The Federal Reserve has now shifted to a full-on, break-the-glass emergency footing on inflation. It’s busting out the big guns in the form of a lumpy interest rate increase and very loud threats that it will not stop until the beast of high inflation is finally slain. And if that remedy pushes the country into a recession, well then so be it. The result was the worst week for the stock market since those scary days back in February 2020.
Markets moved seamlessly from the ghastly Friday of the previous week to an equally dire Monday of last week, plummeting further as speculation began to grow of the need for a 0.75% interest rate hike by the Fed after being spooked by Friday’s hotter-than-expected May Consumer Price Index (CPI) growth. Monday’s plunge took the S&P 500 into official bear market territory (down over 20% from the high).
It is said that the stock market has a memory and it could well have been that it was remembering what had happened just a month ago, at the time of the last Fed meeting. As a reminder to those who don’t live and breathe this stuff 24/7, the 0.50% increase in rates that day was met in the hours following the announcement and press conference by smug, nodding approval from the usual talking heads on CNBC and elsewhere (“this is exactly what they should have done, the market will be happy”) and Fed chair Jerome Powell said in his press conference that the possibility of more than 0.50% had never even been considered.
And indeed, the market did party nicely higher for the rest of that day. But the next day saw an absolute bloodbath - markets slaughtered across the board with nowhere to hide. The exact same set of facts that been widely accepted as good news at 2:30pm on a Wednesday turned out to be disastrous by the opening bell on a Thursday.
Surely that exact market scenario couldn’t play out again identically just weeks later. Could it?
The frenzied speculation of the 0.75% hike grew to a near-certainty by Wednesday morning last week, with trader positioning in the futures market showing the probability of this outcome moving from 4% to 97% in the space of three working days and the Fed duly obliged in the afternoon with officials announcing a 0.75% rate rise, which increased the Fed’s benchmark federal funds rate to a range between 1.50% and 1.75% and the median expectation among officials for the mid-point of the fed funds rate to be 3.375% by the end of the year.
Interestingly, the Fed removed the long-used phrase indicating that it “expects inflation to return to its two percent objective and the labor market to remain strong.” from its post-meeting statement. Powell claimed in the press conference that the phrase was removed because it gave the false impression that the inflation rate in the US was uniquely dependent on Fed actions when it is clear that events beyond the Fed’s control in China, Ukraine and at supply chain ports around the world are having a significant impact on US inflation.
In terms of expectation-setting, he also said that he doesn't anticipate hikes of this magnitude to be "common". However, he hedged nicely by stating that the July meeting could see an increase of “between 0.50% and 0.75%”. Well played, sir. But we haven’t forgotten what you said in your press conference in May.
The immediate reaction on Wednesday afternoon, just like last month, was a reflexive rebound in stock prices. However, considering the prior string of five, sometimes intense, consecutive losses, there was a sense that this response may be little more than a reaction to oversold short term conditions, especially considering it was led by the biggest loser names and no-one was really fooled.
Then, in an eerie echo of events just a month earlier, markets cratered the next day with profit-less tech and Small Cap stocks in general getting mauled the hardest and the least badly-affected being the defensive stocks like consumer staples and utilities. As I have said before in previous reports, this type of sector price action does not typically reflect a market on the brink of recovery.
If you wanted to sum up this week’s action in one sentence, it would read something like: The market appears to be desperately trying to reprice itself lower to discount in advance the growing likelihood of a recession caused partly by the acceleration of interest rates deemed necessary to fight soaring inflation.
Short term gyrations don’t matter much, though. What investors really want to know is; when is all this shit going to end? No-one knows of course, but on one hand, if the Fed is right and inflation is essentially a 2022 problem that fixes itself in 2023, then the end of this decline in stocks is much closer to the finish line than the starting line (not to say that the bottom is in yet).
On the other hand, if the Fed is wrong (which it has been pretty much all along when it comes to inflation .. remember “transitory”?) then we are not close to a bottom yet because the past six months of reactionary, growing Fed hawkishness at every turn is only going to continue.
