has dropped recently to below $90 a barrel. But here's the rub.
The Fed has little influence over the future price of oil. Geopolitical events, currencies, and global supply and demand are much weightier factors in determining where the price of oil goes next. What if oil climbs above $100 a barrel next week? What will that do to the future CPI report, and how would markets handle that?
As I have been advising readers for weeks my target for the S&P 500 Index on this bounce was 4,100 to 4,200, give or take a few points. This week we hit 4,257. Now what?
I warned readers back in June 2022 that after this relief rally, "somewhere in middle to late August," we would start a decline that could take us back down to 3,800 to retest or slightly break the year's lows. That remains my forecast.
However, this decline will be accomplished in fits and starts. Investors are caught in the throes of greed and FOMO. So, for example, next week we could see a series of shallow pullbacks, only to have those who have missed this rally buy the dip. These Johnny-come-latelies will expect even higher highs. They may even push us back toward 4,250 on the S&P 500. However, by the end of next week we should be declining.
This kind of market action could continue for the next few weeks. As it does, I would expect the markets to be making lower lows, and lower highs. By September 2022, we will likely see the lows I am forecasting. What is my thinking behind this rather gloomy prediction?
I expect oil prices have bottomed for now and will rise over the next few weeks. Geopolitical tensions could heat up as well adding tension to global markets. The Fed will continue to tighten, despite the atmosphere of hopefication that has infected investors right now. Corporate earnings will continue to fall and profit warnings will become more commonplace as the economy continues to slow.
None of my thoughts are original. I am simply echoing the bear case. The only difference is that I have been predicting this since December 2021.