For much of the past decade, the Fed has been desperate for a stagnant labor market, especially from a wages perspective. To that end, it added trillions of liquidity to the global economy, which had the secondary effects of bubbles in all kinds of assets. Still, until a few years ago, the Fed was mostly unsuccessful in this goal of a strong and tight labor market. Now the Fed has the opposite problem. It is desperate to cool down an overheated economy, and the place of this is the job market. Yet its aggressive interventions have largely failed in terms of curbing wage inflation or even job growth, as evidenced by the latest reading showing unemployment claims plunged to new cycle lows. In today’s commentary, I want to focus more on these dynamics and discuss its implications for our portfolio. Then we do our usual roundup of relevant market topics. Read on below for more information….
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(Enjoy this updated version of my weekly commentary originally published on September 29)e2022 in the Newsletter on POWR Shares Under $10).
Over the past week, the S&P 500 is down 3.1% (SPY). Significantly, this feels like a sort of ‘moral victory’ for the bulls, given the steeper losses over the past 2 weeks. We even had some nice 2%+ bounce attempts.
But these naturally rolled over to lower lows. More importantly, we have now broken below the June lows, although there is some hope that the lows were undercut before finishing higher in Tuesday’s and today’s sessions.
On Wednesday, shares jumped more than 2% in some of the most oversold parts of the market. However, all of these gains were returned in today’s session.
The main factor in the decline was unemployment claims, which plunged to new lows. Remarkably, the labor market continues to strengthen despite a plethora of challenges and increasing signs of economic weakness in several sectors and around the world.
This is, of course, great news for the economy and the country.
But why is it so bearish for the stock market?
Well, this is one of those times when we have an economy versus market type situation.
Good economic news is bad for the markets for obvious reasons, as is bad economic news. The reason is the Fed’s ultra-hawkish stance. Good news means more tightening.
Bad news means earnings are likely to fall, but it’s unlikely to lead to lower rates (until inflation bends meaningfully downwards).
In fact, this is the exact opposite dynamic we had in the months following March 2020, when the Fed took an extremely moderate stance. This was another: the economy is not the market, and the market is not the economy-type situation.
Bad economic news caused stock markets to rise because it meant the Fed would ease more and/or longer. Good economic news was good, because it meant profits would rise, but not lead to tighter monetary policy or higher rates.
Implications
For the scholarship (SPY), the main implication is that… the bear market isn’t nearly done yet.
The Fed (and the stock market) is caught between a rock in the surf and has no easy options. Killing the inflation beast seems unlikely without more economic pain.
The headwinds of higher rates are quite powerful. The best case scenario for stocks is that we still have a quarter of economic data and earnings that are better than expectations.
This would probably lead to a range-bound market with some nice rallies like we had in July, but it’s far from a bull market.
In order to have another bull market, we need the Fed to pull out and a tipping point in economic data, especially housing and industrials. Both are currently unlikely.
As for the portfolio, we will do our best to navigate the current situation. The upside is limited and limited so we have to use bounces and rallies to make a profit and cheer. Downside is steep and significant. In general, risk management is paramount.
Let’s think of it this way: To go back to a sports analogy, let’s say a soccer team drives across the field for a winning touchdown.
Well, they’re going to throw it or pass it on to their best players and use their best game. Now is not the time to go for a Hail Mary or a flea flash. (Of course there are exceptions.)
The same goes for us. This is not the time to make big swings. It’s a time to hone, study, conserve capital and level up our investment IQ and process for the next bull market.
Market topics
Now let’s take a look at some key market topics…
UK Bonds: Something extraordinary happened this week as the Bank of England launched a two-week QE program amid rate hikes.
The impetus was the collapse of the pound and gilts due to the extremely generous budget of the incoming Prime Minister Truss, which is sure to lead to wider deficits just as tariffs rise.
Essentially, the central bank is fighting inflation while the fiscal authorities are fanning the flames.
What I’m thinking about – is this an anomaly or a taste of what’s to come for other European countries in a similar situation with rising electricity prices and skyrocketing inflation.
Growth stocks: Growth stocks cannot rally meaningfully until inflation comes lower. This is a fact because higher rates are anathema to the asset class. Higher rates mean that long-term cash flows are less attractive.
Furthermore, many investors may opt to get a guaranteed return of 4% for 2 years in Treasuries in this market environment, versus something like 10% in growth stocks that come with an insane amount of risk and volatility.
Oil: One bright spot for bulls is the drop in oil and gasoline prices. Imagine the present moment, but with gas prices over $6 a gallon.
What I’m not sure about is how much of the weakness is due to SPR sales? Or is it that oil was at an all-time high amid the Russia-Ukraine news forming a classic “sell the news” inflection point?
Or could it just be that the energy markets are reacting to an impending recession?
I think the answers to these questions are very important, and it’s something I want to continue to delve into in future comments. For now, though, I see energy more as a trading tool than an investment.
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All the best!
Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Shares Under $10 Newsletter
SPY shares closed at $357.18 on Friday, down $-5.61 (-1.55%). Year-to-date, the SPY is down -23.93%, versus a % increase in the benchmark S&P 500 index over the same period.
About the author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR growth and POWR Shares Below $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
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