If that’s the case, and if it is true that the market has memories, we could well be looking at a base case of completing a total round-trip to the immediate pre-COVID-crash levels of February 2020 (for the S&P 500 that’s SPX 3383, about another 8% fall from here). For reference, the COVID-low of March 2020 is SPX 2237, still another 39% below where we are.
A quick look at the other main drivers of stock market performance doesn’t really provide much comfort. It is becoming clear that China is not abandoning its zero-Covid policy and as a result the market must continue to consider the possibility that new lockdowns could be enacted at any time and with little or no advance notice. And the Ukraine conflict drags on and on with no sign whatsoever of any kind of imminent conclusion.
On the economic data front, the Producer Price Index (PPI) measure of wholesale inflation was a little better than expected but retail sales dropped unexpectedly.
The housing market is starting to seize up with buyers, sellers and builders all looking to be on the brink of basically going on strike.
Mortgage rates have essentially doubled this year, tossing millions of potential buyers onto the scrapheap with home prices where they are. Sellers suddenly face the prospect of trading in their lovely, recently-refinanced 2.75% mortgage for a 6% one if they sell their home and buy another. Many figure that they’d be a lot better off by taking their home off the market and maybe spending some money on renovation instead (despite a raw material shortage and enhanced labor costs). Figures last week showed housing starts fell nearly 15% between April and May and the number of building permits issued dropped 7% over the same period.
So we have less inventory, crippled buyers and de-motivated sellers. Not a great combo. Major real estate brokers Redfin and Compass reacted last week by each laying off close to 10% of their staff.
Other News: Crypto edition
The price of Bitcoin is in free-fall, last week sinking below the 20,000 level as well as breaking below its 2017 high and has now shed well over two-thirds of its value in just eight months (in what is still only the fourth worst sell-off in its short history). Other digital coins are getting completely slaughtered as well.
Only a year out from its Initial Public Offering (IPO, see FINANCIAL TERM OF THE WEEK below), Coinbase has already had to come out and deny rumors of bankruptcy (at which time we learned via regulatory filings that the company reserves the legal right to potentially seize its own customers’ crypto assets invested on the platform to help pay off its own creditors if it ever did happen) and the stock price has fallen even further since these rumors first emerged. The company also announced just last week that it was laying off over a thousand employees in cutting its workforce by nearly 20% and has been reneging on job offers it had made to candidates.
Crypto lender Terra/Luna UST collapsed in May which proved tragic in the sense that so many people’s lives and savings were destroyed, even driving a number of them to suicide. Watching one of crypto’s biggest assholes (a high bar indeed), Terra founder Do “Have Fun Staying Poor” Kwon, get what was coming to him was a brief schadenfreude interlude.
And then last week, we saw other crypto lenders Celsius Networks and Hong Kong-based Babel Finance, firms with not dissimilar business models to that of Terra/Luna, alarmingly freezing all client transactions (including withdrawals), citing “extreme market conditions”.
Crypto hedge fund Three Arrows Capital fell apart last week and got liquidated after failing to be able to make margin calls (a concept not understood by most laser-eyed bros) which then caused yet another crypto lender Finblox, heavily dependent on Three Arrows for much of its liquidity, to also block its customers’ ability to withdraw their funds.
Even the massive Binance crypto exchange suspended withdrawals of Bitcoin pending some clarity on what on earth was happening in crypto-world.
A number of dominoes may be falling and this could be serious stuff. The Coinbase story even made the front page lead of the Financial Times last week. Crypto investor money is now seen to be at potential risk of instant incineration or even possible confiscation in an arena that was supposed to be the transparent, libertarian brave new world for everyone.
And with NFT sales down more than 92% over the last year, I think it’s safe to say that the whole crypto industry and crypto-adjacent ecosystem is in seriously deep shit in the short and medium term at the very least, no matter how the bros furiously try to spin it on Twitter and Discord.
Store of value? Nope. Not even close.
