June 19, 2022
Weekly Market Outlook
By Keith Schneider and Donn Goodman
The truth can be difficult to hear.
Telling the truth is also hard when the message is not what the recipient wants to hear.
Dealing with the truth is even harder, especially when it’s unexpected and disappointing.
This week, investors had to deal with a heavy dose of truth about the state of the economy. Based on the markets’ response, it was painfully unexpected and disappointing as demonstrated by…
…S&P 500 down -8.7%
…NASDAQ down -9.4%
…Russell 2000 (IWM) -10.8%.
Over the past few weeks, Jerome Powell and Janet Yellen have gradually admitted that they got the inflation story wrong and backtracked on their “transitory” narrative.
They’ve not only flipped their transitory inflation narrative but also taken an aggressively hawkish point of view focused on bringing down runaway price hikes even if it risks the “R” word.
In our opinion, they’ve been forced to change their position because 90% of Americans say inflation is their number one concern.
Even a rational ‘data dependent’ Fed governor can only second-guess trending inflation data for so long.
So a somewhat unexpected and arguably disappointing moment of truth occurred on Wednesday at 2:15 EST when the Fed raised the key lending rate by not .50%, but an impressive 0.75%!
This is impressive because it is the largest one-time increase since 1994.
Plus, they broadcasted that they were likely to continue to pump the economic brakes at upcoming meetings throughout the Summer and into the Fall. All the while acknowledging their actions will run the risk of causing a recession.
Was It Enough?
0.75% is historic, however…
There were a handful of economists and asset managers that were pushing the Fed to get even tougher and raise the lending rate by 1% - 2%! They feel a bigger move was needed to let the world and the markets know they would do anything to fight insidious inflation.
The market initially liked the Fed’s recent hawkish action, as demonstrated by its rally into the close on Wednesday.
Unfortunately, after investors had 12-24 hours to consider the reality of the situation (the hard cold truth), Thursday the markets sold off and added to the rout that occurred on Monday. Between those two days the markets shed 5% and sent the markets to new lows for 2022. The S&P 500 and the NASDAQ went back to prices we last saw in the 2020 lockdown market deep correction.
The interest rate market has been forecasting this hard truth for months now. Recently piercing the 3.0% level on 10-year Treasuries, interest rates rocketed much higher this week before pausing around 3.5%. These are levels not seen since 2018.
The S&P 500 has now wiped out all of 2021’s gains, and NASDAQ touched price levels from August of 2020.
Whether from the news media, the Federal Reserve or The Treasury Secretary, the truth about the state of the economy has changed. There is a new reality and narrative. These truths will likely permeate the economy going forward throughout 2022 and well into 2023:
The debate over the true cause of the current hyper-inflation will continue: Is it Biden’s new climate stance and anti-fossil fuel rhetoric? Is it the tighter and prohibitive regulatory environment? Is it the Russian invasion of Ukraine? Is it the global supply chain disruptions coming out of the pandemic? Is inflation directly related to China’s zero tolerance stance against COVID?
The cold hard truth is that it’s a combination of all the above and more. Oil prices were on the rise long before the Russia-Ukraine incursion. Food prices have been trending up for the past several years. And labor shortages are directly attributable to the substantial number of retirements that occurred during the COVID lockdown.
We are in a tough economic environment. The Federal Reserve has boxed itself into a corner. It wants and needs the economy to slow down to do two things: reduce demand in all phases of the economy, which will relieve some of the acceleration of pricing; at the same time, keep employment and wage gains strong.
Another hard truth is that even if inflation comes down to 6% over the next 6 months; raising the Fed Funds to the targeted 2.5%-3.5% will not be enough. Many economists use the Taylor Rule, and a simple version of that premise is that rates must rise to equal or greater than the rate of inflation.
BE CAREFUL. As noted above, we are in for additional volatility, resets and repricing, and unknown future Fed action. Plus, we don’t know how the gasoline shortage plays out or when the Russian-Ukraine incursion will end.
Having entered a true bear market last week, the question now is how long might we remain in a bear market? In the table below, we show past statistics from Dow Jones Industrial Average declines after 145 days beginning in 1948. The four very quick bear markets of 1987, 1990, 1998 and 2020 are also included in the chart:
The average additional decline was 12.4% over an average of 139 calendar days. Based on DJIA’s close on June 13 and these averages, DJIA could find its bottom around October 31, 2022, at 26732.13. This would represent a total bear market decline of 37.4% in 298 calendar days.
However, we point out that several bear markets ended more quickly and anything and everything is possible. However, with the Fed pointing to further aggressive action, we continue to suggest taking prudent and conservative action.
9 Ways to Deal with The New Reality (many are repeats of recent Market Outlooks)
One final note: It is also possible that the Fed could be boxed into a corner where if they raise rates too much or too fast, the stock market could crash. A market crash could force the fed to back off and exacerbate already existing inflationary pressures.
Market Insights from our Big View service: