WHY GOOD NEWS IS BAD NEWS FOR MARKETS
Nearly all the equity market gains from the two-day rally on Monday and Tuesday were wiped out by Friday. The table shows the peak value of the indexes at the turn of the year, the index lows (three of the four indexes had new lows on September 30), the percentage change from the peak, and where the closing prices stood on Friday (October 7) relative to their lows. Note that three of the four major indexes are close to their September 30 lows, and, as the week ended on a sour note, are likely to test those lows as the new week begins.
Things aren’t much better in bond land. The 2-Yr. Treasury closed the October 7 week at 4.31%, slightly above its close of 4.27% the prior week.?(Only the baby boomers remember those kinds of yields!) And while four basis points doesn’t appear to be out of the ordinary, that yield was as low as 4.10% on Monday (October 3). The 10-Yr. Treasury displayed similar volatility: 3.83% on September 30, 3.62% on October 3, and closing the week (October 7) at 3.88%. The important 2s/10s spread inversion was -44 basis points (bps) at the quarter’s end and -43 bps at last week’s close.
Why so much volatility in the financial markets? For equities, September 30 was the quarter’s end, and part of the sell-off was due to window dressing on the part of fund managers not wanting to show high levels of equity holdings for the quarter-end reporting period. The Monday/Tuesday rally was at least partly due to extremely oversold conditions, but there was the new sentiment in the market questioning the Fed’s ability to raise rates with a developing Recession at home not to mention the struggles Europe, Japan, and other allies are having with the values of their currencies, the impacts on their financial markets, and the specter of a developing default cycle, all due to an over-zealous Fed.
“Surely the Fed would have to pay attention to such developments” was the market sentiment during the Monday/Tuesday rallies. There was even a rumor on the October 1-2 weekend that the Fed had called an emergency meeting to deal with such concerns. Indeed, a Fed meeting had been called, but this Fed’s Open Market Committee meets every month via Zoom. When a meeting is not listed and published on the public agenda, the Fed is required to use its “emergency” powers to call such a meeting. (It has done so every month this year outside of its regular schedule.) So, the rumor turned out to be just a rumor.
Besides the market being oversold, much of the Monday/Tuesday price spike was based on that “hope,” i.e., that this Fed had come to its senses and would not carry out its stated rate agenda. On Wednesday, the Australian central bank raised rates by 25 basis points; the market had anticipated 50. So, there was still some “hope” that the Fed might only raise 50 bps at its November meeting instead of the anticipated 75. Unfortunately, those hopes were dashed as FOMC members Bostic, Daly, and Williams put the kybosh on the notion that this Fed would soon “pause” or deviate from its plan, much less “pivot” anytime soon. Markets began slipping on Wednesday and by Friday, those slips and slides turned into a rout (the DJIA: fell -630).
The Good News
On Friday, the market plunge intensified because of the “solid” labor market report (i.e., good economic news has now become bad news for financial markets, as good economic numbers give the Fed even more reason to be hawkish). The payroll report number was +263K, right around the expected level. But what was unexpected was the fall in the unemployment rate from 3.7% to 3.5%. Remember, the Fed, itself, forecast a 4.4% unemployment rate by December. Thus, the employment report put another nail in the “hope” coffin, and on Friday market participants threw in the towel.
How We Know It’s a “Recession”
Sometimes history repeats itself; most of the time it rhymes.
When Bear Markets End
Because the incoming data continues to point to Recession, even some of the sell-side analysts (Goldman, BAC…) are now using the “r” word (not capitalized) because it is qualified by the “m” word (“mild”). They are now talking about when the “Bear Market” might end.
History tells us that “bad stuff” continues to happen in the economy?after?the Fed’s first rate cut. That’s because monetary policy acts with long lags. Over the last seven Recessions, the S&P 500 low occurred, on average, 11.6 months (median 10 months) after that first rate cut (the data ranges from two months (1980 Recession) to 21 months (2001 Recession)). According to this Fed, we are many many months away from that first rate cut. “Bad stuff” is likely to continue.
Incoming Data
Inflation
The Labor Market
Prior to layoffs, hours fall, full-time positions become part-time, and real take-home pay falls as do job openings.
Final Thoughts
We are in a Bear Market in equities, and, for the first time, in a simultaneous Bear Market in fixed income. That’s because the Fed normally raises interest rates when the economy is expanding, not when it is contracting. The normal relationship between fixed-income prices and equity prices is that when one is rising the other is falling, and this has spawned the idea that investor portfolios should have both asset classes for balance. This Fed, however, is tightening into the teeth of a Recession and the result has been Bear Markets in both asset classes. Given that the Fed employs 300-400 economists, they have to know what we have written here.
Much of the inflation is now in the rear-view mirror. Considering falling commodity prices and shipping rates, slowing demand, falling real take-home pay, and 0% CPI for July and August combined, the best word to describe current Fed policy is “overkill.” While most of the inflation is behind us, most of the Recession lies ahead. By the time this Fed recognizes reality, the economy and financial markets will be in deep trouble. As indicated above, this Fed is also having a huge impact worldwide. The consequences of that could ultimately be significant for the dollar’s reserve currency status, the loss of which would have dire implications for the U.S. economy.