I want to update how I'm thinking about the market after Federal Reserve Chairman Jerome Powell spoke last Friday and the European Central Bank (ECB) came out over the weekend, sounding equally hawkish.
A message had to be delivered and it was
The forum last week allowed central bankers to deliver a stark message. They are fighting expectations as much as anything else and they wanted to hammer home their alleged willingness to hike interest rates in the face of bad economic data. Maybe they have all changed their stripes, but I believe they saw an opportunity to deliver a coordinated message and they took it.
The Fed put is still there; it just will take longer to be implemented
The Fed will watch the economy and markets. It will be slower to respond to economic and market weakness, especially if inflation remains high. But if inflation rolls over, along with the economy, it will still act. It basically has just reset how quickly and aggressively it will act.
Be careful on quantitative tightening
I have argued that quantitative easing basically allowed all asset prices to rise faster than they would otherwise -- that at every step along the risk spectrum, investors were forced into riskier decisions. In the bond market, you could buyer longer maturity bonds, more structured bond, or lower credit quality to get that incremental yield. That played out to high-yield bonds, to dividend stocks, to regular stocks, to disruptive stocks and even crypto. I see no reason why quantitative tightening won't have a similar impact on the way to balance sheet shrinkage. Every investor will be afforded the opportunity to take less risk for the same potential/incremental return. That will weigh on asset prices.
Bad news will be bad for stocks
At its simplest, that is what changed for me last Friday, at least in the short term.
I think we will get bad news.
Therefore, I'm still bearish on risky assets, though I am starting to buy a few things to trade in case there is a bounce (because the market got too weak on Friday relative to what Powell will do) or that the economic data will be good (I expect weakness relative to expectations, but it could go the other way).
Bottom line
Adding some longer-dated Treasury, high-quality investment grade/muni positions (iShares 20+ Year Treasury Bond ETF (TLT) for Treasuries, iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) for credit, and am using closed-end funds for munis). I'm selling leveraged loans (Invesco Senior Loan ETF (BKLN) and SPDR Blackstone Senior Loan ETF (SRLN) if you have them, or for me, some leveraged loan closed-end funds).
I'm neutral commodities and leaning toward bearish (Energy Select Sector SPDR Fund (XLE) , SPDR S&P Metals and Mining ETF (XME) ). Despite all the problems on the energy supply side and the mess that Europe is in, I'm too pessimistic on the economy to be comfortable being long commodities here. That translates to neutral on emerging markets, ex China, where I'd be selling that bounce if I had any (iShares China Large-Cap ETF (FXI) ).
Disruptive stocks and crypto are still a sell. I might look at buying Grayscale Bitcoin Trust (GBTC) for a trade at some point (33% discount to net asset value), but not yet. I think Bitcoin and disruptive stocks (ARK Innovation ETF (ARKK) as a proxy) will move in tandem and downside is in store for them. I think that bleeds into the semiconductor space as a whole, which leaves me cautious on Invesco QQQ Trust (QQQ) (I did remove most of my QQQ shorts here on Monday morning and may look for a buying opportunity, but I'm trading QQQ and ARKK generally from the short side here).
Thanks and good luck on this final summer week (respect and be aware of the abysmal liquidity out there across all products).
