Traders and investors enter the back half of May in decidedly poor spirits.
Ironically, that may be the most compelling argument for a near-term, bear market rally. Sentiment extremes are decent contrarian indicators and market participants are extremely disheartened.
A dubious, late-week upside romp couldn’t save US shares from another weekly decline, the sixth consecutive (figure below). At the same time, bonds are a basket case, which means risk parity, 60/40 and multi-asset portfolios in general are suffering.
“Correlations are volatile. And no correlation has been banked from a risk reduction standpoint more than that of the offsetting interaction between stock and bond prices,” Macro Risk Advisors’ Dean Curnutt said.
“With $100 invested in an equal weighted portfolio of the SPY and TLT, an investor has lost 18% in 2022,” he added, noting that “1-month realized vol on the combo is 22% on the back of daily moves near, and in some cases exceeding, 3%.”
Equity strategists are beginning to trim forecasts. Goldman slashed its target for the S&P last week, and I’d expect a wave of additional cuts if the selloff doesn’t abate sustainably.
Already, the aggregate target has notched its longest weekly streak of declines in a decade (figure above).
Investors will enjoy some relief from top-tier US data this week. Retail sales is the only marquee print (figure below), although the Empire and Philly gauges will be scrutinized for evidence of a slowdown.
The preliminary read on University of Michigan sentiment for May was bleak, which doesn’t bode well for consumption. Over the weekend, Goldman cut their forecast for the US economy in Q2 citing the prospect of “consumer caution.”
Soaring prices for gas and food are chipping away at disposable incomes, and wage increases aren’t keeping up with inflation. It’s the same story month after month.
Pump prices hit a new record high (in nominal terms) last week, and April’s CPI data showed food prices rose a 17th consecutive month.
“Along with the control group and the correlation with personal consumption, we’ll also be mindful of the breakdown between necessity and non-necessity spending as higher gas and food prices pull dollars from discretionary spending,” BMO’s Ian Lyngen and Ben Jeffery wrote, adding that “higher wages as a derivative of the tightness of the labor market have thus far failed to keep up with the increases in consumer prices, and as such the ‘tax on consumption’ dynamic is still very much top of mind.”
Given the surge in mortgage rates (figure below), market participants will also watch a hodgepodge of housing indicators due this week, including starts and existing home sales.
Recent data suggested rising borrowing costs and sky-high prices are beginning to weigh on demand. A correction seems like a matter of “when” not “if.” I’m a broken record on that. Stopped clocks are right twice a day. And the Fed is poised to lean against the market with MBS runoff.
Speaking of the Fed, traders will hear from a bevy of policymakers including Bullard, Mester and Powell, all of whom have market-moving potential. It’s anyone’s guess where yields go from here. There’s an argument to be made that we’re somewhere near the breaking point vis-à-vis the interplay between real rates and risk assets.
“While the rise in rates has been a one-way move since the start of this year, we believe the magnitude of the selloff now presents a greater danger for financial conditions and the economy,” TD’s Priya Misra said. “This is because the selloff has been driven by long-end real rates — likely a function of the market pricing in QT and rising global rates.”
Outflows, Misra observed, are piling up. The fund exodus comes to more than $80 billion YTD, exceeding the taper tantrum (figure above). “Ongoing outflows could make it more difficult for markets to stabilize as selling flows continue to exacerbate the price action and increase volatility at a time when many buyers are unwilling to step in,” she added.
10-year real yields came into the new week off local highs but still up dramatically since the deeply negative levels revisited in early March. As Misra alluded to, any additional tightening in financial conditions risks tipping equities into a more dangerous spiral, which could be difficult to arrest.
Still, there’s now widespread agreement that the vaunted “Fed put,” to the extent it still exists, won’t be relevant for the foreseeable future due to the read through of higher stock prices for financial conditions.
“To say it’s a challenging start to the Fed’s hiking campaign would be to imply that the FOMC is uncomfortable with the weakness in stocks,” BMO’s Lyngen and Jeffery remarked. “In fact, it’s likely the opposite as monetary policymakers have long lamented asset price inflation resulting from the efforts to limit the fallout from the pandemic.”
Total market cap of US equity and fixed income is something like $80 TR? Or more.
$80 BN outflow is a lot, but suggests that average discretionary investor’s cash level cannot have increased by all that much. A percentage point, maybe.
Not much aggregate derisking done to date.
H-Man, I agree that nothing has changed in the macro to warrant a significant rally in equities or bonds. It simply is a very ugly picture.
I’m thinking watch for some incremental less-negative news that could trigger a “transitory” bear mkt bounce. Covid lockdown ease in Shanghai, perhaps. Then as next FOMC approaches, and start of actual QT, window of oppty for derisk starts to shrink.
H-Man, I wandered into 80’s inflation (prime at 21%) and found that 10.3% inflation in 1981 didn’t slow down to 3.2% inflation until 1983. So how long will it take to get to 2.5%?
My retirement portfolio, largely in cash for the past 3 years is down only 0.8% on the year. There is one safe place to be right now.