“I have not failed. I have just found 10,000 things that do not work.” – Thomas Edison
Today’s update and next week’s article will be shorter than usual as I am taking time to visit with “Family”.
The “change” was noted in February. The New Era strategy highlighted that “buy the dip” was no longer the way to proceed. That has worked out well as 2022 has been one of the worst years ever when it comes to the “buy the dip” trade.
Today we’ll see just how poorly the market has performed this year after big one-day moves in either direction. One-day rallies have seen no further upside momentum, while “buy the dip” after big down days has been replaced with “sell the dip.” There has been no shortage of big one-day moves this year with 42 declines of 1%+ and 40 gains of 1%+. At the current pace, 2022 would end the year with 61 one-day drops of 1%+ and 59 one-day gains of 1%+. The only years since 1953 that saw more than 60 one-day drops of 1%+ were 2008, 2002, and 1974. The only years that saw 59 or more 1%+ up days were 2020, 2009, and 2008. These stats also highlight the multitude of false moves that have plagued all of us this year.
Below is a chart showing the S&P 500’s average percentage change on the day after one-day drops of 1% or more by year. As shown, so far in 2022, the S&P has averaged a further decline of 0.45% on the day after 1%+ drops. We haven’t seen this kind of next-day weakness following big one-day drops since 1987 (which is skewed by the October crash that year).
As shown in the chart, throughout the 1990s and 2000s up until this year, the S&P has generally averaged next-day gains after 1%+ drops, which fueled the “buy-the-dip” mentality that reached a fever pitch after the COVID crash in 2020.
Bull vs. Bear Trends
Notably, the three years before 2022 averaged some of the strongest next-day gains after 1%+ drops in the last 70 years. From 2019 to 2021, you could set your clock to bounce back after 1%+ drops. That is the hallmark of a bull market trend. The opposite has been the case this year in this bear market.
Not only have the dip-buyers disappeared this year, but also the momentum buyers aren’t around either. This year the S&P has averaged a decline of 0.33% on the day after 1%+ gains. That’s not a record, but it would be the fourth worst year for this reading since 1953 if the year were to end today.
Along with looking at next-day moves after 1% drops or gains, the next-week moves are also negative. This year, the S&P has averaged a further decline of 1.05% in the week following one-day drops of 1%+. That’s the worst of any year on record. Again, though, this comes on the heels of 2021 when the “buy-the-dip” mentality probably hit its peak. In 2021, the S&P averaged a gain of 2.06% in the week following a 1%+ daily drop. Once again highlighting the difference between a bull and bear trend.
It seems that the “consensus” is “surprised” with Fed commentary, still talking of avoiding a recession and generally oblivious to what has been telegraphed for months. Newsflash; I expect markets and the economy to get much worse before it gets better. We’ve seen the market tell us how bad this economy already is. How else would you categorize the worst start to a year on record for traditional 60/40 portfolios? The problems in ’22 don’t end there. As shown below, deal flow has certainly reversed significantly with IPOs almost non-existent recently.
The Misery Index shown below uses YoY changes in gas prices, mortgage rates, real wage growth, the unemployment rate, and the inverse of the S&P 500. As shown below, the all-time high in this Misery Index came in April 2020 during the peak of COVID lockdowns. It then fell to an all-time low in early 2021 (when everything was firing on all cylinders and inflation was still low).
Recently, this index spiked back up again to what would have been a record high if you remove the COVID spike, but just recently it has started to pull back slightly. Investors are wondering how much more misery needs to occur before we see a trend shift.
Inflation and how quickly it decelerates will probably determine whether the S&P either makes a new low or a new high first. However, there are other factors at work as well and we’ve already discussed one of them.
Q3 earnings season could be the next catalyst
Forward earnings peaked in late June and the Q2 reporting season saw the Street start reducing estimates for the remainder of ’22 and ’23. Now bottom-up estimates for Q3 and next year are down 5.5% and 3.7%. They might have fallen if it were for inflation as they typically hold up better when inflation is elevated.
Yardeni Group expects forward earnings of the three S&P stock composites-S&P 500, MidCap 400, and SmallCap 600-to move sideways for the rest of this year before resuming their climb. Fundstrat doesn’t paint the same picture. Their research suggests earnings expectations remain too high and can easily drift lower through the first half of next year.
