Testing the Lows

Steven Bouchey

It’s Saturday morning and I wanted to share some thoughts that both Ryan Bouchey, CFP® CPA, our Chief Strategy Officer and VP, and I had on the markets with all the volatility over the past couple weeks. Investors’ emotions are being tested again as we retest the lows of June 16th and there’s a feeling of capitulation that some maybe experiencing.

“Fear is the most basic emotion we have. Fear is primal. Fear sells” - Max Brooks

The media knows this and highlights the bad news surrounding this market, so viewers are glued to their TVs and they get to sell more advertising. I am in the camp that the glass is half full, not half empty for good reason. There are as many gurus who feel the market will be higher by year end as there are ones who feel it will end lower. We continue to be patient waiting for the markets to turn around again, which they will.

A tough year in the markets turned that much tougher these past few weeks. Elevated inflation numbers, Fed missteps, and global economic uncertainty have converged to make the last two weeks awfully volatile. While this environment feels scary, and rightfully so, we need to step back and look a bit closely at where we are and what is happening.

The S&P is 45 points (3,711) above the June 16th market close low this year of 3,666. As we re-test this year’s market low, I’m trying to keep a few things in perspective when determining where this market is headed from here.

The last two weeks, and really the last month of volatility, seem predominantly driven by the latest inflation data and Fed uncertainty. Inflation has a dramatically negative effect on consumer sentiment, and for good reason. As we’ve discussed in the past, last year consumer sentiment (before the markets peaked) went even lower than it did during the worst of Covid, based on fears of future inflation. The fears became true as we started to see and feel the impacts all around us – grocery stores, fuel pumps, car lots. Just as we started to see a reprieve (both in data and in some parts of our daily life like the gas station), we saw another spike in CPI for August. This hasn’t treated equity or bond investors kindly these past two weeks. If we’re seeing slowdowns around us, like housing and gas, why does inflation continue to stay high?

Even though housing is slowing, it’s still relatively inflated, especially year-over-year. It’s hard to tell how long this will last. But lack of supply will only get worse as mortgage rates rise and those who own at 3% or lower are less likely to sell. Demand remains high, so even with the home affordability getting worse, prices aren’t necessarily cratering. Rents have also risen and there is a lack of urgency to lower rents. Another big element has been higher wages. While this is great for workers and consumers, it does play into higher inflation. This is a very “sticky” element of inflation – once it starts it’s unlikely to slow down until something more dramatic happen in the economy.

The markets also haven’t fared too well following Fed Chairman Powell’s latest comments this week. He came out tough, which he needed to do, and scared the markets even more while doing so. Powell essentially declared he needed to start a mild recession to prevent a significant recession. The markets have reacted accordingly. We now know that a “soft-landing” is becoming harder and harder to accomplish. However, it doesn’t necessarily mean we have to see extreme volatility like we saw in 2000 or in 2008-2009.

We need to remember the Fed is not the be-all end-all and some feel they have made mistakes. Strike 1 ... in 2018 with forced pivot on rates, Strike 2 …  in 2021 with “transitory” call on inflation. Now the question is will Strike 3 be hiking rates so aggressively high that they push us into an ugly recession that we don’t need to go into? Wharton’s Jeremy Siegel had a spirited interview yesterday with Scott Wapner on CNBC which I provided a link to below.

Now that we have tested June’s lows – could this be it? The good news is that the VIX (the markets’ measure of volatility) spiked 14% this week. Why is that good news? As pointed out by Nicholas Colas from DataTrek, the market has only bottomed out when the VIX rises over the 30-point threshold. So far it’s been hovering around 27, and Friday’s bounce drove it to over 30. The VIX is a measure of market volatility, so how is a higher VIX a good thing? Well hopefully Friday’s spike brought us that much closer to a bottom.

What’s in store from here on out? I wish we had a crystal ball. The good news is that these lower stock prices play very favorably with current valuations, bringing them much more in line with 20- and 25-year averages. I’ve said, and continue to feel that these lows are driven predominantly by inflation numbers and the Fed. We know what the Fed plans to do, and I do feel like we are closer to a peak in inflation than ever before. If this is the case, then I imagine the rest of the year will be driven by earnings and earnings expectations. The biggest headwinds here are global economic conditions, and our own economy pulling back the reins out of caution, not necessarily due to a consumer slowdown. If this happens, then we are much more likely to have a milder pullback.

The U.S. economy continues its strength, albeit with some signs of weakness. We know when market conditions become tough, the market generally doesn’t wait for good news to recover. In fact, much like we saw at the Covid lows, the market generally bounces ahead of any positive guidance. While there’s no denying the news lately has felt bad and has been bad for markets, it’s not the time to overreact or panic. We could be closer to a market bottom than we think.

Over the past few months, we’ve made some moves in the market that are meant to be defensive within our equity sleeve. We own sectors like health care and consumer staples which generally fare better in this type of environment. We want to hold good companies with strong balance sheets, positive cash flows and good dividend growth potential. You may see additions to these parts of your portfolio if volatility is here to stay.

We’ll continue to be proactive from here. As 3rd quarter comes to a close, earnings and earnings estimates will be at the forefront. The S&P is off just over 22.5 % YTD. If inflation numbers have indeed peaked, and 3rd quarter earnings and future estimates stay where they are, we could be close to market lows for now. These will be our main focus in the weeks ahead. And it may only take one positive CPI reading for September to get this current market back on track.


Jeremy Siegel’s Thoughts on Fed



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