Bear Market Melt Up
The markets, the nation, and the world are on hold this week, as Fed policy, U.S. elections, and a European financial and energy crisis keep markets locked into a narrow trading band.
As we write on Tuesday, the biggest question is what will happen on Wednesday, when the Fed releases its Open Market Committee statement.
As we reported in Monday’s Concierge letter, the “Fed pivot narrative” has arisen repeatedly over the past several weeks to spark short bear market rallies.
The entire financial industry is so dependent on a return to the free money policies of the past decade that any small indication the interest rate hikes we’ve seen this year will soon slow – and eventually reverse – we have reached the point that nothing else really matters.
However, the prospects for less than the 75-basis point increase indicated for this week are dim. Here’s how we put it on Monday:
Despite the fact that according to respected Fed watcher Nick Timiraos, the Fed is set to go forward with the expected 75 basis points hike this week. In effect, what we have now is the market speculating on the possibility of a slowing (not reversal) of the rate hikes, possibly starting in December.
In other words, even just the hope that rate increases will slow down eventually is enough to temporarily bolster the market.
A Soft Pivot?
Of course, the subtext for all this wishful thinking is the Nov. 8 midterm election. Democrats are desperately trying to salvage what is looking like a potential catastrophe, and Treasury Secretary Yellen is starting to play a more aggressive part in shaping the economic outlook with fiscal policies to counteract the Fed’s relentless hawkishness.
Gordon Long of MATSAII.com describes Yellen’s expanding role:
It appears US Treasury Secretary’s plan is to implement a first time ever “Operation Twist” by the US Treasury. To begin this “Soft Pivot” so the Treasury doesn’t have to pay too much to buy Long Bonds nor offer too much to sell Short Term T-Bills, it has begun ‘talking-down’ the aggressive rate hikes we have witnessed. Expect markets to react positively to these signals. The White House administration hopes a rebounding market will assist them with voters at the November 8th mid-term election polls.
If Yellen’s soft pivot talk is matched by any hint of softening at the Fed on Wednesday, we can expect the market to respond favorably, in keeping with the aims of the White House.
A Fly in the Ointment
There’s a big problem with this “stock market rebound scenario,” though.
Last week’s topsy-turvy market saw a big rotation out of tech stocks into more recession-resistant, production-based companies. While the Dow was up, NASDAQ was down… and the biggest tech companies absorbed some massive losses.
These “FAANG” stocks (Netflix was the exception) took a huge beating, and – due to their enormous market caps and the weight this gives them in the indexes – now represent a serious drag on any possible stock market recovery.
Apple, Amazon, Meta, and Alphabet are all currently listed as Sell or Strong Sell in most analyst recommendations. It’s hard to see how the NASDAQ or the S&P 500, which include these stocks, can recover if investors are moving out of positions in these companies.
And as if that wasn’t enough, there’s this idea from Barron’s: Meta, Amazon, and Other Stocks Most Vulnerable to Tax-Loss Harvesting.
Inflation is Not Going Away
The other problem with this hopeful outlook is that inflation is not showing any signs of receding. Without going into all the economic inputs that lead to this conclusion, there is one very reliable indicator we can look at to understand the outlook for lower prices going forward: oil.
When Crude Oil touched $120 a barrel in early March, it became clear that price inflation was not going to be a “transitory” phenomenon…the high cost of energy would subsequently cascade through the economy, keeping prices high for some time to come.
One expected consequence of steadily rising interest rates is a tightening of economic activity… this is why some commentators say the Fed wants to “cause a recession.” With an increasing cost of capital, businesses have to slow down. This should theoretically lead (among other things) to a reduction in demand for oil…and consequently lower oil prices.
Yet oil prices remain stubbornly high, still around $90 a barrel even after this unprecedentedly rapid series of rate hikes. Even though economic activity has slowed, the price of Crude is not coming down. Like the overall inflation rate, Crude Oil is resisting the Fed’s monetary machinations.
It’s Called Stagflation
A stagnant economy – we’ve seen two quarters of negative growth, the textbook definition of a recession, regardless of what the spinmeisters say – combined with high inflation is the worst possible combination for policy makers.
It puts the Fed and the Administration between a rock and a hard place…something we first discussed way back in January:
If we recognize inflation is a potentially devastating force, and any increase in market rates runs the risk of seriously tanking the markets, we get a sense for the difficult sport the Fed is in.
Does the Fed have the will to impose real anti-inflationary measures, and will the Democrats allow it?
Rates have gone up, and the market has tanked… and 10 months later we are still nowhere near a solution to the intractable problems underlying the weak stock market, to say nothing of the real economy.
As a reminder, here is the list of dangers that we have highlighted all year, any one of which could trigger the dreaded Bear Market Bomb of 2022 (or, at best, 2023):
- Runaway inflation
- Interest rate hikes
- Debt defaults
- Crashing bond values
- Global supply chain bottlenecks
- War in Ukraine
- Tension with China
- Chinese real estate bubble
- U.S. stock market bubble
- Decades-long bond market bubble
- And more…
Lest you think these are the ravings of some amateur, wannabe Macro analyst writing from home in his pajamas (!), consider this Yahoo Finance interview from highly respected economics professor and best-selling author Nouriel Roubini. Roubini lists 10 “Megathreats” which coincide rather neatly with those we’ve named.
As we complacently await the outcome of the election and the market’s response to the latest Fed moves, it remains of the utmost importance we keep the big picture firmly in mind. Economic crises tend to unfold slowly, then all at once.