Deutsche Bank reports:
“Earnings are likely to slow dramatically or even turn negative outside Energy. Along with lower multiples and recession risk, this makes a sustained rally difficult.”
If these scenarios pan out as forecast, relatively speaking, that represents a better platform for Value stocks.
Other factors that are also in play are the trajectory of the US dollar and the 10-year Treasury yield. Both are still in uptrends but possibly nearing inflections, with the dollar-to-yen (and other currencies) more overbought than it ever has been and the 10-year yield near resistance where stocks bottomed in June.
All of the evidence brings the word Stagflation into the picture. A long drawn-out period of above-average inflation accompanied by weak or negative growth. Sound familiar? We have already had the first look at that this year. I continue to see a large trading range with big rallies followed by large pullbacks that will continue to frustrate everyone. All of that should continue until we see more clarity on inflation, recession, and earnings.
The Week On Wall Street
Coming off of last week’s CPI induced selloff, all of the major indices posted gains on Monday. The rebound rally was short-lived as sellers took over on Tuesday as traders weren’t inclined to stay “long” before the Fed rate announcement. That worked out to be a wise choice as market participants hit the sell button, once the Fed’s message was digested.
The more investors looked at the poor economic data and the worsening technical situation the more it turned into a waterfall selling event. The back to back week losses dropped the S&P by 9%. The NASDAQ lost 10.2% in the last 2 weeks.
The latest from the Atlanta Fed GDPNow model now forecasts Q3 GDP at 0.30%. Since late last year, I’ve been trumpeting a message that growth estimates were too high. With Q1 and Q2 coming in at negative growth that has proven to be correct. The initial (+2.5%) Q3 forecasts we’re calling for a big rebound in the latter half of this year, and once again I noted there was no “growth” initiatives in place for that to occur. Unless we see a complete turnaround in a very short period the US economy is flirting with three consecutive quarters of negative growth.
We can’t cheerlead or “talk” the economy into a growth pattern. This void in reality that is being exhibited is stunning and dangerous. The incentives for growth aren’t there and the anti-business climate is cemented in place.
U.S. Leading Economic index fell 0.3% to 116.2 in August after dropping 0.5% to 116.5 in July. This is a 6th straight monthly decline and the 7th out of the last 8 months. The 116.2 print is the lowest since June 2021 and is down from the 119.4 “record high” from February. The components were mixed with four decliners, five making positive contributions, and one unchanged.
Supply chain issues are still plaguing manufacturing
We keep hearing how the supply chain is improving. While that may be true and it might be slowly improving, I did find the Ford (F) announcement last night very surprising. The company expects to incur an extra $1 billion in costs during the third quarter due to inflation and supply chain issues.
It is also noteworthy that this isn’t a semiconductor supply issue. Instead, it’s all about parts supply, and the commentary from other manufacturers suggests this isn’t a “Ford” problem. This doesn’t add confidence to the investment backdrop and it certainly brings into question the source of the supposed good news on supply chain issues.
Housing starts report beat estimates with a 12.2% August pop from a 2-year low. However, a 10.0% permits drop to a 2-year low dampened enthusiasm.
Existing home sales declined 0.4% to 4.8 Million in August after slumping 5.7% to 4.82 Million in July. Sales have been falling since February and are at their lowest since June 2020. The month’s supply of homes was steady at 3.2 and is up from the record low of 1.6 in January. The median sales price slid to $389,500 after falling to $399,200 in July. Prices remain elevated but the pace of appreciation is slowing and is at 7.7% y/y currently, from 9.5% y/y in July.
The NAHB home index dropped another 3 points to 46 in September after tumbling 6 points to 49 in August. It is a 9th straight monthly decline; indeed it has declined every month this year, and is the lowest since May 2020. The index was at 76 a year ago. The report noted builders continue to see headwinds from elevated building costs and rising mortgage rates. The housing market has been rocked by the FOMC’s aggressive rate hike policy.
It’s getting harder and harder for the cheerleaders to claim this economy is in “good shape”.
