Stocks traded modestly lower after a day full of ups and downs. In the wake of Friday’s oversized gains investors toiled with hopes that the Fed may switch gears earlier than expected.
Are we there yet? Yesterday felt like an ordinary day in the market. By ordinary, I mean from a time before all the wild volatility and bloodshed we have witnessed lately. Of course, it would have been better if stocks closed slightly higher rather than slightly lower. Friday’s market action was certainly notable in which stocks posted their largest daily gain since May of 2020. Imagine that - the largest single-day gain for the S&P500 since May of 2020 whilst fighting eyewatering inflation, a rate hike-loving Fed, global unrest, and rising prospects for a recession. Back in May 2020 we were only fighting a once-in-a-lifetime, deadly pandemic. Oh, and we were coming out of a 3-month, lockdown-inspired recession. That was nerd humor. You see, for stocks, it’s all about expectations and less about what might be happening at the moment. I have discussed this notion often in my notes, and days like Friday throw it into sharp focus. Was Friday just a one-off in which traders were just… happy before the weekend, or were stocks sending a message about the future? For starters, Friday was an above-average volume session, so we can cross “low volume day” off the list. That is positive when stocks rise, especially ahead of a weekend. Yesterday’s market action was the first test of that. Stocks rallied through noon but lost steam in the afternoon only to close slightly lower. If Friday were a one-off, we would have expected more selling pressure as traders rushed in to take short-term profits. Ok, before we go any further, let’s take a dose of reality – we are still some -19% lower than January’s high, and there was a recent failed attempt at a rally in late May before a hot CPI number sent stocks to fresh lows. I think that I read somewhere that stocks are set for the worst 6 months since 1970. For the record, I was around at that time, but I was not likely paying attention to the stock market. So, what is it that stocks have to be positive about?
We are currently contending with 3 big elephants in the room. Seems pretty crowded in here, eh? Those elephants are Fed rate hikes, inflation, and recession. The Fed just 2 weeks ago hiked rates by +75 basis points, something it hasn’t done since 1994. After the announcement, the Fed Chair said that another similar-in-magnitude hike could happen in July as well. Markets were already expecting it, so the admission did little to upset things. However, in last week’s Senate testimony, Powell acknowledged that there was a possibility that the economy could fall into a recession as a result of the Fed’s rate hiking and that the Fed would modify its policy if the threat increased. Those words allowed the markets to factor in a less aggressive Fed which would possibly end hiking early, or even begin to cut rates. Elephant number 1 instantly seems a bit smaller.
Elephant number 2, inflation, is still looming large, but there may be some signs of some weight loss in the future. Many economists were expecting inflation to peak last month, but in fact, the numbers came in hotter than expected. CPI is a backward-looking number and stocks are, theoretically, forward-looking, so what do we know about inflation in the future? Well, we have been getting some clear signals that retailers are preparing to slash prices to reduce bloated inventories, which are oversized due to reduced consumer demand in response to higher prices. That is how prices are supposed to self-regulate… the sales just haven’t hit yet. Many expect those price cuts to come mid-summer as retailers attempt to make room for Fall inventory. Additionally, commodities have declined some -10% since peaking earlier this month. Prices of commodities like crude oil, copper, wheat, and lumber, for example have all moderated in recent weeks and months. Sky high prices of these and other commodities have played a key role in the current state of inflation, so price moderation may portend a less pricey future. Finally, we have witnessed a steep fall off in consumer sentiment, which typically leads to decreased demand for goods. Weaker demand will certainly impact prices and eventually cause them to moderate.
Finally, there is elephant number 3, recession. It is unfortunately that elephant, which remains the wildcard. While it is still a minority of economists who believe that a recession will occur in the next 12 months, their ranks are rising. A definitive accounting of economists’ expectations pegs that probability at 33%, up from 30% in the beginning of this month, and just 15% at onset of 2022. Economists who argue against recession cite the fact that unemployment remains low, that consumers still have plenty of savings piled up, and that banks are strong and lending money. Let’s hope they are right.
Now, a word on the markets themselves. Remember last year’s discussion on how overpriced stocks were as result of the nearly 2-year recovery rally? Looking at the PE Ratio of the S&P500, it would appear that all of the recovery froth buildup has been washed away. This year’s forward estimate at 17 times is far below last year's 25 times, and 2020’s 30 times. Indeed, this year’s estimate is quite cheap relative to the past 10 years’ PEs, indicating that stocks may be oversold. That could be positive for stocks going forward, but before you celebrate, it is important to remember elephant number 3, which still looms quite large. Moreover, the other 2 elephants can also experience weight fluctuations. You must also make room for a new elephant that will squeeze its way into the room in the next few weeks: earnings. All that said, it is nice to have at least a few positive signs in these turbulent times.
YESTERDAY’S MARKETS
Stocks slipped yesterday as investors continued to factor in last week’s news, especially the possibility of a friendlier Fed. The S&P500 fell by -0.30%, the Dow Jones Industrial Average traded lower by -0.20%, the Nasdaq Composite Index declined by -0.72%, and the Russell 2000 Index advanced by +0.34%. Bonds were lower and 10-year Treasury Note yields climbed by +6 basis points to 3.19%. Cryptos declined by -3.03% and Bitcoin gave up -2.31%.
NXT UP