One Crowded Theater

Last week, in “Something Wicked This Way Comes,” I said it’s “becoming more difficult to shake the feeling that something bad is about to happen to the US economy, markets or, quite possibly, both.”

US equities haven’t managed a winning session since.

Stocks crumbled again Friday, with losses accelerating into the close, a dubious encore to Thursday’s unfortunate late afternoon meltdown. The Nasdaq 100 fell at least 1% in every session this week on its way into correction territory (figure on the left, below).

The S&P hardly fared better. It was the second worst week for the US benchmark since the original pandemic melee (figure on the right, above).

Rising real rates and the prospect of an aggressive Fed tightening cycle turned the screws on risk assets, while evidence continued to mount that the US economy is losing momentum.

Earnings didn’t help. Results from Morgan Stanley and Bank of America were decent, but Wall Street’s traders underwhelmed in Q4 (figure below). Concerns around rising expenses cast a pall and served to underscore worries about the mounting cost of talent wars and labor shortages.

Meanwhile, disappointing guidance from Netflix and Thursday’s disconcerting Peloton headlines were a reminder that past pandemic performance is not necessarily indicative of future results.

The fundamentals, as they say, aren’t looking particularly sound. Thankfully, there’s still scope for a flow-driven bounce. “The case for at least a short-term ‘mechanical’ rally (meaning not one built on sentiment improving, per se) following Op-Ex and out-of the Fed next week still largely stands,” Nomura’s Charlie McElligott said Friday, adding that “the majority of the (negative) Gamma set to roll off today is in client downside and Puts, meaning Dealers will have much less Delta exposure to hedge and sell futures against come next week.”

It was a dire stretch for crypto, which proved, yet again, that the idea of Bitcoin as an uncorrelated asset is false until proven otherwise. Coinbase dropped a harrowing 13% on Friday. So goes Bitcoin, so goes Coinbase (figure on the left, below).

Since November, total crypto market cap is down $1.1 trillion (figure on the right, above).

For those wondering, I did add some Ether this week, but my foray into the cryptoverse quickly morphed into a pseudo-obsession with DeFi lending. I bought what I bought, but from here, my involvement will likely be concentrated in lending and liquidity pools.

Coming quickly back to equities and the Fed, BofA’s Michael Hartnett wrote that Jerome Powell is now likely to be very aggressive considering Joe Biden’s inflation problem. “The Biden administration needs lower inflation which equals an aggressive, ‘independent’ Fed,” Hartnett said, on the way to suggesting markets may have to digest five, or even six, rate hikes.

An aggressive Fed, in turn, means there’s a “high probability” that the average max drawdown in midterm election years is exceeded in 2022 (see the table above, from BofA).

As for the January FOMC meeting, BMO’s Ian Lyngen on Friday wrote that “unless the Fed is going 50bps in March and has designs on selling from SOMA in the coming quarters, Powell is far more likely to message confirmation of consensus rather than push the hawkish pricing further.”

I suppose I’d just reiterate that the bigger danger for Powell right now is probably not the next two inflation prints. After all, it’s too late to influence those. Rather, the risk is that in the course of trying to thread the needle, he inadvertently conveys a sense of panic.

US equities are one very crowded theater. And Powell is a man with a penchant for accidentally yelling “Fire!”