The Global Scene
Germany’s headline PPI increased 7.9% month over month. Yes, you read that right – month over month. High energy costs are taking their toll.
Japanese core inflation was above 2% annualized again in August, though at a slower pace than July. Despite massive energy inflation, Japanese CPI is still just 3.0% YoY, within its long-term range; that illustrates just how entrenched low inflation is in Japan.
The world is still flocking to China, as they remain a key player contributing 30% to global growth.
Foreign direct investment in the Chinese mainland expanded 16.4 percent year on year to 892.74 billion yuan ($127.24 billion) in the first eight months of this year.
In my view, these two developed economies have the best chance of avoiding recession. However, if the EU sinks into a deep recession, and the US continues on a negative or slow/no growth trajectory, all bets are off.
After this week’s FOMC meeting, and another 75 basis point rate hike, the Fed Funds Rate is 3.25%
Jay Powell delivered another aggressive policy move. He repeated the Committee is “strongly committed” to bringing down inflation and is “acutely” aware of the pain it causes. Without price stability, the economy does not work for anyone and will not sustain a robust labor market. Analysts are acting “purposely” to rein in inflation.
He noted the economy has slowed “modestly,” yet the labor market has remained “extremely tight” and out of balance. The Fed expects a better balance over time that will ease wage and price pressures. Inflation remains well above our 2% goal, he added, but longer-term inflation expectations remain “well anchored.” He stressed that this is not a reason for complacency. Indeed, the longer inflation remains elevated, there is increased “risk” it becomes “entrenched.” He appealed to history and noted the consequences of taking the foot off the brakes prematurely. Restoring price stability will require keeping rates restrictive “for some time.”
The Fed will keep at it with a restrictive policy for some time. Two things will need to happen to get inflation down, inducing sub-trend growth and softening in the labor market. In terms of when knowing when to slow or stop hikes, the FOMC will be looking at a few things: including growth running below trend, the labor market in better balance, and clear evidence of inflation coming down toward the 2% mark. The Fed is very mindful of the time it will take financial conditions to wend through the economy to bring down prices. It is difficult to ascertain how it will all unfold but suggested there will be a point where it will be appropriate to slow the pace of hikes and assess. He added the Fed is at “the very lowest level of what is restrictive.” The chances of a soft landing diminish as policy becomes more restrictive, or has to remain restrictive for longer.
In reality, there is nothing in this announcement we didn’t already know or realize. Fed “pivots” and “pauses” are a hope strategy that for some reason has been in the conversation among analysts and pundits alike.
The Fed is in the picture and they will continue to raise rates to fight inflation. When inflation is under control, they will stop raising rates.
Period, end of the debate.
The Federal Reserve’s preferred measure of the yield curve is the spread between 3-month and 10-year US Treasuries, which still has a modestly positive slope at about 25 basis points (bps). Besides that, another widely followed point on the curve is the spread between the 2-year and 10-year US Treasuries (2s10s). As of Wednesday’s close, the 2s10s curve inverted to the tune of 52 bps making it the most inverted it has been since 1982!
It was nearly as inverted in April 2000, but back then the maximum point of inversion was 51 bps. Think about that for a minute. A lot of people, maybe up to half reading this right now weren’t even alive the last time the 2s10s curve was as inverted as it is now! Looking at the chart below, since the mid-1970s, there has never been a period when the 2s10s yield curve was as inverted as it is now that a recession wasn’t just over the horizon.
Getting back to Chair Powell. At one point in his press conference this week, he responded to one question with the answer that “No one knows whether this process will lead to a recession.”
Let me get this straight. The yield curve is extremely inverted, GDP growth in the first two quarters of this year has already been negative, and forecasts for growth in Q3 have been steadily declining as we close out the month. All this is before the recent unprecedented round of 75 bps rate hikes have had the opportunity to filter through the economy, and yet the Fed Chair is unsure of whether the US economy is either already in or on pace for a recession.
Now I know that it’s not a good look for a Fed Chair to forecast a recession, but let’s also stop the cheerleading rhetoric that got the economy into this mess in the first place.