Inflation hedge? Haha. Obviously not.
Ultimate replacement for the dollar whose future as the world’s reserve currency is doomed? Have you looked at what the dollar has been doing during this crypto cremation?
Safe from confiscation by The Man? It would seem not (see Coinbase’s potential deposit-grab, for example).
Self-polices effectively against unscrupulous or incompetent individuals and organizations with no need for formalized strict regulation? Er, no. It doesn’t.
Can safely generate income though staking? Not any more, it would seem (see above).
Is crypto currency valuation still primarily determined by the Greater Fool Theory (which tends to work - until it doesn’t)? Yep.
Things could be worse though, you might live in El Salvador.
Full disclosure:
I personally own a very small amount of Bitcoin and Ethereum and have no intention of selling any of it on the (admittedly declining) off-chance that all the optimism about crypto is maybe one day justified - but if it does all go to zero, my overall financial situation is not going to be meaningfully impacted at all.
I am frequently happy to recommend a similarly-sized crypto holding (i.e. an amount that, if entirely wiped out, would have virtually no real overall financial consequences to the owner) to certain clients as a part of a goal of increased diversification that is not generally highly-correlated to the overall stock market - in most cases, a maximum of maybe 1-2% of total investable assets, no more.
I can often facilitate their ownership of Bitcoin or Ethereum using the Flourish platform which is exclusively available to clients of certain financial advisors such as myself.
Under The Hood:
Following the carnage and brutal selling of Friday of the previous week and Monday of last week, the pathetic attempt at a bounce-back rally on Tuesday, despite strong short term over-sold conditions, was maybe even more concerning. Obviously there was no real demand from investors positioning themselves for Wednesday’s Fed decision and following a head-fake rally right after the announcement the market was crashing again.
Signs of a sustainable bottom begin with deeply oversold market conditions, especially in longer-term indicators and we may have seen some of these begin to appear last week. For example, the bottom fell out of a key momentum indicator, the Percent of Stocks Above Their 30-Week Moving Average, which fell below the commonly-accepted oversold level of 15%.
By Thursday, more than 90% of stocks in the S&P 500 had declined for five of the past seven days. Precedents for this since 1928? Zero. By some measures we are seeing one of the most overwhelming displays of selling in history.
After Thursday’s carnage, nearly 40% of stocks in the S&P 500 closed at their one year lows. By point of comparison with the Great Financial Crisis, this stocks-at-their-one-year-low measure peaked in November 2008, four months before the indexes themselves bottomed in March 2009.
For those who have been looking for complete capitulation to signal a possibly sustainable return to a bull market, last week may have provided some green shoots. But always remember that bear market rallies are entirely designed to look and feel like true bull market rebirths, otherwise they are not doing their jobs – pulling in as many hopeful investors as possible into the jaws of an ongoing bear market.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
The upcoming week’s calendar ..
A very light calendar this week. U.S. stock and bond markets will be closed on Monday in observance of Juneteenth. There will only be a handful of earnings reports or annual shareholders meetings when investors return, most notably from Mastercard, FedEx, Blackberry, Lennar, Activision, Darden Restaurants and CarMax.
The release of the manufacturing and services purchasing managers’ indexes on Thursday will give us further insight into the state of US economic expansion.
On the real estate front, we will learn about existing home sales and the weekly mortgage applications survey will likely be watched with more interest than usual.
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US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):
↑Bullish: 20% (down from 21% the previous week)
→Neutral: 22% (down from 32% the previous week)
↓Bearish: 58% (up from 47% the previous week)
Net Bull/Bear spread .. ↓Bearish by 38 (Bearish by 26 the previous week)
Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Bull-Bear spread: Bullish by 8
Source: American Association of Individual Investors (AAII). All numbers rounded.
