(Please enjoy this updated version of my weekly commentary published September 1st, 2022 from the POWR Stocks Under $10 newsletter).
Over the last week, the S&P 500 (SPY) is down by about 5.5%, although it was down by a bit more than 7% at today’s low.
In last week’s commentary, we discussed that the market was at an inflection point – either this would turn out to be a routine dip after the strong and steady advance that we have had from mid-June, or this would be a more meaningful pullback/correction.
Clearly, the latter scenario was correct as Fed Chair Powell and a steady stream of FOMC officials made it clear that they have no plans to let up on the rate-hike gameplan and that more needs to be achieved in the battle to tame inflation before any sort of pause or pivot is even a consideration.
This killed a major tenet of the bull case – the Fed would be easing up on hikes due to inflation peaking and weakness in certain segments of the economy. Clearly, this is not the case as the Fed has painfully made clear.
In fact, it seems dismayed by the market starting to price in rate cuts in 2023.
This was maybe most plainly laid out by Minneapolis Fed Chair Neel Kashkari who bluntly stated that he was unhappy to see the market rally after the July FOMC meeting and was pleased to see it decline after Jackson Hole.
Now, with a more hawkish Fed expectation, the market is facing another inflection point which is likely to be resolved by a combination of Friday’s employment report, August inflation data, and the next FOMC meeting.
Silver Linings
Given the market’s decline and Fed disappointment, it’s easy to lose sight of the bull case. And, I think it bears repeating and should be respected.
For one, recent economic data continues to trend in the right direction. In essence, we are seeing continued strength in consumer spending, while other parts of the economy are weakening but not necessarily in contraction mode.
But, the inflation picture continues to improve.
Basically, the supply chain improvements are working their way through the system. We have used car prices trending lower. The weakness in housing is a foreshadowing of rents declining as well.
In fact, if we compare the current situation to the market bottom in June, inflation is lower, while real-time growth indicators are in a better position.
Reasons for Caution
‘Don’t Fight the Fed’ is engraved in the minds of every trader and investor because it’s true.
People have PTSD from shorting the market for much of the past decade, while the Fed was determined to push unemployment lower and prevent the economy from descending into a deflationary spiral.
Currently, the Fed is an adversary of any stock market bull.
Another challenge facing the global economy and stock market (SPY) is a crisis in Europe which will negatively impact growth.
Essentially, energy prices for electricity are soaring and could get worse in the winter. Caps on industrial production are one solution to alleviate some of the pain.
However, this is due to rising energy prices which are inflationary.
This means that unlike other bearish developments like the coronavirus or the Fed’s rate-hiking cycle in 2018, the Fed won’t be coming to rescue asset prices.
Another issue is that while US growth could outperform relative to expectations and even stay positive on a real basis, this isn’t the case with the rest of the world.
Weakness for the rest of the world (ROW) vs the US economy means a stronger dollar which will weigh on companies in the stock market.
In fact, most of the earnings weakness of recent months can be attributed to a stronger dollar rather than inflation (close to historically high-profit margins is evidence) or economic weakness (earnings growth of 6% vs expectations of 4% entering Q2 earnings season is evidence).
Takeaways
In a way, this helps the inflation picture, especially in the US.
The stronger dollar helps lead to cheaper imports which would be a deflationary impulse. But, the brunt of the pain would be felt by foreign countries especially those with large current account deficits funded in dollars.
In my opinion, this is a low-conviction market. It’s better to not attack.
One lesson from my nascent pickleball career is to not beat yourself and give your opponent a chance to beat themself.
Taking big swings would be tantamount to doing so. So, that’s the first major takeaway.
The second is that a resolution to this mix of a bearish backdrop but some positive developments is a range-bound market.
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SPY shares were trading at $401.15 per share on Friday morning, up $4.73 (+1.19%). Year-to-date, SPY has declined -14.91%, versus a % rise in the benchmark S&P 500 index during 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 Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
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