Goldilocks & The Three Bears
By Crest Capital Advisors on September 2, 2022
Dow: (2.99%) to 31,318.44
S&P 500: (3.29%) to 3,924.26
Nasdaq: (4.21%) to 11,630.86
Russell 2000: (4.74%) to 1,809.75
10 Year Yield: 3.19%
Outperformers: All Sectors Lower on the Week
Underperformers: Materials (4.99%), Technology (4.98%), REITs (3.94%)
US stocks were down for the week, with major indices lower for the third consecutive week. The S&P 500 ended the week back below the 4,000 level and is now off about -8.8% from the peak of the summer rally. Treasuries were weaker as well with yields on the 10-year Treasury pushing back towards the highs of the year at ~3.25%, eventually settling slightly lower at 3.19%.
Overall, a risk-off atmosphere pervaded the market this week as the market followed through from last Friday’s horrendous Powell speech. Stocks tried and failed to rally on 3 of the 5 trading sessions, making this a week marked by opening rally attempts reversing into closing losses. The path of monetary policy remains the central question, but there was also some worry on Friday about ongoing inflation prospects in Europe as Russia announced they are keeping the Nord Stream pipeline closed for extended maintenance. This was one of the major catalysts attributed to causing the Friday risk reversal to the downside.
Friday’s August jobs report was the highlight of the week and it showed the second weakest payroll growth this year, along with a substantial uptick in the unemployment rate. It beat consensus expectations only thanks to revisions of prior months. The unemployment rate increased because the number of unemployed persons expanded by the most in 29 months, at the same time as the labor force expanded robustly. This not only shows the higher level of unemployment that Powell perversely wants but also that what he calls the “overtight” labor force can grow to meet those unfilled job openings he always mentions. Average hourly earnings fell to the lowest in 6 months; hours worked fell; the monthly job-finding probability fell. With the near certainty of August CPI reporting a second-in-a-row month of outright headline deflation, and with this soggy jobs report, there is a good chance the Fed may have the data it needs to slow the pace of rate hikes.
Overall, the economic data on jobs this week was described as ‘Goldilocks’. Not too hot, and not too cold, but rather just right to ease the anxiety of the Fed. The 3 bears, however…Prices, Powell, & Putin…well, they all still need to be contended with before we can get this market to settle down and resume an upward path.
But, Should We Really Take Him At His Word?
The biggest influence on markets this week continues to be the ripple effects of Fed Chair Powell’s commentary at Jackson Hole last Friday, August 26th. As our readers know, that speech helped catalyze a 1,000-point Dow sell-off on Friday which extended through much of this week. The notion that the Fed would “keep at” raising its benchmark interest rate and that policymakers need more evidence inflation is headed downward was enough to close the book on the “Fed pivot” rally, or at the least to put a large dent into it. And don’t get us started about the reference to “pain to household and businesses”.
But as Wharton Professor Jeremey Siegel says, “let’s not take Chairman Powell’s words as gospel”. After all, here is a man who as we all know stood at the very same podium a year ago for the 2021 Jackson Hole Conference and said inflation was not a problem. And, here’s a man who shortly before that famously said “we’re not even thinking about, thinking about raising interest rates”. Before we come off too harsh towards Powell, the entire FOMC Committee missed the inflationary storm! In last September’s FOMC meeting, half of the committee said there was no need to raise rates in 2022. Five members said ¼ points might be needed and the most hawkish member was projecting a mere ½ points by the end of 2022! Go back and read this again! This was just 1 short year ago!
So, why should we take them at their word today when they once again make projections to the end of 2023; they have NO IDEA what is really going to happen!? The answer is, we shouldn’t! The Fed’s track record is not good and yet the market is trading today as though they are omniscient. Last year they said they’d keep rates low throughout 2022. The data had other ideas and therefore the Fed had to change course. Today they say they are going to keep raising and hold rates high through at least all of 2023. What if the data changes? Will the Fed change? Of course, they will!!!
Let’s look at the data and once again thank Professor Siegel for his work in this regard. He found the following:
- Out of 27 inflation indicators over the last 30 days, 26 of them have come in below expectations. Inflation is definitively moving down.
- The price indices in the ISM report this week showed the 2nd biggest decline in 70 years, only exceeded by the Great Financial Crisis (GFC). So, the inflation news on the ground is coming in really well.
- The US Money Supply (M2) has not grown for 4 straight months. There are only a few times in history where this has ever occurred.
So, the Fed communicating today that they will stay tight through 2023 when they have no idea what will happen in 2023 is not good messaging. The stock market is most worried about a policy-induced recession today. And hence, the problem in markets over the past week or so.
Look, we agree that it is not time to pivot towards lower rates today, but it is time to pump the brakes on the magnitude of the rate hikes being contemplated by the Fed. Another 1 – 1.25% of hikes over the next three meetings were already expected by the market and the Fed should proceed to take those. But to keep on from there may prove too much given the large lag effect in interest rate policy changes.
