Get ready for an avalanche of recession warnings across all media platforms. That's the conclusion from last week’s Consumer Price Index (CPI) report, as inflation hit yet another 40 year high which almost guarantees that the Fed announces on July 27th that it will raise interest rates by at least another 0.75%, putting even more pressure on the economy.
Indeed, after the Bank of Canada last week hiked interest rates by 1.0%, by Wednesday evening US bond futures markets were pointing to a 78% probability of a full 1.0% raise by the Fed at that next meeting.
“Peak Hawkishness/Peak Inflation” is pretty much the first key to a potential stock and bond market bottom and a visibly declining CPI is the “proof” the Fed needs to believe that we’ve past peak inflation and that they can ease up somewhat. We are now going to have to wait at the very least another month before getting there, although every move higher does increase the hope among the optimists that the next time will finally be the data release that shows a peak has been reached.
The optimists’ case around the hot CPI report is:
admittedly, inflation hasn’t peaked yet but they are hopeful that it’ll peak very soon (next month?) as recent falling commodity prices start to make themselves felt in the data
the Fed won’t hike to a final level any higher than currently expected (it may hike faster, but the end result should be the same) and it will “stop” at around 3.50% by year end
that the slowing economy will stop the Fed from “going too crazy” with rate hikes later in 2022 or early 2023, and in a year or so we’ll actually be talking about rate cuts.
However, in my view, here's the bottom line: There was nothing in Wednesday’s report that even hinted at the fact that inflation has yet peaked and the peak inflation narrative was proved wrong again for the third month in a row. It may well show a lower headline rate in a month’s time but even a peaked inflation rate will still be very, very high. Interest rates are still going higher and will definitely continue to do so.
The idea that the Fed will automatically stop raising rates simply because it hits 3.50% by the end of the year seems illogical to me. The Fed has said that it will fight inflation to the death, not just knock it down by a percentage point or two, using interest rate hikes as its weapon and is prepared to plunge the economy into recession if need be to accomplish this. In my view, there’s nothing magical about a Fed Funds rate of 3.50% that will, of itself, give the Fed pause at year end.
Endless recession warnings and predictions will keep pouring out of all media outlets. All of this could well lead to continued volatility in the days, weeks, or even months ahead. Stay strong. You all know my advice. If not, call me and I’ll share it. Also see the “ARTICLE OF THE WEEK” below.
The week had gotten off to a rocky start on Monday as we learned that Macau will close down most businesses, including shuttering all its casinos, for at least one week following a COVID outbreak - while Shanghai will continue with massive testing in what is a signal that China’s Zero COVID policy is still very much in effect.
There was then mostly confusion and nervousness in relatively low volume stock markets ahead of Wednesday’s CPI report and early Q2 earnings announcements. Markets tumbled late on Tuesday after a fake news report on the open sewer that is Twitter claiming to be an early leak of the CPI inflation data due the following day (showing a 10.2% annual rate of inflation) got such traction that the US Bureau of Labor Statistics was forced to come out and announce that it was a forgery. But by then the tweet had already triggered some program selling and had spooked a good number of traders.
When reality hit on Wednesday morning, we saw that CPI had in fact surged 9.1% from last year, up from the 8.6% rate in May and a lot more than the 8.7% increase analysts had expected. This was the highest annual inflation print since November 1981. The Core Rate, that excludes food and energy, rose 5.9% from a year ago, slowing fractionally from May's 6.0% increase. Analysts had expected a 5.7% increase.
For the month of June only:
overall inflation was up 1.3%, the highest monthly increase since Green Day strolled down the Boulevard of Broken Dreams in 2005
energy inflation was up 7.5% (41.5% year-on-year)
inflation (without energy) was up 0.7% (6.6% year-on-year)
inflation in used cars and trucks was up 1.6%
inflation in rents was up 0.8%, the highest since The Pet Shop Boys first sung about hanging out with West End girls in 1986
owners’ equivalent rent, a CPI euphemism for house prices, was up 0.7%
As a result, real (inflation-adjusted) wages got crushed in June. They are down 2.9% from April 2021, and down 3.6% from December 2020. The average worker is taking real pay cuts. Wholesale inflation numbers (raw material costs to manufacturers as shown by the Producer Price Index - PPI) provided no relief when they were released last week, these prices are up 11.3% year-on-year.
JP Morgan Chase (JPM) and Morgan Stanley (MS) fell hard on Thursday, taking most of the financial sector with them, after both suffered big declines in their investment banking businesses but market-volatility boosts to their trading operations. JP Morgan Chase CEO Jamie Dimon warned about a potential economic slowdown.
Consider that, on just Wednesday and Thursday alone, investors were hit with ..
