The S&P 500 is back down to the 3600 level. Every time it rallies it falls right back down as it hits its near term moving average resistance, or the top end of its downward trending channel. The market has been like that since August when it gave back its entire summer rally, when it realized the Fed is not done raising rates from its Jackson hole commentary.
It seems the market tries to call the bottom each time as it "wishes" or rather " hopes" perhaps the Fed is done this time, only to be disappointed as the rally loses steam once again. Strangely enough the more the market rallies, the more the Fed will have no reason to stop and be convinced that the market can take it.
Last Friday we had the non-farm payrolls that came in at 263k vs. expectations of 255k. This was enough to turn the entire market around as the labor market continues to stay strong, leaving the Fed with no ammunition to stop its rate hiking cycle as inflation is their main concern. We have tested this level now three times, does it finally break lower here?
Investors used to trading the market over the past decade are used to the Fed stepping in each time the market wobbled. The market is down from its lofty premium of 20+x P/E and now down to the more reasonable 15x-16x, but then again, what is the fair value multiple today?
The past decade has been one of lower rates, almost risk-free money which led to a very low equity risk premium that contributed to the higher discounted cash flow (DCF) for the stocks. Today, we are in a much different environment, one where inflation is a lot stickier, long term interest rates are quantifiably higher, hence the fair value of the market would seem to be much lower.
The same logic that took long duration assets higher over the past cycle, e.g., Technology or the famous Cathy Wood (ARKW) fund, would imply the same logic should take them lower. After all, the Fed destroyed true price discovery in these markets with their mad experiment of endless money printing.
Today US bonds have collapsed with the US 10-year bond yields at 4%. Central banks are trying to stem the decline of their respective currencies but to no avail as their only alternative is to print even more, which takes their currencies even lower.
The CPI for September is to be released tomorrow where consensus is at 8.1% with the core at 6.5%. There is no doubt that the inflationary trends have subsided but they have surely not abated. The market could cheer if it gets a slightly dovish print, but the bigger question is whether that would justify the Fed to end its rate hiking cycle.
For now, the market is torn between bulls, who are too used to buying the dip as they have done so over the last 10 years, and the bears who are convinced that this time the Fed has lost its control over the markets. Liquidity has been a big driving force of the markets over the past few years and this has led to exaggerated multiples. The market is now trying to find a new floor to price risk assets as the multiple shrinks to reflect the new world order of higher rates, stickier inflation, and less liquidity.