One week ago, we suggested that the pending Fed announcement on interest rates would be the impetus for a quick retest of the market’s 2022 lows, which occurred during the third week of June. Markets have consistently deteriorated since the end of August in the face of continued inflation and a uniquely hawkish Federal Reserve. We have noted multiple technical warning signs of a pullback to those early summer lows – and perhaps another leg down.
Unfortunately, we were right, and investors immediately sold “the news” of another 75 basis point hike last Wednesday, resulting in yesterday’s closing price of the S&P 500 being the lowest of the year. The good news to go along with this is that markets (stock and bond) are technically now oversold (14-day RSI is below 30) and some type of relief rally is likely. The bad news is that any rallies that we do get are unlikely to change the technical or fundamental picture. We are in a confirmed bear market with index prices well below the important support offered by the 50- and 200-day moving averages. Moreover, forecast corporate earnings growth is contracting and forward looking GPD is essentially zero. All in all, we are in a very difficult situation as investors. Our central bank (the Fed) seems determined to continue raising rates no matter how much damage is done to equity prices. This alone could be a concern and a potential harbinger for further declines as the economy is squeezed. In most cases previously, the Federal Reserve would be reducing rates and increasing liquidity in order to support stocks and the broader economy. It is often this dovish activity that gets us out of bear markets. No such luck here. It appears the Fed is intentionally going to weaken the economy, in hopes of bringing inflation back to the target of 2-2.5%. There are a lot of questions circulating right now about how this is going to turn, and I certainly don’t have the answer myself. I can say that we have never seen this situation before, and nobody knows if a so-called soft landing can be achieved by raising rates further and faster than at any time since at least 1949. The odds seem stacked against it to me.
One troubling effect of the current rise in interest rates is the strength of the U.S. dollar. Yesterday, the British pound touched its lowest levels ever versus the dollar. The Japanese yen is not faring much better. The U.S. dollar serves as the reserve currency of the world and its relative strength or weakness has profound impacts on other countries, our GDP, and all asset classes. We will have to see if this indirect result of the Fed’s actions causes any systemic stress. It is another risk to be watching for in my opinion.
I will conclude with a hopeful comment and one that I touched on earlier this summer in a commentary and discussed during a webinar with our professional partners. Inflation and rising interest rates are tied to commodity prices. It is rising commodity prices that are the cause of both. It is this strength in commodities that causes rates to rise and become a drag on corporate growth. This cause-and-effect relationship at the corporate and consumer level is why we have periodic bear markets and recessions. An attribution of this process within the economic cycle is that bond prices peak first (fall 2021), stock prices peak second (December 2021) and commodity prices last (late spring 2022). The reverse occurs coming out of bear markets. Bond prices bottom first, then stocks, and finally commodities. It now appears to me that commodities have peaked and are falling even faster than stocks on a relative basis. I view this as good news, and believe it indicates that we are on our way toward the end of this bear market and the beginning of a new bull cycle. Of course, being in the car and on the road doesn’t in and of itself tell us how far we have to drive. Unfortunately for us passengers, the Federal Reserve is driving the car and it doesn’t appear to be too concerned with how long of a trip we signed up for.
Key terms: The relative strength index or RSI is a technical indicator used in the analysis of financial markets.