There was a bounce this week. As I’ve previously said, markets were getting tactically oversold, and I expected a tactical bounce after eight consecutive down weeks. Regardless of the positive price action today there are still plenty of signs that we are late in the cycle. Hence, you can probably set you watch by the high likelihood that there is a wave of downgrades from analysts coming on all things cyclical. This would win the day over bullish hopes and the market may have to deal with these downgrades and negative pre-announcement in the lull between earnings seasons.
The market is still facing several risks and an approaching downturn in earnings revisions. When earnings revisions get to the Southern Hemisphere of my model (meaning the average stock is having its earnings projections cut downward), historically there has been 10% to 15% downside remaining. It could be different this time, but I think the below risks I’ve been highlighting in my work have not had their final word yet with regard to their effect on markets.
- Russia/Ukraine conflict—no end in sight
- Elevated energy prices and their negative impacts on both inflation and consumer demand
- Rising interest rates
- Tightening monetary policy
- Growth slowdown fears increasing, leading to a 1-3 month duration of estimate revisions cuts for all things cyclical
While the market interpreted the Fed minutes as bullish, they largely validated what my position had been, and they definitely weren’t fully dovish. In fact, key inflationistas like Jeremy Siegel from Wharton are even now voicing concerns that the Fed may commit a serious policy error and unleash a worse recession than might have otherwise occurred. When Siegel is worried about the Fed overdoing it, you can surmise that they mean business. The Fed also clearly stated that it might raise rates to a restrictive level, above the neutral level that market participants had been recently expecting.
As I have repeatedly said though, the Fed may well pivot before what the market currently expects transpires. A good analog could be the 4th quarter of 2018 when the market expected a recession and hiking cycle that never occurred.
The minutes suggest we have two more 50 bps hikes ahead and then the Fed may shift to a more data-dependent stance. The Fed is in unprecedented waters and QT hasn’t even started in earnest yet. However, even without the wild card catalyst of a Fed trying to preserve its credibility, in the history of my model when earnings revisions start to move into the Southern Hemisphere, then we usually have somewhere in the neighborhood of 15% downside before stabilization and retracement back to the upside occur.
This rally today is likely of a tactical nature and I my work suggests a high likelihood that it will ultimately fail. Furthermore, I expect the market to be even more driven by macro headlines during the lull between earnings seasons, which should make for some very choppy waters indeed.
