Market Slice: Bad is Good, Down is Up

 

What to expect in this week’s Market Slice:

  • Bad news may just be the good news we need
  • What exactly is a “zombie company” and how is this impacting your trading
  • An interesting recount of the housing interest rates as they have changed since October

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More Market Madness

Markets started the week strongly to the upside, after a 2%+ decline on Friday. Are we surprised? It is now evident the Fed pivot narrative – which has driven multiple short-lived bear market rallies over the past several months – has again attained (temporary) ascendency.

The sure sign that the Mr. Market is betting on a Fed policy reversal is the consistent reaction of traders bidding up stock prices on bad economic news. That’s what happened last week, when higher-than-expected inflation numbers resulted in a strong rally on Thursday. Although those gains were quickly reversed, it seems evident some big players are gambling that economic conditions will force Fed Chair Jerome Powell to reverse course.

Here’s how Paradigm Press’ Jim Rickards put it:

“Substantively nothing had changed, but a new narrative did take over market psychology. The narrative is a version of the old saying ‘Bad news is good news.’”

“Traders said that the more extreme version of Fed tightening expected would kill inflation faster than expected and set the stage for interest rate cuts early next year. Those expected rate cuts would be good for stocks, so it makes sense to buy stocks now!”

After Friday’s bloodbath, the “pivot fantasy” took hold again on Monday. Despite lousy manufacturing data, the market soared. “When crappy economic numbers come out, the stock market doesn’t react negatively,” Paradigm’s The 5 quotes Sean Ring. “The market leaps for joy as it thinks the Fed will go in and rescue it!”

And it continued rising on Tuesday – although not as much — when we got some good earnings news. In other words, bad news is good news, and good news is… meh.

However, it’s important to keep developments like this week’s rally in perspective. Notice the trendline on this 3-month S&P chart:

S&P 500 chart from january 2022
Chart courtesy of barchart.com

Even as we head into overbought territory, prices remain well below the recent downtrend. This is even clearer when we zoom out to the one year chart. The higher trend line is from the January high:

S&P 500 chart from january 2022

Despite temporary bouts of euphoria fueled by ungrounded expectations of a Fed cave-in, any hope for an end to the current bear market is clearly whistling past the graveyard.

Speaking of Zombies

There’s another side to the interest rate hike problem: zombie companies.

Zombies are companies that earn just enough money to continue operating and service debt but are unable to pay off their debt. Such companies, given that they just scrape by meeting overheads (wages, rent, interest payments on debt, for example), have no excess capital to invest to spur growth. Zombie companies are typically subject to higher borrowing costs and may be [just one] event—market disruption or a poor quarter performance—away from insolvency or a bailout. Zombies are especially dependent on banks for financing, which is fundamentally their life support. Zombie companies are also known as the “living dead” or “zombie stocks.” — Investopedia

We last discussed this issue in June when we wrote:

Many lower-rated corporate borrowers are faced with the unappetizing prospect of debt service rising above their ability to pay. According to a recent tweet from bond expert Stephanie Pomboy, investors should “Prepare to see an absolute ONSLAUGHT of corp[orate] defaults and downgrades. The myth of corp[orate] B/S [balance sheet] strength is about to be shattered spectacularly.”

In a nutshell, the Fed’s artificial stimulation of economic activity through unsustainable ultra-low interest rates is coming to a thundering end. And the end could be far more shocking than Fed Chairman Powell and Treasury Secretary Yellen, or their sock puppets in the media and on Wall Street, could ever imagine.

So far, the impact of rising rates has not shown up as impaired cash flow for these debt-heavy zombies. But as we’ve pointed out frequently – as recently as last week — the effects of rate hikes take time to work their way through the economy.

When the time comes for overleveraged borrowers to roll over their debt, we may see Pomboy’s “spectacular shattering” of the myth of corporate balance sheet strength.

Here’s an interview with David Trainer, CEO of New Constructs, conducted by Wealthion’s Adam Taggart. ZOMBIE Companies! How Many Are There & What Threat Do They Pose To Markets?

And for a thorough and entertaining look at the academic view of zombie corporations and their role in the economy, check out this interview with Ph.D. student Max Goebel from Monetary Metals.

 

Haunted Housing

Another trailing effect of this year’s rapid rise in interest rates has been the slowdown in the housing market, which is beginning to push some panic buttons in the industry.

Consider this headline from Tuesday’s Zero Hedge:

US Homebuilder Confidence Collapses In October, Future Sales Hope Hits Decade-Lows

The article points out the higher monthly payments necessitated by higher mortgage rates – which of course follow from higher Fed Funds rates – are exacting a disastrous toll on home buyers…and, consequently, home builders.

It appears delusion and hope can only last so long – even when one’s salary depends on it – as US homebuilder confidence crashed to COVID lockdown lows in October after refusing to see what everyone else was seeing [for] months.. and what homebuyers were clearly feeling as prices soared along with mortgage rates and devastated affordability for most Americans. Against expectations of a small drop from 46 in September to 43 in October, the headline confidence index crashed to 38 – its lowest since the nadir of COVID-lockdown panic (that was worse than the weakest forecast of all economists surveyed)…

Source: Bloomberg

Nor is this a passing phase… October marked the 10th consecutive month of declining confidence in the new home construction industry, which is one of the mainstays of the domestic economy.

Housing could be considered a canary in the economy’s coal mine… an early warning that all this recession talk may soon turn into something more uncomfortable than unaffordable gas and food prices.

A housing collapse, or even just a significant slowing in this engine of growth, could be a very bad sign for those hoping this will be a short and shallow downturn. Consider these items:

October 5Mortgage Application Pace Plunges to 25-Year Low as Housing Recession Deepens

The pace of mortgage applications has fallen to a multi-decade low amid high housing interest rates, according to the latest data from the Mortgage Bankers Association (MBA).

The Market Composite Index, a measure of mortgage loan application volume, declined by 14.2 percent on a seasonally adjusted basis for the week ended Sept. 30, 2022, compared to a year earlier. The Refinance Index fell 18 percent from the previous week, while the Purchase Index registered a decrease of 13 percent.

October 9 — US housing affordability is at the lowest level on record

Source: Goldman, Chart courtesy of themarketear.com

October 12 —

Chart courtesy of themarketear.com

October 18 — Housing market tracker

Several high-frequency data points for the week of October 9 indicate an ongoing deceleration in housing, including:

1. Pending sales down 28% YOY, vs a 25% decline last week, according to Redfin, a national real estate brokerage

2. Price declines on 7.9% of active listings, up from 7.7% last week and 5.0% in 2019

3. Mortgage purchase applications down 39% YOY, vs a 37% decrease last week

4. Median listings and sale prices 5% and 6% lower than their May/June peaks, respectively, though they remain higher YOY

Rising rates = declining affordability = lower sales = less confidence, job losses, and lower profits… in a business where builders are constantly at the edge of bankruptcy, even in boom times. Not a pretty picture. And as housing goes, so goes the economy.

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