Equities have suffered an utter meltdown in the past week as the hot inflation implications of U Mich and CPI pushed stocks into “no bid.” There are many explanations offered for this, but the ultimate takeaway is that equities are in the midst of liquidation. As @jasongoepfert of Sentiment Trader notes:
- 5 of the last 7 days have seen 90% of S&P 500 stocks fall
- “Since 1928, there have been exactly 0 precedents”
Rigged Pachinko — “heads I win, tails you lose”
Inflation has become the singular focus of markets. And the challenge for investors and markets is that the path of inflationary drivers from supply chains, consumer demand, war outcomes, labor markets are uncertain.
And given the cumulative uncertainties, markets have increasingly viewed the Fed as the single most influence on future outcomes. That is, markets have essentially assigned zero probabilities to “right tail” events (these challenges resolve without Fed intervention).
- this focus on “left tail” outcomes means investors generally view every data point as supporting Fed needing to tighten monetary policy
- a “heads I win, tails you lose”
Equities have become capitulatory
Bottoms are dangerous. This is also why investors remain hesitant to take risk. Witness the ugly reversals of the last few days. But as Mark Newton, Head of Technical Strategy of FSInsight notes, signs of “capitulation” are growing. He details these in his Technical commentary.
…most “eye catching” is 2% of S&P 500 is above the 50D moving average, vs 1.2% seen at prior lows
But the most eye catching, is the fact that only 2% of the S&P 500 is trading above the 50-day moving average. Think about this:
- only 9 stocks are trading above their 50D moving average
- In March 23, 2020 (major low) and December 24, 2018 (major low), this figure was 1.2%
- another 4 stocks need to fall below respective 50D and this matches capitulatory lows of 2020 and 2018
- JUST 4 STOCKS
- NOT 50, NOT 20, NOT 10… 4
These are the 9 stocks that are still managing to trade above their 50-day moving average. The strongest is 7% and the weakest are less than 1% from falling below:
- Fedex FDX 0.85% +7% (>50D)
- Dominos Pizza DPZ 0.30% +4%
- Phillips 66 PSX 2.80% +3%
- Monster MNST 0.28% +1.5%
- Catalent CTLT -0.57% +1.0%
- IBM IBM 1.61% +0.8%
- Waters WAT 0.48% +0.2%
- Dollar General DG -1.05% +0.08%
- Exxon XOM -0.22% +0.03%
If we are being overly “theoretical” and want to trigger machine nirvana, 4 of these 9 stocks needs to fall below their 50-day.
- 5 of 9 of these names need to fall <1% and they are below their 50D
- of course, this is “closing lows” and needs the rest of the market to stay low
- but you get the picture
13% of S&P 500 is >200D moving average
Many investors prefer to look at the 200-day moving average and this figure has fallen to 13%. This is not nearly as low as prior lows:
- March 23, 2020 was 3%
- December 24, 2018 was 8%
- Another 5% is 25 S&P 500 stocks need to fall below their 200D
- So, a slightly higher figure needed
13% is a bottom 5-percentile reading
This 13% figure ranks as a bottom 5-percentile reading since 1994. So in the past 30 years, this is a rare reading:
- Equities are higher 6M forward 80% of the time
- Median gain is +15.5%
This 13% figure ranks as a bottom 5-percentile reading since 1994. So in the past 30 years, this is a rare reading:
- Equities are higher 12M forward 90% of the time
- Median gain is +26.2%
So even if stocks are not at the same lows in March 2020 and December 2018, they are close.
Why Fed 75bp hike post-FOMC is a logical response to U Mich survey and political considerations
Since Friday’s CPI (higher CPI) and U Mich Consumer Confidence survey (rise in consumer inflation expectations), consensus expectations for June is now a 75bp hike (vs 50bp prior). This is a break from the forward guidance given by the Fed and has prompted multiple interpretations of this move.
- ultimately, the Fed move seems appropriate given the rise in consumer expectations for inflation
- many forward indicators for inflation point to a downturn coming, including rollovers in housing (lumber), autos/used cars (prices falling), apparel and furniture (piling inventory), supply-chain related (easing)
- inflation has been primarily goods/supply-chain driven, but the rise in gasoline and tight labor is shifting the perception towards inflation sticking.
- prior studies (below) show that consumer expectations for inflation collectively are perceptually accurate on inflation (r-squared >90%)
- and that this change in consumer forward expectations actually influences interest rates historically (2-quarter lead)
- hence, if inflation expectations are rising, this requires the Fed to act
- however, the “glitch” in this is that it seems that gasoline prices itself has a sizable influence on consumer
- in other words, the best way to contain inflation expectations is to see oil prices/gasoline level off
- as OECD notes, half of the rise in global inflation in 2022 is due to second-order effects from Russia-Ukraine war
Financial markets have become a single-decision market — Inflation
The May CPI report (reported Friday), coupled with the U Mich Consumer Confidence survey, showed inflation remains sticky. And while there was some evidence, on the margin, of inflation pressures cooling (core CPI), financial markets saw both reports as upside reads to inflation.
- Equities sold off sharply as both inflation expectations and Fed funds YE 2022 forecasts moved up
- Inflation forwards (12M) moved up to 5.4%, but below the cycle high of ~6% on 3/24/2022
- Fed funds by YE 2022 move up 1.5 hikes to 3.3% (2.9% two days ago)
- Fed Funds are at cycle highs but inflation below peak
- One interpretation is that markets believe Fed needs to move faster even though inflationary pressures could be cooling. But the pace of cooling is just not sufficient.
The first 3 days of this coming week are the most consequential
Many of our clients, including macro PMs, note the nearly singular focus on inflation-impacts makes this market environment one of the most dependent they have ever seen. The market moves over the last few days exemplifies this. Over the coming week, there will be quite a lot of incoming data:
- May NFIB small biz optimism survey –> wages and inflation
- May PPI –> inflation
- June Empire Fed –> economy and inflation
- NAHB Housing Index –> housing
- FOMC –> biggest event, obviously
Figure: Themes in 2022 – “BEEF”
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
* Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”