Much-hotter-than-expected inflation reports - both CPI and PPI,
The openly-discussed possibility of a full 1.0% rate hike later this month,
Highly underwhelming earnings from market giants (JPM & MS) and
Increased turmoil in Europe (political machinations in both Italy and the UK as well as continued ugly developments in the conflict in Ukraine),
.. yet the S&P 500 finished the week higher than where it closed on Tuesday (although still down for the week as a whole). On the face of it, that resilient performance was impressive and certainly better than some of the relentless declines that we saw in April, May and June. It would seem that this degree of bad news has been already priced into the S&P 500, which remains in the previously-identified range pivoting either side of SPX 3800.
However, what is not yet priced in is the scenario of a serious economic slowdown in an environment of falling corporate earnings and that is where the risk lies, with the potential to drive prices down another 10%-20% or more. This could explain the lack of broad buying sentiment discussed in “Under The Hood” below.
Having said that, stocks did stage an impressive rally on Friday, partly due to a strong, but not-too-strong, retail sales report and the market processing the University of Michigan’s preliminary estimate of its closely-watched Consumer Sentiment Index (see “FINANCIAL TERM OF THE WEEK” below) that ticked higher to 51.1 from last month’s record low of 50.0. It was only the second time this year that the index has advanced and consumers’ pessimism about future inflation levels also eased somewhat. The Fed likes to see things like that.
Other News:
Great news for international travelers who are bad at math .. After last week’s foreign exchange market activity, one Euro is now essentially the same as one dollar.
Buyers pulling out .. Housing market deals are falling through at the fastest clip in two years, as home buyers are using a slowing market to try to renegotiate. In addition, buyers are backing out because higher mortgage rates mean they can no longer afford the home they agreed to buy. Roughly 60,000 home-purchase agreements across the country in June (almost one in seven of the total number homes that went under contract), fell through.
The desperate buyers of earlier this year were waiving inspections and appraisals as a tactic to jump the line and get the property they wanted. Now they are increasingly keeping these contingencies rather than waiving them. which can give them the flexibility to call the deal off later.
Crypto-world just keeps on getting rocked .. Major cryptocurrency prices sank again midweek, with the price of Bitcoin falling back below $20,000 again as things just got more and more toxic in the crypto ecosystem. The present whereabouts of the founders of the now-dissolved crypto hedge fund Three Arrows Capital are apparently unknown, suggesting that they may well now be on the run. Like 1920’s gangsters and bank robbers.
Elsewhere, crypto lenders Celsius and Voyager Digital, who each froze customer withdrawals recently, both entered bankruptcy last week and all their customers are now vulnerable to being completely wiped out as they are deemed to be only unsecured creditors in the bankruptcy process. Coinbase’s stock price is now down 87% from its high just last November. Just sayin’.
Under The Hood:
Last week saw a new multi-month low in Buying Power AND a new multi-month high in Selling Pressure. Half of all stocks are now 30% or more below their one year highs. A year ago, that number was less than 10% of stocks. Even just six weeks ago, it was down around 30%. This all demonstrates a distinct lack of interest on the part of potential buyers to get sustainably involved at these price levels. Historically, the only way the required level of interest has developed is for stock prices to go even lower to finally attract enough indiscriminate buying.
The reaction of buyers to recent oversold conditions continues to disappoint and it has become increasingly clear that there is simply not enough interest in stocks at these price levels for a sustainable rally to begin. The mass scooping up of bargains will likely have to wait until prices fall further. Remember, shorter term investors can lose a lot more money turning prematurely bullish in a bear market than they do in the steep, early declines. There’s a really good chance that Friday’s solid-looking rally could well just be another in a long line of bear traps.
Interestingly for those fans of the “complete COVID round-trip” theory (that all the gains since February 2020 need to be erased before things can finally turn around), the closely-watched S&P 500 200-day moving average is now closely lined up with the pre-Feb 2020 high of around 3400 in the SPX. Some technical analysts believe that, at the very least, this has the potential to provide quite a hard-floor level of support if we get down there (SPX closed on Friday at 3863).
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
The upcoming week’s calendar ..
Q2 2022 earnings will continue to emerge this week, with roughly 70 S&P 500 firms scheduled to report. Among the highlights will be Netflix, Bank of America, Goldman Sachs, American Express, IBM, Verizon, Johnson & Johnson, AT&T, Dow, Snap, Lockheed Martin, United Airlines, American Airlines, Freeport-McMoRan and, interestingly, both Tesla and Twitter.
Overseas, while the Bank of Japan is expected to keep its target interest rate unchanged, the European Central Bank is expected to raise its key interest rate by a quarter of a percent, from negative 0.5% to negative 0.25%. The US Federal Reserve's next monetary policy meeting will take place on July 26-27.
