Markets Rally On Friday, But Still Down For The Week

Good Evening:

This was another dramatic and volatile week in markets. A higher-than-expected inflation reading on Wednesday spooked markets a bit, but an even bigger sell-off occurred on Thursday when the S&P 500 briefly dipped to lows below 3,860. Today, markets recovered with a strong rally that brough the VIX back below $30. At one point the index was up above 4,030 but the rally steadily faded in the afternoon as the herky-jerky May markets continued to process multiple risks and the advent of a tightening cycle with what is looking like an anachronistically tough Federal Reserve hell-bent on bringing inflation down toward their 2% target. This is certainly not what they had in mind when they introduced Adjustable Inflation Targeting.

Earnings continued to be a mixed picture and in this hair-trigger market it seems that guidance and the general malaise amongst investors is carrying the day against fundamentals. Disney, for example, had a report that was strong in many ways but sold off. Fear rather than greed appears to be driving the bus these days.

Trading sessions have been volatile. If you don’t like the market’s direction than wait five minutes. Despite the increasingly common intraday swings from red to green and back again, the VIX is not showing the typically extreme levels and signs of backwardation that we usually like to see because they often suggest bottoms are imminent.

Cryptocurrency and technology were some of the hardest-hit areas as the inflation numbers prompted fears of an Old Testament Fed. Apple and Microsoft were some of the last titans to fall below meaningful recent lows. After Apple sold off on Wednesday, it lost the mantle of the world’s largest company to Saudi Aramco, which is valued at around $2.4 trillion.

Our Head of Technical Strategy, Mark Newton, wrote in one of his daily notes this week that the technical collapse of index lynchpins Apple and Microsoft suggested that we could be in for more downside. When Apple opened on Thursday it was the final FAANG to enter a bear market (more than 20% down from recent highs). All the other FAANG components had already lost more than this. Amazon was nearly 45% down from recent ATHs and Facebook was more than 50% down as of Thursday, but these names of course recovered some of these losses. Mr. Newton cautions that, from a technical perspective, there still is likely some downside on the horizon.

Similarly, our Head of Quantitative Strategy Adam Gould notes that some of the primary indicators he pays attention to which might suggest an immediate bottom have not yet reached levels where he would be confident giving the all-clear. Some of his other readings suggest that volatility will likely continue to be elevated for the immediate future. He will be carefully watching for evidence of capitulation.

Markets were extraordinarily volatile for the last week. On Wednesday, markets sold off after the CPI came in higher than expectations. Many pundits were hoping for some relief on inflation. While pandemic-era catalysts for higher inflation, like used cars, have begun to definitively retreat, other stickier components, like shelter, are showing problematic gains. On Thursday, the market started out lower, made an ill-fated rally, and then turned lower again.

Wells Fargo Analyst Colin Langan double-downgraded both Ford and General Motors and slashed their price targets nearly in half on Thursday. The report he issued on the industry made the argument that the spike in raw materials prices has significantly changed the profit dynamics for Battery Electric Vehicles (BEVs) and could result in delaying the point of cost parity with gas guzzlers by at least a decade. The automakers have been adversely affected by inflationary pressures from multiple episodes. and the margins on cars are notoriously thin. Langan also asserted that the regulatory environment may hamper legacy autos from profitably selling BEVs.

The highly anticipated Russian offensive in Ukraine’s eastern regions has not had much more success than their ill-fated initial operations. The Ukrainians and Russians have been fighting in this same area since 2014, and the conflict there somewhat resembles the intractable Western Front during the First World War, where offensive gains were highly elusive and incredibly expensive in terms of lives and resources. This is one area where tail risks lurk. After Vladimir Putin’s May 9^th Victory Day speech, it doesn’t seem as if he’s afraid of a protracted conflict in Ukraine. However, the more his military appears inept, the more tempting it may be for him to escalate. Ukrainians have beat Russian forces back from Kharkiv, almost to the border.

Similarly, the prospect of economic escalation and supply-chain interruptions in global markets like Africa and the Middle East have the potential to beget more political instability. The United States is relatively insulated from the direct economic effects of the conflict, but the Eurasian continent and economies across the world are beginning to feel the harsh consequences of war. Despite these risks, there are a lot of incredibly strong companies that are cheap right now.

Despite the doom and gloom and volatile nature of markets, our entire team believes that this period will ultimately yield an excellent buying opportunity for long-term investors. We all feel the sting when the big red candles hit the screens, just like anyone else does. Our seasoned team has decades of experience on Wall Street and has been through many periods fraught with risk and fear. Now is the time to get grounded in data, process, and logic, and not let emotions drive decisions. At FSInsight we believe mastering your own cognitive bias is just as crucial a pillar of investing as understanding the fundamentals of your chosen investment. Like golf, it is simultaneously a game against your own shortcomings and biases and the other golfers, or investors, in our case. Be sure to make informed decisions based on your investment goals and time horizon. Don’t chop up the fairway because you’re frustrated.