LAST WEEK BY THE NUMBERS:
- Last week’s best performing US sector: Consumer Staples (two biggest holdings: Proctor & Gamble, Coca-Cola) - down 4.2%
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) - down 17.4%
- The S&P 500 did a little worse than the NASDAQ-100
- The US and International Developed Markets again underperformed Emerging Markets
- Large Cap fared somewhat better than Mid or Small
- Value underperformed Growth
- The proprietary Lowry's measure for US Market Buying Power is currently at 160 and fell by 16 points last week while that of US Market Selling Pressure is at 205 and rose by 19 points 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 a long way below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 31**. SPY ended the week 23.4% below its all-time high (01/03/2022)
- QQQ, the NASDAQ-100 ETF, is still well below both its 50-day moving average and its 90-day and also remains a long way below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 34**. QQQ ended the week 32.0% 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 upcoming stock market risk and volatility implied by S&P 500 index option trading (often referred to as the“fear index”) ended the week higher at 31.1 and is still above both its 50-day and 90-day moving averages and continues well above its long term trend line
ARTICLE OF THE WEEK:
Each week I'll link to an interesting article I have come across recently.
This week: Recognize what it is that you are watching! Whether it’s on CNBC or Fin-Tok, it’s unregulated financial advice. Mostly really BAD financial advice from people unqualified to give it with an agenda to make you poorer and them richer.
It’s also a deeply honest commentary on the learning process and experience of someone who only discovered the stock market over the last couple of crazy years.
FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia (may be edited at times for clarity).
An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. An IPO allows a company to raise capital from public investors. The transition from a private to a public company can be an important time for private investors to fully realize gains from their investment as it typically includes a share premium for current private investors. Meanwhile, it also allows public investors to participate in the offering.
Before an IPO, a company is considered private. As a pre-IPO private company, the business has grown with a relatively small number of shareholders including early investors like the founders, family, and friends along with professional investors such as venture capitalists or angel investors.
An IPO is a big step for a company as it provides the company with access to raising a lot of money. This gives the company a greater ability to grow and expand. The increased transparency and share listing credibility can also be a factor in helping it obtain better terms when seeking borrowed funds as well.
When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public.
Typically, this stage of growth will occur when a company has reached a private valuation of approximately $1 billion, also known as unicorn status. However, private companies at various valuations with strong fundamentals and proven profitability potential can also qualify for an IPO, depending on the market competition and their ability to meet listing requirements.
IPO shares of a company are priced through underwriting due diligence. When a company goes public, the previously owned private share ownership converts to public ownership, and the existing private shareholders’ shares become worth the public trading price. Share underwriting can also include special provisions for private to public share ownership.
Generally, the transition from private to public is a key time for private investors to cash in and earn the returns they were expecting. Private shareholders may hold onto their shares in the public market or sell a portion or all of them for gains.
Meanwhile, the public market opens up a huge opportunity for millions of investors to buy shares in the company and contribute capital to a company’s shareholders' equity. The public consists of any individual or institutional investor who is interested in investing in the company.
Overall, the number of shares the company sells and the price for which shares sell are the generating factors for the company’s new shareholders' equity value. Shareholders' equity still represents shares owned by investors when it is both private and public, but with an IPO, the shareholders' equity increases significantly with cash from the primary issuance.
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This material represents an opinionated assessment of the market environment based on assumptions at a specific point in time and is always subject to change. No warranty of its accuracy is given. It is not intended to act as a forecast of future events, nor does it constitute any kind of a guarantee of any future results, events or outcomes.
The material contained herein is wholly insufficient to be exclusively relied upon as research or investment advice. The user assumes the entire risk of any actions taken based on the information provided in this or any other Anglia Advisors post or other communication.
Posts may contain links to third party websites for the convenience and interest of our readers. While Anglia Advisors has reason to believe in the quality of the content provided on these sites, we have no control over, and the firm is not in any way responsible for, the accuracy of such content nor for the security or privacy protocols the sites may or may not employ. By making use of such links, the user assumes, in its entirety, any kind of risk associated with accessing these sites and making any use of the information provided therein.
Clients of Anglia Advisors may maintain positions in securities and asset classes mentioned in this post.
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