Fiscal stimulus enabled through monetary accommodation has produced an artificial ecosystem in order to try to create a broad "wealth effect" and prevent the public, our public, from feeling any short-term economic pain as the nation/planet went from one shock to the next over a more than decade-long time frame.
I think we can all agree on that.
The warnings of an economy possibly being permanently to semi-permanently trapped in the political snares of "easy money" were for the most part scoffed at, however, as some economists predicted that weaning the patient off of the addiction would drive inflation, force market disruption and land the economy in a state of contraction.
Here we are, all these years later, regardless of blame (for there is enough of that to share), with inflation running at historic levels, despite deflationary technological advances, with financial markets 20% to 35% beneath their headline peaks and many parts of these markets down even twice that much. Here we are with a U.S. economy running at Q2 growth of 0.0% (according to the Atlanta Fed's GDPNow model) on top of a first quarter that saw this national economy contract 1.5% (according to the Bureau of Economic Analysis).
Knowing full well that one can not truly whistle their way past the graveyard, just what are the good citizens of our community to do?
Let's explore.
Last Week
Though U.S. equity markets managed to squeak out minor gains last Friday, the week was a tough one. While the FOMC delivered a necessary 75 basis point increase to the target range for the fed funds rate (to 1.5% - 1.75%) and promised another hike of 50 to 75 basis points on July 29, markets were forced to price in a more committed, more hawkish central bank. This morning, futures markets trading in Chicago are pricing in a 96% probability of a 75 basis point increase made in late July.
The S&P 500 gave up 5.79% last week, and is down 22.9% this year. The Nasdaq Composite surrendered 4.78% last week, is down just short of 31% in 2022, and closed 33.4% off of its November high. The Russell 2000 took a profound beating of 7.48% last week, to finish on Friday -25.81% year to date. Over a seven-day stretch ending last week, the S&P 500 experienced five days where at least 90% of constituent member stocks declined. There are exactly zero instances of anything like that in stock market history.
Last week, the markets' one bright spot, was finally taken out to the woodshed.
As fears of a lasting global recession took root, energy commodities such as crude oil and natural gas were sold sharply, and the Energy sector SPDR ETF ( XLE) , though still up 33.68% for 2022, gave up a whopping 17.16% over just five days. Heck, there were bills to pay, margins to be met... and profits to be taken in one place and one place only. Though Energy led directionally, all 11 sector SPDR ETFs shaded a deep red for the week, with Consumer Staples ( XLP) the top performer, which you may have expected. What you likely did not expect is that the top performer would still be tuned up for 4.3% to the downside.
I Don't Know
How am I supposed to know
Hidden meanings that will never show
Fools and prophets from the past
Life's a stage and we're all in the cast
Nobody ever told me. I found out for myself
You gotta believe in foolish miracles
It's not how you play the game, it's if you win or lose
You can choose
Don't confuse
Win or lose
It's up to you
- O. Osbourne, R. Rhoads, R. Daisley (Ozzy Osbourne), 1980
Signs, Signs - Everywhere There's Signs (Five Man Electrical Band, 1971)
Goldman Sachs ( GS) says a mild recession is priced in. J.P. Morgan ( JPM) says too much recession is priced in. Nomura came out over the weekend and said that the U.S. will fall into a mild recession in 2022. Nomura warned that monetary conditions will continue to tighten, acknowledged that consumer sentiment is already off the deep-end, and that disruptions to U.S. energy and food supplies have worsened all while the global outlook has deteriorated. On that note, Treasury Secretary Janet Yellen, also speaking over the weekend, warned that "unacceptably high" prices are likely to be with us throughout the current year as the U.S. economy slows. (How do you slow from contraction, which is where we are now?) Fortunately, as she will readily admit, forecasting inflation is not a strength for the Secretary of the Treasury.
While we're on the topic, a survey of economists by the Wall Street Journal shows that 44% have the U.S. economy in a state of recession within 12 months, up from 28% in April and 18% in January. As a group, these economists cite higher borrowing costs, ongoing supply-chain issues, massive wealth destruction that will slow household spending, and doubts that the FOMC can cool inflation without driving higher unemployment among the many negative forces driving an expected reduction in economic activity.
