David Rosenberg is the founder of Rosenberg Research and author of the daily economic report Breakfast with Dave.
The countertrend market rally really took off in the middle of June. Why? Because that was when the markets started to believe that the Federal Reserve, by front-loading interest-rate hikes, was blazing the trail for an earlier rate pause and pivot, something reinforced by taking Chair Jerome Powell’s subsequent comments regarding “data dependency” to mean the potential for a pause.
It was then that Mr. Market began to price in two full rate cuts by the Fed for 2023. The 2s/10s yield curve, the difference in yields between two-year and 10-year U.S. Treasuries, was positively sloped to the tune of 13 basis points, and the U.S. dollar’s strength began to subside. High yield spreads began a period of compression as visions of a soft landing danced through everyone’s minds. And 10-year real yields, the poster child for financial tightening, embarked on a two-month slide from 63 basis points to 36 basis points just the other day.
But alas, there are many at the Fed who are stepping out and sounding more hawkish than its Chair and the tone of the published set of Federal Open Market Committee (FOMC) minutes. No, no, no, the Fed is not done raising rates, and some committee members are openly stating they are ready to vote for another 75-basis-point hike at the Sept. 20 to 21 FOMC meeting.
Just as the S&P 500 Index tested its 200-day moving average, reversed 50 per cent of the bear-market decline in the first half of the year and saw more than 90 per cent of its members rise above the 50-day trendline (not to mention the CNN Fear and Greed Index moving into the “greed” column), the S&P 500 has now hit the wall. No kidding.
A near three-point P/E multiple expansion in two months’ time doesn’t exactly happen every day. Also, keep in mind that since the S&P 500′s June lows, four stocks have done the heavy lifting for the index – Apple Inc., Microsoft Corp., Amazon.com Inc. and Tesla Inc. Together, these companies comprise an 18-per-cent share of the index (based on market cap) but have explained 30 per cent of the returns. This speaks to lopsided participation and is not a healthy sign – a great example of Rule No. 7 of Bob Farrell’s 10 market rules: “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”
But now the real interest rate is on the rise. High-yield spreads are starting to widen again. The U.S. dollar is beginning to firm. Profit estimates are coming down and guidance is generally poor. Global demand is clearly fading as the Commodity Research Bureau (CRB) price index was sitting at 625 at the mid-June FOMC meeting and is down to 590 today. And the futures market is fearing the Fed again, because those high hopes of a rate-easing cycle resuming in 2023 have fallen by the wayside – now giving just 65-per-cent odds for only one rate cut, and not until the end of next year.
History rhymes. Remember that. And true fundamental lows in the stock market tend to occur after the last Fed rate cut, not the first one. The rally after the pause and the rally after the first easing are always head fakes. Stock markets bottom when the Fed has eased aggressively enough to take the 2s/10s curve to positive 140 basis points on average and on a median basis.
The futures market is now saying this initial rate cut won’t happen until late 2023, so how is it even possible that the S&P 500 bottoms this year or even next? The refrain “don’t fight the Fed” works in both directions. And recession bear markets, to reiterate, don’t end until the tail end of the Fed easing cycle, which is increasingly looking like a 2024 event.
Play the long game by being patient and nimble – since intermittent rallies will come and go – and focus mostly on capital preservation.
The ultimate lows and the next fundamental bull market could well be two years away. Think 1973 to 1975, think 1980 to 1982, think 2000 to 2002 and think 2007 to 2009.
David Rosenberg