Food For Thought
Cutting off investments in fossil fuels would be the road to hell for the United States. This is what JPMorgan’s chief executive Jamie Dimon said during a congressional hearing on a range of topics.
After laying out net-zero plans that require a shift away from fossil fuels, Rep. Rashida Tlaib asked JPMorgan’s chief executive:
“Please answer with a simple yes or no, does your bank have a policy against funding new oil and gas products, Mr. Dimon?”
“Absolutely not, and that would be the road to hell for America. He went further, as well, saying the country needed to invest more not less in oil and gas.
“We aren’t getting this one right. The world needs 100 million barrels effectively of oil and gas every day. And we need it for 10 years. To do that, we need proper investing in the oil and gas complex. Investing in the oil and gas complex is good for reducing CO2. We’ve all seen, because of the high price of oil and gas, particularly for the rest of the world, you’ve seen everyone going back to coal.”
Ladies and gentlemen, we are on the road to hell, and I’ve warned about this policy error for well over a year now.
It seems the only people that don’t have this “right” are the people making policy. Until that changes, we remain on this road to a long drawn out painful recessionary period that will cripple middle America.
The Daily Chart of the S&P 500 (SPY)
As support levels failed during the week it triggered a waterfall selling event.
The June lows were tested, but for now, they have held. With the continued selling pressure in place and no catalyst on the horizon to change sentiment, the path of least resistance is lower.
Investors keep looking for this “capitulation” moment. Some believe they may have seen it on Friday. I’m not so sure. Counter rallies are always possible, but this bear market is firmly entrenched.
Thank you for reading this analysis. If you enjoyed this article so far, this next section provides a quick taste of what members of my marketplace service receive in daily updates. If you find these weekly articles useful, you may want to join a community of SAVVY Investors that have discovered “how the market works”.
The 2022 Playbook is Now “Lean and Mean”
Opportunities are condensed in Energy, Commodities, Utilities, and Healthcare. Along with that I’ve defined Bearish to Bullish reversals. However, now that we have seen a genuine global recession scare, nothing is “safe”.
Each week I revisit the “canary message” which served as a warning for the economy. The focus was on the Financials, Transports, Semiconductors, and Small Caps. I used them as a “tell” for what direction the economy was headed to help forge a near-term strategy. Unfortunately, all of the canaries remain very, very sick.
The message here was very clear and has never changed. The signals were evident since 2021.
2022 will be a more challenging year for investors to navigate successfully. Inflation, interest rates, and policy error are the chief threats to investors in ’22.
The economy needs more than the Fed to fight inflation. Policy errors continue to impact the scene.
The market’s dilemma; rising interest rates don’t fix the supply chain and labor shortage issues or rising energy costs.
Policy errors are taking their toll; high energy costs and high Inflation are embedded in the economy.
Warning signs are flashing – Unless we see these signals reverse, economic trouble lies ahead. Market leadership is about to change in Q2. It’s time to review your holdings.
The Bear is in control
The Jimmy Carter cocktail – Stagflation is back on the “menu”. The war on fossil fuels will continue to have a devastating effect on the global economy.
Confidence polls are at historic lows. The anti-business policy and rhetoric take a bad situation and make it worse. In the current backdrop, the potential for a sharp V-bottom for the economy and the markets is low.
Economic data continues to come in weak and isn’t aligned with the “no recession” commentary.
The bears still hold the key.
That commentary isn’t “hindsight”. All of those “calls” are documented here on Seeking Alpha. I’ve got a good idea of what comes next for the market, and I’m ready to publish my Q4 outlook. This is no time for anyone to be navigating this scene without solid advice. Savvy Investors have followed a strategy that has allowed them to “survive” this bear.
I expect to keep investors on the right side of the trade.
Please allow me to take a moment and remind all of the readers of an important issue. I provide investment advice to clients and members of my marketplace service. Each week I strive to provide an investment backdrop that helps investors make their own decisions. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore it is impossible to pinpoint what may be right for each situation.
In different circumstances, I can determine each client’s situation/requirements and discuss issues with them when needed. That is impossible with readers of these articles. Therefore I will attempt to help form an opinion without crossing the line into specific advice. Please keep that in mind when forming your investment strategy.
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Best of luck to everyone!