In the world of real estate, the National Association of Home Builders will release its housing market index for July, followed by the Census Bureau's new residential construction statistics for June and the National Association of Realtors' existing-home sales for June.
Finally, the Conference Board will release its leading economic index for June and S&P Global will release both its manufacturing and services purchasing managers’ indexes for July.
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US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):
↑Bullish: 27% (up from 19% the previous week)
→Neutral: 27% (down from 28% the previous week)
↓Bearish: 46% (down from 53% the previous week)
Net Bull/Bear spread .. ↓Bearish by 19 (Bearish by 34 the previous week)
Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Source: American Association of Individual Investors (AAII).
LAST WEEK BY THE NUMBERS:
- Last week’s best performing US sector: Consumer Staples (two biggest holdings: Proctor & Gamble, Coca-Cola) - down 0.1%
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) for the third week in a row - down 3.3%
- The S&P 500 did a little better than the NASDAQ-100
- US Markets and International Developed Markets did far less badly than Emerging Markets
- Not much in it but Mid Cap eked out a rare narrow win over Large and Small Cap
- Value strongly outperformed Growth
- The proprietary Lowry's measure for US Market Buying Power is currently at 157 and fell by 1 point last week while that of US Market Selling Pressure is at 207 and also fell by 1 point over the course of the week
- SPY, the S&P 500 ETF is still well below both its 50-day moving average and its 90-day and also remains far below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 42**. SPY ended the week 19.4% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, is still below both its 50-day moving average and its 90-day and also remains well below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 47**. QQQ ended the week 27.8% below its all-time high (11/19/2021).
** RSI readings range from 0-100. Readings below 30 tend to indicate an over-sold condition, possibly primed for a technical rebound and above 70 are often considered over-bought, possibly primed for a technical decline.
- VIX, the accepted measure of anticipated likely upcoming stock market risk and volatility implied by S&P 500 index option trading (often referred to as the“fear index”) ended the week a touch lower at 24.2 and remains a little below both its 50-day and 90-day moving averages. It continues to run above its long term trend line.
ARTICLE OF THE WEEK:
This week .. In his Pep Talk, Jonathan Clements reminds us not to do anything stupid with a portfolio in these conditions and to focus on four things: expectations, history, intrinsic value, and most importantly, time horizon. “This is where savvy investors get their edge. It’s tough to outsmart other investors. But we can play a different game – by focusing not on next week but on the next 10 years.” And that’s what good investors do. They endure.
FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia (may be edited at times for clarity).
MICHIGAN CONSUMER SENTIMENT INDEX (MCSI)
The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States conducted by the University of Michigan. The survey is based on telephone interviews that gather information on consumer expectations for the economy.
Consumer sentiment is a statistical measurement of the overall health of the economy as determined by consumer opinion. It takes into account people's feelings toward their current financial health, the health of the economy in the short term, and the prospects for longer-term economic growth, and is widely considered to be a useful economic indicator.
It was created in the 1940s by Professor George Katona at the University of Michigan's Institute for Social Research. His efforts ultimately led to a national telephone survey conducted and published monthly by the university. The survey queries consumers on their views of their own personal finances, as well as the short-term and long-term state of the U.S. economy.
The preliminary report is generally released during the middle of the month and covers survey responses collected in the first two weeks of the month. The final report is released at the end of the month and covers the full month. It is designed to capture the mood of American consumers. Whether the sentiment is optimistic, pessimistic, or neutral, the survey signals information about near-term consumer spending plans.
Because consumer spending accounts for about 68.5% of gross domestic product (GDP) in the US, the MCSI is regarded as one of many important economic indicators followed by businesses, policymakers, and participants in the investment community.
Each month, the university conducts a minimum of 500 phone interviews across the continental U.S. The survey asks 50 core questions and covers three areas: personal finances, business conditions, and buying conditions. The answers to these questions form the basis of the index. Consumers are asked questions such as:
Would you say that at the present time business conditions are better or worse than they were a year ago?
Would you say that you (and your family living there) are better off or worse off financially than you were a year ago?
Do you think that a year from now you (and your family living there) will be better off financially, or worse off, or just about the same as now?
What do you think will happen to interest rates for borrowing money during the next 12 months—will they go up, stay the same, or go down?
During the next 12 months, do you think that prices, in general, will go up, or go down, or stay where they are now?
About 60% of each monthly survey consists of new responses, and the remaining 40% is drawn from repeat surveys. The repeat surveys help reveal the changes in consumer sentiment over time and provide a more accurate measure of consumer confidence.
According to the University of Michigan, the surveys "have proven to be an accurate indicator of the future course of the national economy." Surveys have demonstrated their ability to accurately anticipate changes in interest rates, unemployment rates, inflation rates, GDP growth, housing, car demand, and other key economic measures.
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