Powell needs to at least acknowledge on the ground improvements. And WHEN (not if) this finally happens, then the stock market environment will become much more favorable.
A Final Thought
The fact that Powell invoked Arthur Burns (largely derided as overseeing the Fed regime that let the inflation genie out of the bottle) shows us that they are heavily influenced by their legacy and the market’s perception of their credibility. We get that. But we’d also argue that it doesn’t do them any good if they overtighten and make the same mistake on the downside as he made on being too slow on restricting liquidity in 2021 and early 2022! It will be a tough situation to have to explain to average Americans why they are better off without a job and struggling with recession than they are with a job with wages that simply aren’t quite keeping up with an increased cost of living.
Financial Conditions Index
The Fed was not pleased to see the financial conditions index easing alongside this summer’s stock market rally. You can see in the chart below with the S&P 500 in the bottom panel and the green arrow showing the upward move in stocks corresponding with an easing of the Financial Conditions in the upper panel. The red line shows the path of the Fed funds rate.
The slight ramp higher (representing tightening financial conditions) into the speech was the market pricing in a hawkish speech beforehand and then the move after was the continuation of that trend on the Fed’s surprise uber-hawkishness. Powell can declare mission accomplished via “Open Mouth” operations. Markets responded just like they wanted to see.
Peak Inflation – Still Happening
Still lost in the post-Powell panic attack in markets, we continue to get more and more better than expected (in this case lower) readings on inflation! US Gasoline futures have now declined for 80 straight days. Would you have guessed that gas (and oil futures too!) prices would be lower today than they were PRIOR to Putin’s invasion of Ukraine?! How many forecasters predicted this? Probably none.
So with Putin’s price hike eliminated…now we just have to work off the large rise that happened prior!
And remember those images of cargo ships lined up outside ports, unable to offload their goods? Well, take a look at the plummeting numbers of ships in port in Los Angeles and Long Beach. You’re not hearing about it because the problem has gone away.
This slowdown in shipping is showing up in the Baltic Exchange Dry Index which continues to decline and is now back to Summer 2020 levels!
And finally, we note the prices paid component of the regional Fed surveys has been in decline for some time now. August was no exception.
Chart Manipulation
We’ve written in the past as to why one should dismiss analog comparisons. Just because one period looks like another for some arbitrary period of time, does not mean that the trends will endure or that the outcome shown in the analog (usually showing a huge drop on the horizon) is pre-ordained. Frequently, analogs are poorly constructed and compare environments that are not at all similar.
So when we came across the charts below this week, we thought we’d share as it shows how one can readily make the current market environment fit the narrative of the creator. Here you have (2) bullish analogs (comparing 2022 to 1962 and 2015) as well as the obligatory bearish analogs (comparing 2022 to 2008 and 1973).
For the record, we don’t think any of these comparisons are valid.
Economic Funnies
Corporate Boardrooms today…unfortunately.
Crazy Stat(s) of the Week:
Here are this week’s crazy stat(s):
- US Bonds are down -11.6% over the last 2 years, their worst 2-year return in history!
- A Mickey Mantle baseball card recently sold for a record $12.6m at auction. The rare mint 1952 Topps card of the Yankees slugger surpassed the previous high for sports memorabilia.
Quote of the Week
“Let’s not take Chairman Powell’s words as gospel, because here’s a man who as we all know a year ago stood at the same podium and said inflation was not a problem. Here’s a man who in congressional testimony told us, ‘we don’t think money matters, our studies have shown money doesn’t matter’, then they proceeded to explode the money supply at the greatest rate in our history.”
– Professor Jeremy Siegel, Wharton School
Calendar of Events to Watch for the Week of September 5th
Calendar of Events to Watch for the Week of September 5th
Earnings flow slows a lot around the Labor Day Holiday In the US. On the Economic calendar, we are tracking a handful of Federal Reserve speeches at events next week with the highlight being Fed Chair, Jerome Powell, speaking at The Cato Institute’s 40th Annual Monetary Conference on Thursday, September 8th. The main economic report will be the Services PMI data for August due out on Tuesday. Overall, this may be a week to pause and wait for the Consumer Price Index data on tap for the week of September 12th.
Monday 9/5– Happy Labor Day! Markets (and Crest Capital) will be closed in observation.
Tuesday 9/6 – The ISM Services index for August is anticipated to come in at 53.6, down from 56.7 in the prior month. Investors will be focused on the prices paid components as well as new orders and outlook data.
Wednesday 9/7 – No major US economic reports but looking overseas we’ll get important data on China trade, Eurozone final Q2 GDP data, and Japan Q2 GDP.
Thursday 9/8 – Besides being the opening day of the 2022 NFL season, investors will be checking in the weekly jobless claims numbers and we’ll also get yet another riveting speech from Fed Chair Powell.
Friday 9/9 – US Wholesale inventories for July is the only economic report on the calendar.
Source: FactSet
