Stocks retest the lows with investors facing an aggressive Fed, consumers in combustible mood
Lily Tomlin could have been referring to today’s stock markets when she declared, “No mater how cynical or realistic you are, it is impossible to keep pace.” Wall Street has tried for several months to dimen the view of the future and brace itself for a potentially corrosive inflation. But these attempts are not being met with reality. While Friday’s higher-than-expected consumer price index did not blow away predictions, it was still enough to cause bond yields to melt up and Federal Reserve rate-hike expectations to boil over. This also caused stocks to sweat a near-retest their previous 14-month lows of just three week earlier. Investors are encouraged to search for the conditions that will make it worse. With consumers in an ebullient mood, high gas prices, and the burden on proof being placed upon those who forecast a retreat from inflation, they face a summer with an aggressive Fed. That is when all the possible bad news appears priced in, and then the forces of mean-reversion begin blowing behind the bulls. Although some factors are beginning to align in the right direction, it’s unlikely that we will be there completely. Testing the tape After eight trading days holding in a narrow range and retaining just about all of its 9% rebound off the May 20 intraday low, the S & P 500 gave way starting Thursday, eventually falling more than 1% three straight days, losing 5% for the week and finishing exactly at 3900 – right on the May 20 closing low. The intraday bottom was 3810 a few days ago, leaving a little cushion. The market appeared to be causing more panic to overconfident bears, suggesting that any rally should be sold. It didn’t work out. The relief rally stopped well before the index reached its 50-day mean, and even the 4300 high in May. The index’s year-end low is 20% below its peak. The decline shouldn’t stop there. This is despite the unusual history of 19% setbacks in indexes during a handful of non-recessional or mild-recession corrections. (2018, 1998, 1990). There are many technical reasons that some observers had set 3800-3900 as their downside target. This was more than one month ago, when the index wasn’t below 4100. Average Nasdaq Composite stock fell 50% from its peak, which is quite a comprehensive drop considering the persistence of momentum in Nasdaq names. When indexes fall in price they also go back in time, and the S & P 500 now trades at a level first reached more than 16 months ago in early February 2021. The post-Covid-crash increase in equity prices is being consolidated by this long. Although there isn’t a strict standard for such matters, the multi-wave corrections which culminated in December 2016 and February 2016 reached levels that were nearly two years ago. In one narrow regard, the three straight days in which more than 80% of S & P 500 stocks fell has approached so-bad-it’s-good status. Strategist Tony Dwyer of Canaccord Genuity notes that only 3% of S & P stocks were above their own 10-day average price near the end of the week, the lowest since sharp declines in June 2020 and October 2020 were close to running their course. Dwyer does not believe this to be a signal to place a bet on a quickback. He prefers to see the Volatility Index, VIX accelerate much faster than it is. Yet he said in the final hour of trading Friday: “Today’s inflation data has picked up expectations for an even more aggressive Fed, which may take some punch out of their meeting and probable rate hike next week at the FOMC meeting…Expectations are already pretty grim and that is when I try to be careful and not get too negative into a sharp decline.” One can also see a very grim or even defensive position in aggregate investor positioning readings. Deutsche Bank claims that asset manager and leveraged fund are currently net short equity index futures in the highest degree since mid-2016 Brexit vote. This is also true before the near-2016 correction low, as well as the panic over U.S. downgrades. Bank of America’s Bull & Bear Indicator, which captures fund flows and other market-based risk-appetite measures, tells a similar story, well in the fearful depths that typically imply a contrarian buying opportunity, which worked well in 2016, 2018 and 2020. Of course, prices continued to decline despite prolonged periods of stressed markets such as 2008-’09 and 2000-’02. Valuations have reset sharply lower, the S & P 500 back below 16.5-times forward earnings, right where it was when the index last bounced a few weeks ago. This is still a range of fair value, not cheap. Even though the median stock seems a lot more expensive than the index overall. The earnings forecasts have been holding up quite well. However, this is due to large upward revisions in energy profits. All other sectors are flatlining for 2022 earnings growth. Although valuation has been reduced to a minor headwind, the balance of risk and safety is still intact. Investors are less anxious than the consumer. Consumer surveys show that consumers feel more anger and sadness. Friday’s preliminary University of Michigan Consumer Sentiment Poll was weaker than it was during the global financial crisis. If not corrected higher, this will mark the worst monthly reading since 1978. The poll is almost exclusively about inflation with a layer of general social malaise. Even with strong consumer finances and a healthy labor market, it is hard to imagine a worsening consumer mood that doesn’t lead to greater consumer withdrawal. Positive extremes in Michigan’s consumer sentiment are, over the years, quite positive contra indicators for stock performance over subsequent twelve months. JPMorgan calculates that the S & P 500 has averaged a 25% gain in the year following the eight Michigan sentiment troughs going back 50 years, with the worst return at 14%. This is because troughs can only be seen in retrospect once sentiment has recovered from a low. We are not yet there. According to the Conference Board, the consumer confidence survey asks respondents what they expect stocks to rise. The 28% that said they expected stocks would increase was their lowest estimate since February 2016, when stocks were in a slump and experienced a 6-month correction of 15% and a recession/deflation fear. Another public-opinion survey shows that only 28% of Americans believe it is a good time to purchase a home. This indicates that Fed’s forward guidance, which has driven the 30-year fixed rate at 5.5% above the Fed’s benchmark 5,5%, has caused a severe and sudden retrenchment within the real estate industry. It all creates an unclear but easily discernible picture of the backdrop, which is both bad enough to permit some market relief in the near future and not too bad to make it a positive for risk assets.