The ‘Big Low’
The "big low" isn't in.
That's the overarching (and all too familiar) message from one of the sell-side's most recognizable names.
At times this week, you could spot a faint glimmer, barely perceptible through an enveloping fog of recessionary gloom. It was still there on Friday, but disconcerting reports from Snap and Seagate, along with a big post-earnings drop for Verizon, once again suggested market participants might be squinting at an oncoming train, not the light at tunnel's end.
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The economy seems to be slowing faster than most strategists have contemplated. If that continues you can expect a Fed pivot early next year. End of Q/T and some modest rate cuts look like a base case. And you may only have July and September for increases. When inflation unwinds due to slower growth it unwinds very quickly…..
So your position is that the rate hikes are transitory, LOL
(For the record, I agree.) Core inflation was abive 8% when the Fed finally eased off the accelerator, it’s going to take some time for the cruise ship to slow down. If the Fed brakes too hard, (which it appears they’re going to do) they’re going to find out that the deck chairs weren’t bolted down (deck chain this analogy is the housing market)
Walt, this was a wonderful blend of Charlie M. and Hartnett, my 2 favorites. Delicious stuff !
That Cleveland Fed nowcast number is ugly. Still think we could see 75bps hikes in July and September.
Multiple questions to ponder.
What will make equities bottom.
When to start front-running.
What to do while waiting.
#1 is the issue addressed in this post. It is a cause & catalyst question, is how I’d think of it. I don’t know that it makes sense to try to point-estimate “when”, just having a correct view on “what” will be hard enough.
#2 is more of a valuation question, in my mind. You start front running when the loss you’ll suffer (from being too early, because you don’t know “when” in #1) looks tolerable to you but not to most (when everyone is front-running, no-one is). We’ve talked about valuation at length.
#3 is my focus right now. We might wait for 2 months or for 12 months (there are tail cases too). Two months, cool, enjoy your summer. Twelve months, really should try to do better than nothing.
Trying to do better than “nothing” probably entails a significant risk of a negative return at this point. You’ve made a good case for SP500 at or below 3000. Just wait for it.
I can’t tell you when there will be a bottom, but I will stick my neck out and say that I will be surprised if the market sails smoothly through the next five months to year-end. There’s an election, BA.5 is only two-weeks into its reign of terror in China, Europe and especially Germany will be tested with respect to gas supply going into the winter, and we can’t predict what will happen in Ukraine.
I’m not thinking so much of buying equities here.
Though I think some specific stocks are nibble-worthy here, swimming against the tide is tough.
But I’ve thought at some point, the time to buy fixed income would come. The more bearish one is about the economy, the more interesting duration looks.
I’m putting most of my income slated for reinvestment in fixed income CEFs, maybe half of that in muni-CEFs. Prices are down so these are cheap and yields on new stuff are rising. Stocks? Nobody knows anything.
The time to buy was last week. Yields on the 10yr fell 25bps this week, with a big move down on Friday. With the eurozone and EM markets on the verge of implosion, the flight-to-safety trade may overwhelm efforts by the Fed to get rates up across the board. The question is, how low can the yield on the 10yr go with a 125bps increase in the Fed Funds rate pretty much baked in? And how low can it go in an all-bubbles-burst (incl. eurozone, Japan, China credit) scenario?
It seems we’re at a stage where people think that peak inflation will mean peak rates, and that positioning is already too pessimistic.
There’s little scope in the short term for a hawkish surprise, so I’m thinking the S&P rallies to about 4,500 until September. At that time folks will realize that Powell must continue tightening continuously until inflation goes well below 2%. Only then we get a 2018-style spasm with a symbolic backstop from the central bank.
But rates will need to remain high for a couple of years for inflation to go back to normal, so equities will have a pretty bad Sharpe ratio for long enough that everyone, including pension funds, will throw in the towel.
Somehow we’ll get back to P/E ratios of 12 in 5 years.
In the current environment there are two forces working to bring down inflation – central bank tightening and the world’s productive capacity. Filling gaps in the supply chain will go a long way to bringing down inflation. If we can muddle along long enough without manufacturing a deep recession, supply will catch up with demand. Time is on our side. Meanwhile, I’ll continue trading and keep some dry powder close at hand.