For his part, President Biden said that he does not see a recession as inevitable, after speaking with former Treasury Secretary Larry Summers on Sunday (not exactly who I would think to go to for economic advice). Summers sees the need for the U.S. unemployment rate to hit 6% and stay there for five years (or 7.5% unemployment for two years, or 10% unemployment for one year... how nice) in order to contain inflation. In other words, Summers sees a need for more than 10M of you or us to lose our jobs from today's levels in order to control consumer-level inflation and not get them back for an extended period. Well, he is right about one thing. That would curb inflation. And eating.
You may have heard of the Phillips Curve, which to varying degrees of success, tries to make the connection between the correlation between unemployment (wage growth) and inflation. Now get used to hearing about the "Sacrifice Ratio" which tries to measure the effect of rising and declining inflation relative to an ecosystem's total production. In other words, simplified... Using the sacrifice ratio as a tool would imply tinkering with aggregate output in order to adjust inflation at the consumer level.
Prepare to be "sacrificed" my friends. Summers also called for the end of forward guidance on monetary policy.
Front and Center
The fact is that the S&P 500 now trades at 15.4 times forward-looking earnings. Financial markets have never rescued themselves. The onset of a new bull market or the turn of the worm has always coincided with the Fed turning dovish on monetary policy (at least for as long as I have been around, and I am not that young).
In recent years, that spot where the Fed responds favorable to equity markets crying "Uncle" has been around 13.5 times. That's where the Fed "put" has been. Of course, inflation is what the Fed is trying to control and we have not experienced this kind of inflation since I was running sub-5 minute miles for distance. Been a while. 13.5 times might be generous this time around, but even if that's where the put lies, we are talking about another 14% or so off of the S&P 500 (3160-ish) and that's if earnings estimates stay where they are.
The Fed also seems to come to the market's aid when the free cash flow yield of the S&P 500 reaches 6%. Currently that yield is still below 5%. Again, not that closer to artificial help intended to impact price discovery in a positive way.
That's a lot of negativity that I just piled on you. Now for what I think might work.
The S&P 500 has surrendered 5.8% over a month and 17.7% over three. The Invesco 1-30 Laddered US Treasury ETF ( PLW) is down 3.7% over one month and 10.3% over three. The suggestion? As bad as bonds have been, pension funds with mandated monthly or quarterly rebalances may still be forced to move capital into equities toward the end of June. In addition, the Fed will release the results of its annual banking Stress Tests (tentatively) this Thursday. This has historically been a trading opportunity across that space as often the banks are then able to free up more capital in the way of returns to shareholders. Banks may want to retain a higher level of reserves at this time, but this is a potential short-term upside catalyst.
For these reasons, and because markets come in this week bordering on being technically oversold, I suggest slicing and dicing portfolios into baskets. I find that segregating portfolios by mission statement takes some stress out of this job for those who might ask why.
Basket Suggestions
Trading the End of the Month
(High-beta revenue growers): My basket includes Apple ( AAPL) , Advanced Micro Devices ( AMD) , Marvel Technology ( MRVL) , Nvidia ( NVDA) , Microsoft ( MSFT) , APA Corp. ( APA) , Lam Research ( LRCX) and others.
Trading the Stress Tests
(Banks set up for a positive catalyst): My basket includes Bank of America ( BAC) and Wells Fargo ( WFC) .
Investing in an H2 2022 Recession
(Low-beta dividend payers): My basket includes Colgate-Palmolive ( CL) , PepsiCo ( PEP) , Procter & Gamble ( PG) , General Dynamics ( GD) , Lockheed Martin ( LMT) , Raytheon Technologies ( RTX) , Northrop Grumman ( NOC) , CVS Health ( CVS) , Southern Company ( SO) .
Note to Readers: These baskets are not complete, and are still a work in progress. The idea is to let you inside my head a little bit. This is how I am setting up both short-term and, in a loose way, for the medium-term. This is not at all advice. I do change my mind often. Sometimes, I am even... wrong. That said, Rock & Roll.
Economics (All Times Eastern)
10:00 - Existing Home Sales (February): Expecting 5.4M, Last 5.61M SAAR.
The Fed (All Times Eastern)
11:00 - Speaker: Richmond Fed Pres. Tom Barkin.
15:30 - Speaker: Richmond Fed Pres. Tom Barkin.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: ( LEN) (3.97)
(AAPL, AMD, NVDA, MSFT and PEP are holdings in the Action Alerts PLUS member club . Want to be alerted before AAP buys or sells these names? Learn more now. )
