FIVE THINGS YOU SHOULD KNOW
INSIGHTS for INVESTORS
After huge gains in equities this Thursday (+2-3%), equity markets reversed sharply Friday (-3-4%) to finish the month down around 9%. Question…do you really think the world changed all the much in one day?
Our feeling is of course not, but rather that this week’s swings are indicative of a) the common emotionality of the markets and b) the type of behavior often seen as markets try to find a bottom.
This week will check in on a variety of indicators to help you better understand where we sit from technical, fundamental, and quantitative viewpoints and what they mean for where we are likely to head from here.
In short, we still are in the camp that this is a normal correction and not the beginning of a prolonged bear market/recession. It is also important to note that no one signal, or analysis style can predict the future. We use these different viewpoints to understand probabilities and parameters for our emotional preparation, not the need for prediction, on our path to success.
As we told clients back in January in a trade alert, we believe volatility was likely to pick up meaningfully in the first half of the year with visits to 4200 and possibly 4000 in the S&P quite probable. As we sit here today, I think it’s fair to say that outlook proved prescient.
What levels should investors be watching today?
Around 4000 remains a likely floor, with an important technical resistance level above/around 4350 – should the market move through this, it would likely signal the end of this correction.
Lending support to our view that this market pullback is a normal correction is a review of key fundamental data today. As we noted before, prolonged bear markets do not occur without corresponding recessions and recessions are usually signaled by a few important data points such as a) a weakening labor market, b) troubled spreads within fixed income and c) a rolling over of leading economic indicators.
So where are we today?
The labor market is anything but weak, rather labor supply cannot begin to keep up with demand. In fact, jobless claims are at levels last seen in 60’s when the population was half of what it is today, and unemployment remains near historic lows.
Bond yields have moved but not to levels associated with a recession. Credit spreads have come back in after briefly widening, while treasury spreads between short and longer duration bonds have widened back out – both are positives.
Lastly, a look at the recent data from The Conference Board on leading indicators has recently been climbing back to the point that it sits only 0.1% below the all-time high.
While inflation remains a concern, recent CPI data showed a moderation in its acceleration which bodes well for the back half of the year.
Speaking of inflation, the primary concern of course is that sustained high readings will lead the Fed to hike interest rates too quickly. As Wesbury discusses in detail below, there is more to monetary policy than just rates. He states that, “Post Great Financial Crisis the measure of the money supply grew just 6.0% per year, no different than in the prior seven years. So, even with zero percent interest rates, there was no problem with inflation during those years. In complete contrast, this time around, with the same zero percent interest rate policy, the M2 measure of the money supply has soared, growing at an 18.7% annual rate in the two years since February 2020 (right before COVID).” In summary, rates may be tightening but they are more than offset currently by the amount of liquidity in the system.
Another important quantitative data point to look at is investor sentiment, which is historically bad right now, a reality that rarely signals a top in markets and far more often a good long-term entry point.
Here are a few different charts to take in.
Bespoke looked at sentiment levels from the most recent AAII Investors survey which showed bullish sentiment hits lows not even seen since 2009.
CNN’s Fear and Greed surveys also show “extreme fear” across a variety of survey data.
As the chart graphic above states, and a close examination of the dates associated with the red circles, such levels have almost always come near market lows.
If we try to summarize all the above, it would boil down to the following; technical levels suggest we are nearing a likely bottom for markets with perhaps 3-4% more downside which is backed up by sentiment levels often associated with market bottoms. Furthermore, fundamental data does not point to a recession which has occurred alongside every prolonged bear market in modern history.
As reported by FINSUM, “Goldman Sachs released their latest economic forecast and predict the U.S. will grow at its second-highest rate in over 15 years. The 3.1% prediction would only be outpaced by the K-shaped recovery in 2021. Moreover, they said there is a lower risk of a recession in the next year than the rest of Wall Street with about a 15% chance. Attributing much of the inflation to supply chain issues, Goldman seems to be leaning on the latest core PCE inflation numbers that the Fed cares most about which were on the decline.”
These moments are certainly trying, but they are also inevitable along the journey to being a successful investor. Don’t let headlines and emotions distract you from staying process and data driven in your approach.
Have a wonderful weekend,
Tim and the team at TEN Capital
Focus on the Money, Not Rates
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
No one can say that the Federal Reserve can't do the impossible. At long last observers from across the political spectrum agree on one thing – that Jerome Powell and the Fed are well behind the inflation curve and have a lot of catching up to do. These days, that's virtually impossible.
Consumer prices are up 8.5% from a year ago, the largest increase since 1981. And while the Fed is talking tough and lifted the funds rate by a quarter percentage point in March, monetary policy remains very loose.
Chairman Powell has hinted recently at raising the target short-term rate by 50 basis points (a half percentage point) in early May. The market also expects another 50 bp in June and another 100 bp or more, combined, during the four meetings in the second half of the year.
As a result of these projected interest rate hikes, some fear a recession starting as early as this year. And these fears have put pressure on the stock market. The S&P 500 closed on Friday down more than 10% from the all-time high set back in early January.
But we think that for the time being these fears are overblown. Monetary policy is still very loose and would still be loose even if the Fed raised rates to 2.0% or 3.0% immediately.
Before the Financial Crisis in 2008-09, short-term interest rates were a good proxy for judging the stance of monetary policy. The Fed used a system of "reserve scarcity" and lower rates relative to economic fundamentals meant looser policy.
That's because the Fed manipulated the amount of bank reserves in the system to move rates. If it wanted looser money, the Fed would buy bonds from banks, which would increase reserves and lower short-term rates; when the Fed wanted to reduce the growth rate of money, it would adopt a policy to buy fewer bonds (or sell bonds), which meant higher short-term rates. In other words, money supply growth and interest rates were intertwined. When one went up the other went down.
But the Fed no longer implements monetary policy that way; the Fed now runs a policy of "plentiful reserves," and the Fed targets the interest rate it pays banks on those reserves. The money supply and the level of rates are now independent of each other.
For example, after the Panic of 2008 the Fed reduced the short-term interest rate target to essentially zero and kept it there for seven years. During that time the M2 measure of the money supply grew just 6.0% per year, no different than in the prior seven years. So, even with zero percent interest rates, there was no problem with inflation during those years.
In complete contrast, this time around, with the same zero percent interest rate policy, the M2 measure of the money supply has soared, growing at an 18.7% annual rate in the two years since February 2020 (right before COVID).
This is also why the most important data release this week might not be the GDP report out Thursday but the Fed's release of the M2 money supply report from March, to be released on Tuesday. The Fed used to report these data once per week but switched that to once per month about a year ago. The Fed has the weekly data, but when it decided money didn't matter, it stopped releasing it. This is monetary policy malpractice.
The other thing to keep in mind is that although the recent stock market sell-off has affected the banks, the largest banks will have a big wind at their backs in the next couple of years. As short-term interest rates go up, so too will the amount the Fed pays them in interest on the excess reserves it created in the past fourteen years. Depending on how fast the Fed lifts rates, and whether or not banks choose to hold bonds instead of reserves, the Fed could be paying banks $75 to $100 billion next year.
The bottom line is that monetary policy is still very loose and likely to stay that way. And investors need to follow the money: both M2 overall and the money the banks are getting from the Fed. For now, neither are bearish signs.