NYSE MAC Desk - Weekly Recap

STRAIGHT FROM THE TRADING FLOOR

DOW 29,590 (-486), S&P 500 3,693 (-65), Russell 2000 1,680 (-43), NYSE FANG+ 4,789 (-101), ICE Brent Crude $86.65/barrel (-$3.81), Gold $1,652/oz (-$29), Bitcoin ~18.8k (-480)

Taking a cue from Chair Powell's new communication style I'd say this week was - U-G-L-Y (sticking with the 80's classic movie references). Last week we highlighted the negative seasonal trends in the week following September expiration and unfortunately that came to pass with the S&P 500 now closing lower in 26 of the last 33 years. Some of that Powell predicted "pain" has now been inflicted on financial markets with the S&P 500 closing lower by >3% in four of the five weeks since the Jackson Hole address. The S&P 500 followed up a 4.8% decline last week with a 4.6% on the way to testing the June lows today before a modest bounce into the close. Today the Dow Jones Industrial Average closed below its June low joining the DJ Transportation Index which broke that level last week. The index also officially crossed the 20% "bear market" threshold for the first time.

Central banks were at the center of this week's declines, but the big issue is really uncertainty. Geopolitical tensions continue to mount in Ukraine with the Russian referendums and threats of nuclear weapons, the US/China rhetoric continues to deteriorate and there is an election in Italy this weekend which could shake up the bloc - but these aren't the issues that markets seem to be concerned with at the moment.

That uncertainty really comes back to global monetary policy. This week there were over 10 central bank rate decisions with most hiking rates aggressively but at the center of that, is the Federal Reserve. Markets had been recalibrating Fed expectations aggressively since Powell's address a couple of weeks ago. The release of this week's Summary of Economic Projections showed members of the committee expected rate increases to exceed even those adjusted market expectations suggesting an additional 125bps of rate hikes over the next two meetings. The Chairman continued his new direct and unwavering communication saying that the committee will move to a restrictive rate and stay there until inflation is convincingly moving lower, which will cause a period of below trend growth and job losses.

You may be thinking that messaging seems pretty straightforward. It is. However,  the uncertainty piece that I referred to is understanding where the ultimate destination is. Within the Dots it is apparent that officials are split between 4.5%, 4.75% and 5%, but this seems to be a moving target. Chair Powell suggested that we were just getting "into the very lowest level of what might be restrictive". However, when discussing the SEP he essentially said these are our estimates but this "will evolve over time and I think we'll just have to see how that goes" which was like Thornton Mellon checking conditions before trying to pull off the Triple Lindy. So, long gone are the hopes of a pivot. This originally evolved into hopes of a pause, but this too seems to be off in 2023. The uncertainty is really where does it stop. The prospect for much higher rates, increases the range of potential economic outcomes.

The Fed had gotten behind the curve and one can argue that the market led them to this reset. They are now trying to get ahead of the curve, but they weren't the only central bank in this situation. This was widely a global problem, with a few exceptions. However, given the importance of the Federal Reserve and the USD this causing broader implications. Other central banks are now being forced to try and keep pace with the US or see their currencies devalued further. The strong dollar does have some positive impacts on domestic inflation but this weighs on the rest of the globe as it becomes more expensive to service US-denominated debt and purchase goods/commodities. Volatility in currency markets has been surging and is raising concerns that something could break ala 1997. This week Japan did announce that it would intervene to stem currency weakness, but it is difficult to see this working without the BOJ changing its uber accommodative policy stance.

The reset of interest rates flows through asset classes and with investors not confident with where it stops it becomes difficult to value other assets. This is part of the issue for equities. Valuations have been resetting and with the added economic uncertainty the range of potential outcomes for corporate earnings also widens. So, you're forcing investors to guess on both sides of the equation with both those variables being pressured lower.

Unfortunately, I'm not done yet as there are a couple of other issues that have come to the fore front this week. First, it seems like TINA has been buried - RIP. Over the last year I've discussed one of the prevailing mantras over the last decade which was "Don't Fight the Fed". This leads into the second mantra since the GFC, as central banks kept rates low while steadily pumping stimulus into the global economy, "There Is No Alternative". In the global hunt for yield this made equities the most attractive asset. With the 2yr Treasury now above 4% for the first time since 2007 that is no longer the case. Corporate bond yields are now also offering returns not seen in a long time. 

The last two issues I'll touch on are what have historically been the exit ramps for weakness within equity markets - fiscal and monetary policy. Earlier this year I said I expected that the Fed stance would likely ebb and flow with moves in equity markets. We saw the stance soften a bit over the summer as markets were getting hit hard. However, in August as things went too far and financial conditions began to ease, working against what the Fed was trying achieve, Chair Powell dropped the hammer. In years passed the Fed has been able to reverse course to save the day aka the "Fed Put". However, with inflation that put has joined TINA or at least the strike price has been lowered significantly.

The other exit ramp has been fiscal stimulus. Governments adding stimulus in this environment  works against what their central bank "brethren" are trying to do as this adds to inflationary pressures. While we have seen some limited stimulus announcements made in the US this dynamic was full on display today with the UK announcing sweeping tax cuts and subsidies. This was met with a swift response by markets sending the GBP sharply lower, down 3.5% verse the USD and yields up sharply with the 5/10yr yields up 50bps/35bps today alone.   

I know this is gloomy picture but in the words of Hyman Roth, "This is the business we've chosen."

There aren't many positives to point to but I'll try to give you a few. Positioning and sentiment remain at extreme levels (see Chart 1) and short-term momentum indicators are also starting to getting to extreme levels.

We are in the midst of a very negative short term seasonal patterns but that improves in the coming months especially in mid-term election years.

We have seen some pre-announcements but the broader corporate commentary has been more sanguine than the current market narrative. This has lowered expectations ahead of earnings season which kicks off in earnest in a couple of weeks.

The US economy has continued to show resilience (see today's PMIs and labor market data). In the current environment that can easily be added to the other side of the equation as the Fed clearly wants to see demand softening before pulling back. Some of the leading indicators of inflation are showing signs of easing though this will take time to flow through the data. The weakness in commodities and oil should ultimately help on the inflation side of things and provide some relief to consumers.