Key Takeaways
- The S&P 500 closed at 4,431.85 up from 4,397.94 last Friday . The VIX settled at an apprehensive $27.61 and remained elevated all week.
- Earnings have been pretty strong this season with a few notable misses. However, on Thursday night Apple delivered a strong beat that helped fuel Friday’s rally.
- Inflation numbers have continued coming in hot; however, there was also a positive surprise on GDP this week too.
- Natural gas prices spiked and simmering tensions between Russia and the West have given markets another risk to be concerned about simultaneously with a more hawkish Fed.
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Markets had a choppy and tough week as the VIX remained elevated going into a Fed meeting where they presented a hawkish tone. Tensions between the West and Russia weighed heavily on all markets, probably to some degree, but especially those in Europe. Now some major banks are predicting that the Fed will issue a hike at every meeting this year and there’s a flurry of uncertainty going around about how and how fast they will shrink their balance sheet. Markets had an indecisive character and some strong earners got punished, but Thursday afternoon Apple came in like the market’s white night and then Friday had a rally that saw the Dow’s best gain of the year.
This correction has been sudden and swift. There’s an ancient Chinese blessing that doubles as a curse: may you live in interesting times. Well, we all can now appreciate the downside of this dictum. We are not sure that there isn’t some downside left in markets on the short-term. However, if you have a long time horizon, all of our research heads agree that this is a mid-bull market correction and not the start of a major bear market.
Let’s go through some of the things the market is processing. Firstly, there’s a lot of talk going around about how elevated market valuations are even after the correction we faced. While, we understand the apprehension about frothiness in many areas, we also still see a stock market that has a compelling valuation especially relative to bonds. This is where the There is No Alternative of (TINA) comes in.
In the dot com bubble the premium for owning stocks was negative. Now real rates are negative, an environment that has been historically good for stocks. That is very far from the case now and equity assets are still the place to be. Fire and brimstone from the Fed could change that, but we suspect their hawkish jawboning might be backed down over time, despite the flurry of upward projections from investment banks. Remember, that the Federal Reserve has no interest in crowding out private demand with public debt service.
Another area that makes us think this isn’t a major turning point from bull to bear market is because despite the carnage in equities, credit spreads for the most part remained robust and resilient. One of the guiding principles of our evidence-based equity research is that stocks follow bonds. Debt can often be the “canary in the coal mine” that signifies trouble ahead for equities. Again, this key area is giving a bullish signal. The positive catalyst today, Apple’s earnings, may also hold a ray of hope. Most analysts expected lower results due to supply chain difficulties.
Now Apple is the largest company in the world so it can certainly navigate supply chains better by throwing its financial weight around, but given the complexity of its supply chains, we find this bullish and in line with our base case that some of the pressure on supply chains as demand for services relative to goods begins to normalize.
Our Head of Quantitative Strategy, Adam Gould, also pointed out another feature of this latest bout of selling that gives us encouragement. Typically, in very bad sell-offs like during the financial crisis or during the first bout of volatility associated with COVID, the correlations of diverse assets and sectors begin moving toward one. Asset prices deflate as folks panic and move to cash. There has definitely been some panic in the last weeks and some very bad down days. However, correlations have been going down not up. This means that stocks are moving more independently of each other.
Inflation numbers continue coming in very hot, but on the otherhand we had a positive GDP surprise this week. There has been a lot of concern about inflation and many market participancts were worried that the Fed’s transitory narrative was inaccurate. The Fed now seems to have taken this criticism into stride and seems to be dusting off the old hawk wings. The sector rotation continued on a five-day basis only into the Energy sector. We are still bullish on this sector and our Head of Technical Strategy has been putting out some great tactical guidance to peruse if you haven’t already. We also released an article this week on some of our favorite stocks from the perspective of the Electric Vehicle revolution. We see a lot of tangential areas to the actual production of the cars that should benefit, so be sure to check it out.
Geopolitical tensions, like what is currently conspiring in Europe, are always quite scary. This is particularly true when the potential for a nuclear exchange, no matter how small, is a factor. However, we want to use this opportunity to discuss another one of our principles of evidence-based research: the market doesn’t care about what you, or anyone else thinks. There is no logic any one of us can understand for how the market prices geopolitical risk, but it has a tendency to not comport with how we experience and understand it. For example, the total drawdown from Sadaam Hussein’s 1991 invasion of Kuwait was almost three times more than the total drawdown during the Cuban Missile Crisis. The total drawdown from this event also exceeded the total drawdown from the September 11th Terrorist Attacks.
Importantly, our team does data-driven analysis on the extreme indicators we’ve been seeing in things like retail sentiment. Allow our Head of Research, Tom Lee, to walk you through what’s happened in markets in the past when sentiment has reached such bearish levels below.
