Keith Schneider | May 09, 2022 01:11AM ET
This past week in the markets was like a good gangster movie.
All this weighed heavily on the markets (stocks and bonds), resulting in stocks at new lows, and interest rates at new highs when the market closed on Friday afternoon.
It's a mixed bag. There are negatives and positives. Let's go through them one by one:
h2 The Negatives:/h2In March, with the first rate hike since 2018, the Fed clearly broadcast that it would aggressively raise rates again in May. Investors anxiously waited to see exactly how aggressive they would be. They ONLY raised rates by 0.50% on Wednesday. Fed Chairman Jerome Powell said that similar raises were "on the table" in the future, thus eliminating more aggressive 75 bp rate hikes in the future. This was the market's worst fear.
Reflexively, investors initially cheered and sent the market up almost 1,000 points on the day of the news.
However, Wall Street has nervously been waiting for Fed action for some time now. Many economists believe that Mr. Powell and company are late in raising rates.
Worried that the Fed may now become more hawkish, the idea that 75 basis points is off the table gave investors something to cheer about at the time of the announcement, but by the next morning, another concern drove the market in the direction of its current trend, down.
Wall Street woke up on Thursday realizing that this was the most aggressive the Fed has been since 2000, and in response, concluded that it was time to sell stocks.
h3 2. Draining excess liquidity from the system/h3
What probably spooked investors after reality set in was the aggressive path that the Fed is planning to take in draining excess liquidity in their $9 trillion portfolio of bonds (especially mortgage bonds). Since the financial crisis of 2008, the Fed has injected easy money into the system.
This was accelerated in 2020 with the shutdown during the COVID pandemic. According to the Fed, this excess liquidity now needs to be drained from the system along with the Fed Fund rate hikes.
These Fed Fund rate hikes are what exacerbated the market's turmoil on Thursday and Friday!
This period has seen the fastest rise in interest rates in decades (since 1994). The 10-year Treasury rate that began 2022 at 1.5% has risen 100% to over 3% in 4+ months.
The new level of interest rates is now being factored into stock market valuations by analysts on Wall Street. Instead of using high P/E multiples of over 20, they now believe that the market should be pricing in mid-teen multiples. This, along with fears of a future recession, weigh heavily on the market.
As you know, many stock prices have been cut in half or more in just 6 months since the euphoric top.
A rapid rise in interest rates (see above), in addition to lingering supply chain problems, rising crude, and other commodity prices, and geopolitical risk, have all contributed to ongoing investor nervousness.
Now, investors realize that they are facing not only inflation but Stagflation.
For those not familiar with this insidious economic condition, Stagflation is a lingering period of rising and high inflation coupled with slowing economic growth or negative GDP.
Stagflation is usually unkind to stock prices as the growth rates of companies (and revenues) begin to decline while input costs (labor and raw materials) rise. Our last experience with Stagflation occurred from 1972 to 1981 when stock prices went nowhere for about ten years.
h3 3. Aging population and emotional fear/h3Last year 4.5 million people left their jobs, and many of them decided to retire. Many of these people were depending on their retirement accounts to fund their ongoing income needs, believing that the last ten years of sizable gains would contribute to a comfortable lifestyle. Then the market turmoil began in earnest this past January.
Many of these investors cannot take the pain of watching both their stock and bond market investments fall in value. Therefore, sadly these investors have been pulling the trigger in liquidating their investments and moving to cash.
The move into preservation mode may be just starting. Bank of America reported last week that $3.4 billion came out of stocks, and $9 billion moved out of bonds as investors moved to the sidelines. This has amplified volatility and sparked daily volume spikes as some investors feel forced to retreat. This may be further causing volatility and capitulation in the markets.
h2 The Positives:/h2 h3 1. The Fed has begun the tightening cycle/h3This was action investors all expected to help fight inflation and slow the economy down. Usually, the first few triggers are met with negative market action, but eventually, this is baked into the cake and the market finds its footing.
h3 2. Earnings are very good/h3According to FactSet, 87% of S&P 500 companies have reported earnings, with 79% beating their earnings estimates and 74% reporting revenues above estimates. This should provide a floor for how much the market can and will go down.
h3 3. Inflation may slowly subside/h3The global supply chain, exacerbated by China's recent shutdown due to COVID, may resume soon. Also, if the post-COVID buying sprees slow down due to businesses cooling off a bit and higher borrowing costs, we could return to more normal supply chains. This may cool inflation a bit and reduce some of the stress to the system (especially in housing).
h3 4. Consumer demand may be slowing/h3This is the principal reason for higher inflation.
h3 5. A healthy and good job market/h3Unemployment is at 50-year lows, and we are living with a massive number of job openings (11.5 million). This should keep the job market strong even in the face of a slowing economy. A healthy job market should keep wages high (and growing) and help offset some of the economic slowdown.
h3 6. Stock market valuations are becoming more attractive/h3Perhaps we were due for this type of correction. Please note that normal corrections of 10% or greater typically occur once in every 4 years. This is normal and so long as we don't see an additional 5-10% drop, this is nothing more than a correction. Stocks are beginning to look attractively priced to investors and it may not take much for the market to find a bottom here.
h3 7. Investor sentiment is very negative/h3A host of firms are showing extremely negative/bearish sentiment measures at levels that tend to be where market bottoms are formed. Extremely negative sentiment is a good contrarian indicator. If we see even a slight rally in the bond market, we may find the investment sentiment becoming more positive. This could fuel a substantial rally.
h3 8. Commodity prices should begin to retreat/h3If the economy cools off from aggressive Fed tapering and rate hikes, commodity prices should also come down. Demand has a lot to do with influencing commodity prices. While we may be in for elevated prices for some time, the trend could begin to lose some momentum. Much of this depends on the price of crude oil.
h3 9. Geopolitical risk/h3The Russia-Ukraine situation has exacerbated the commodity price story and inflation risk. If this battle gets sorted out in the next few months (likely), then we might well see a positive impact on some of the global supply chain issues.
Having said all that, we do want to remind you that we are going into the most unfavorable period of the year for investing. May to October can be tricky. Additionally, mid-term election years have, in the past, been much more volatile than years not having a mid-term election. Be careful.
h2 Here are some ways that you could protect your own portfolio (create your own drawbridge):/h2Market Insights from our Market internals for SPY improved despite the lower close in price on the key indices. (+)
Neutral
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.