Published September 30, 2022
Blaine Rollins outlines the key questions facing investors these days. Here are some excerpts from his recent commentary:
“You can see the light at the end, but how much risk will you take to run down to the other end? Big returns await if you can only make it to the other side. But there is always the possibility that you make it part way and the train called ‘recession’ interrupts your path. With the FOMC staying on its high-rate hike path and raising the 2023 average terminal dot plot to above 4.5%, not only have the odds of peak inflation risen, but so have the odds of a policy mistake leading to a greater-than-expected slowdown. Right now, the labor economy looks to be in fine shape. But what will it look like after another 150 basis points in hikes? The unemployment rate will rise as the economy slows. But will it rise from the mid-3’s to the mid-4’s or mid-5’s? We just don’t know right now. On top of our uncertainty in fighting inflation in the U.S., the Europeans are attempting to do the same while Putin disrupts the energy markets, the U.K. is embarking on an unpopular financial plan, Iran has unleashed social unrest across all of its social and economic layers, and hurricane Ian is lining up the Gulf of Mexico and Florida. With the VIX above 30 and the S&P 500 closing at a new 2022 low today, do you still want to run through that tunnel?
Speaking of volatility, Bespoke Investment noted last week that 25% of all trading days so far this year have been declines of 1%+. The only other post-WWII years with a higher frequency were 1974 (26.6%), 2002 (28.6%), and 2008 (29.6%). So, if misery loves company, then this could be the bottoming year. With so many issues causing major uncertainty in the financial markets, could we be near a turning point? Could the Fed pivot? Could Putin admit defeat? Could Iran retire its morality police? Could the U.K. stop devaluing itself? Or could the sellers just become exhausted? As it stands now, it looks difficult to want to buy dump trucks full of equities until the 2-year Treasury Yield stops rising. With risk free assets yielding 4% and many higher quality bonds yielding in the high single digits, there seems to be too much competition for equities right now. That could all change when interest rates follow inflation lower, but we aren’t there yet.
Corporate earnings will begin in two weeks. Stocks are down going into the numbers which means that earnings expectations are being lowered. We had this setup three months ago and stocks bounced 10-20% on their mediocre results. This earnings season could get even more interesting if the market applauds uneventful earnings at the same time that the year-end seasonal strength kicks in. Of course, this time, the companies will need to address rising interest rates, higher costs and a potentially slowing economy. Better plan for longer earnings conference calls.”
The Fed’s rise in interest rates has been the fastest in history as shown below.
That has hit stocks hard turning the average individual investor very bearish. See here the AAII bearish reading hits >60% bears and growing.
Leading to a surge in put protection for investor portfolios.
The negativity comes from prospects for lesser profits upcoming. Thus, Goldman Sachs maps out a downgraded future. See corporate earnings per shares at the top and the possible S&P 500 results at the bottom. Even the worst scenario is only another 10-15% away. We are already at the bottom in all of the ‘soft landing’ scenarios. The ‘soft landing’ being no recession; ‘hard landing’ being a recession outcome from the Fed’s attack on inflation.
Never a dull moment in this turbulent market!
Investors suffered from whiplash this week as they continued to assess how high interest rates will go before the Fed declares victory in their war against inflation. Monday saw stocks fall -1% in their fifth straight losing session. A morning gain evaporated Tuesday afternoon to leave stocks down -0.2% with interest rates continuing their ascent. Behind the two days of selling was a recent move by the United Kingdom to dramatically increase government borrowing to pay for new tax cuts and other programs. The sudden shift in financing by the new UK administration has rattled markets and sent the UK currency plunging. Announcement of a bond buying effort to halt the pound’s decline appeared to ease the tensions Wednesday. Stocks rallied +2% while bond yield tumbled. But it was a one-day wonder as sellers took advantage of the bounce to unload more shares. Stocks gave back the entirety of the Wednesday gain with shares of Apple coming under heavy pressure falling -5%.
For all the difficulties the stock market this week, the overall decline was less than might be expected. The S&P 500 (SPY) slid -2.93% as well as the Nasdaq 100 (QQQ) -2.99%. Smallcaps (IWM) held flat at -0.91%.
Warm wishes and until next week.