Talking Points: September 23, 2022
STOCK MARKET • S&P • FED UPDATE
The stock market is now confronting the unavoidable: entrenched inflation and a Fed Chairman ready and willing to be the next Paul Volcker.
In this unusual post-pandemic macro environment the Fed’s dual mandate—full employment and stable prices—are in direct conflict.
- With the employment rate at just 3.7% the Fed has made the correct judgment call that defeating inflation should be their primary focus for the foreseeable future.
- As Chairman Powell stated, a failure to tame inflation with current economic pain would only lead to far greater pain in the future.
And so stocks have seen extreme volatility and have sold off about -10% since the Jackson Hole speech.
Stocks sold off on yesterday’s 75 basis point hike and Powell’s hawkish comments in his afternoon press conference. Some choice quotes:
- “It would be nice if there was a way to just wish it [inflation] away, but there isn’t.”
- “We think we need to have softer labor market conditions.” I.e., the Fed is willing to tolerate higher unemployment.
- “We have got to get inflation behind us. I wish there were a painless way to do that; there isn’t.”
The S&P has again fallen -20% from its peak and the Nasdaq has again fallen -30% from its peak. Both last saw these low levels in July before the summer bear market rally.
Just 15% of S&P 500 stocks are trading above their 50-day moving average; just 10% of Nasdaq 100 stocks are.
The Fed seems to have given up hope of a “soft landing” and admit economic pain will likely be a necessity to bring inflation down.
Rates are going to continue higher until the Fed sees “compelling” evidence that inflation is moving in the right direction.
- What consitutes “compelling” we can’t know, but this uncertainty ushers in volatility in anticipation of every inflation-related data release.
- Also, the certainty of higher rates ensures the continued presence of a massive headwind for stock prices.
Such erratic markets facing certain, known headwinds makes for an extremely difficult trading environment. Tactical, defensive allocations to cash and cash-like instruments will be helpful in avoiding catching a knife that’s both falling and bouncing around.
EXHIBIT 1 - Fast rate-tightening cycles leads to disappointing returns
This chart from Ned Davis Research shows S&P 500 performance during different speed rate-tightening cycles.
Fast hiking/tightening leads to volatile, flat performance historically.
EXHIBIT 2 - how long to kill inflation?
Research from Bank of America shows that in advanced economies, once inflation breaks over 5%, it takes an average of 10 years for it to drop back down to 2%.
EXHIBIT 3 - biggest stocks still seeing high valuations
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The views expressed above reflect the views of EdgeTech Analytics, LLC and are for informational purposes only. These views are not intended to serve as a substitute for personalized investment advice. Past performance is no guarantee of future results and no investment strategy or methodology can guarantee profits or protect against losses.