Persistent pain in the portfolio

Stocks fell in a powerful selloff yesterday as Friday’s hot inflation number continued to instill fear in traders. A sharp drop in crypto assets put further pressure on riskier stocks.

The swoon in June. There is something I like about the month of June. Here in the Northeast, the weather is warm but not too hot, kids and grandkids begin their summer holidays, the summer solstice arrives, we have Father’s Day, and yes, I celebrate my birthday. Unfortunately, June is not the stock market’s favorite month. Historical monthly returns show that June is the 3^rd worst performing month of the year, and as you probably know by now, this June is falling in line with history as a tough one. In fact, this whole year has been a tough one for stocks. The S&P500 lost in all but 2 months year to date with March turning in a +3.58% gain and May registering a scant +0.01% increase. Yesterday’s selloff leaves the S&P500 in bear market territory, a label given to an index when it closes -20% or more below its recent high. What caused the sharp selling and what does it mean for stock investors going forward?

Consumers have been on edge. Prices of nearly everything have risen, wreaking havoc on monthly budgets. The biggest gains have come from basic necessities such as food and energy. You need those to eat and get around. This type of inflation is somewhat unique in that paying higher prices is almost unavoidable. It is easy to put off purchasing a TV whose price has jumped, but not so much that package of chicken to feed your family. The Fed, whose principal inflation fighting tool is rate hikes, is aggressively fighting inflation. That tool, however, is blunt and may not be able to contain the inflation on those basic necessities. Higher interest rates will certainly make mortgages, rent, auto loan payments, and credit payments more costly, causing pain and eventually less demand. That decrease in demand may eventually cause prices of housing, autos, and high-ticket items to recede, but those higher rates will do very little to lower the cost of gasoline, bread, milk, and eggs. The high prices on those items are largely driven by supply. Energy costs have skyrocketed principally due to the decrease supply caused by the war in Ukraine, and they are not only causing pain at the pump for you and me, but they are also impacting delivery costs, which ultimately ends up being born by the consumer. Food / grain commodities such as corn and wheat prices have also skyrocketed, both at all-time highs. Climate conditions have played a role, but the primary driver is also the war in Ukraine as much of the world’s supply of those grains comes from the region. Potash, the principal ingredient in fertilizer has also jumped as it too, is largely sourced from eastern Europe and has been impacted by the war in Ukraine. Higher fertilizer costs only serve to accentuate the upward price pressure on grains.

So far, we have not seen signs that consumers are spending less, however we are seeing signs that consumers are being forced to spend less on non-essential items in order to afford the rising prices on necessities. This has primarily affected the lower-wage earners that make up the bulk of the economy. Some economists fear that if current inflationary conditions persist, consumption may drop off altogether causing the economy to contract leading to stagflation, which has not occurred since the 1980s. There are some signs that consumers are getting nervous as well. Last Friday, in the shadow of the hot inflation figure, the University of Michigan Sentiment release came in well below expectations at levels equivalent to those of the 1980s. Breaking down the figure, respondents were concerned about current conditions and future conditions while bumping up near-term and long-term inflation expectations.

All of these together were principal drivers of yesterday’s selloff. So now that we are in a bear market, what can we expect going forward. History tells us that there may be more pain in the weeks ahead, but in most cases, stocks are higher in the months ahead, meaning, the volatility can continue for another 3 months or so. That puts us into late summer/ early spring. That is also when things become less clear on what the Fed might be doing with interest rates. It is clear that the Fed will be raising rates by +50 to +75 basis points this week and next month. More recently, the last FOMC minutes suggest that the Fed may pause in September but hopes of that seem to have evaporated with last Friday’s CPI number. The Fed is in a tough position. The hot CPI print may force the Fed’s hand, even though it may be inclined to take a wait-and-see approach. The Fed must choose between maintaining its credibility as an inflation fighter or causing more pain to the consumer and increase the chances for a recession. It is no wonder that consumers and stock investors are on edge. One last note on bear markets. History also tells us that they don’t last forever. These conditions are painful but remember that long-term focus always wins.

YESTERDAY’S MARKETS

Stocks experienced a blistering selloff yesterday as inflation fears caused selling in both equities and bonds. The S&P500 fell by -3.88%, the Dow Jones Industrial Average traded lower by -2.79%, the Nasdaq Composite Index dropped by -4.68%, and the Russell 2000 Index declined by -4.76%. Bonds fell and 10-year Treasury Note yields jumped by +20 basis points to 3.35%. Cryptos fell by a painful -22.72% and Bitcoin dropped by nearly -21% from Friday’s close.

NXT UP

• Producer Price Index (May) is expected to come in at +10.9%, slightly lower than April’s +11.0% print.
• PPI Ex Food and Energy (May) may have fallen to +8.6% from +8.8%.
• This morning the NFIB Small Business Optimism Index (May) came in at 93.1, higher than expectations but slightly lower then April’s read of 93.2.