It seems everything stinks all of a sudden. War, inflation, and layoffs are rocking the warm sense of security many of us had heading into 2022.
Stocks are having their worst start in 50 years, and nothing seems to make sense anymore.
So today, I’ll try to provide some context, and what I see as a critical path forward.
Let’s start with a brief recap of the year… Something smelled to me late 2021: The Fed was cranking up the hawkish talk.
They telegraphed that aggressive tightening may be required. That started to shake stocks. Then cryptos began to crumble. Risk assets started to fall, quickly evaporating paper wealth.
The thing is, why it smelled to me, is that Fed was in a bind.
It needed to cool the economy, as froth was evident in the system. Non-fungible tokens (NFTs) were trading for record values. Stocks were memes, and inflation was skyrocketing.
In ordinary times (not after a once-in-100-years-pandemic), the Fed could just measuredly raise interest rates.
But now the U.S. had a $30 trillion national debt (and climbing):
During much of that steep climb in debt from 2008 onward, interest rates were at or close to zero. Financing debt at zero is pretty good.
But when you owe $30 trillion, each 1% rise adds $300 billion in interest.
So I felt the negative speak from Powell and leaders of big banks was fearmongering by design.
You see, by scaring consumers into spending less, the economy could cool on its own and the market could do the hard work for the Fed. I called it ghost tightening.
This language began around December. The subsequent pressure on stocks was from Fed-speak, inflation, and a war in Ukraine in the months that followed.
The first rate hike occurred mid-March. By that time, the S&P 500 had fallen more than 7.8% already.
The next hikes came in May and June and currently stand at an upper limit of 1.75%. Stocks have been consistently sloppy all year, and as I write this, the S&P 500 remains in a bear market, down 20% from last year’s close.
Gas prices soared along with food, which siphons money off the U.S. consumer quickly. That leaves less dollars for discretionary spending, further tightening the economy.
The collective forces work to curb inflation. All the while, the Fed has only raised rates to 1.50–1.75%, well below the average since 1990 of approximately 3.00%.
That is ghost tightening. The economy is slowing without the need for the drastic action hinted at late last year.
Naturally, we will likely see a few more hikes. I believe they will be 50 basis points two more times, and then we will hit a holding pattern. That will still be below the 32-year average. November is election time so likely nothing will happen then.
Now this brings us to the big question: recession or no recession?
Recession or No Recession?
There is no shortage of negative sentiment on our current situation. According to one survey, 76% of CEOs expect a recession.
It’s a forgone conclusion in many news stories, and some Americans speak like we’re already in one.
A recession is defined as two successive quarters with a fall in GDP. That definitely has not happened yet.
So, is a recession assured?
There are those who don’t believe one is coming, and they are not just nobodies.
President Joe Biden said a recession is not guaranteed. Fed Chair Jerome Powell also doesn’t necessarily see one in the cards. U.S. Treasury Secretary and former Fed chief Janet Yellen said that she expects the economy to slow but a recession is “not at all inevitable.”
There are plenty of others who stoically reject the idea of a recession. JPMorgan’s Chief Economist Bruce Kasman said he doesn’t see a recession. Even the notorious shark Kevin O’Leary says there’s no evidence of recession right now.
Given all that, let’s consider the facts…
The Fed spoke. Markets fell. Risk assets fell.
Rate hikes came slow, and then ramped up. But they still sit at nearly half the 32-year average.
We are in a bear market largely precipitated by the Fed’s comments from before hikes ever happened.
Essential costs are tightening the U.S. consumer’s wallet, leaving less disposable money to chase prices higher in other areas.
This sounds a lot like ghost tightening to me.
So, what’s to come? 1960’s economist Paul Samuelson famously said the stock market has predicted nine of the past five recessions.
Could this be another time the market gets it wrong? If so, I think the ghost tightening plan has worked like a charm.
There are little signs of peak inflation popping up.
Goldman Sachs in May released a report showing signs of peak inflation. The prices at the gas pump certainly don’t agree, but energy prices recently cracked. The price of oil fell from $120 to now around $106 per barrel:
Both the Oil Price Information Service (OPIS) and the Energy Information Administration (EIA) released data indicating a demand drop, as I mentioned last week.
Some drivers are likely consolidating trips or just driving less. And that’s the biggest driver of inflation right now: energy.
Should inflation peak, where does that leave us the rest of the year?
Right now, markets are closing out June with ugly price action.
But last week’s volatility was met with low volume. You can see that here as blue and red bars dried up:
Low volume means low signal counts. Monday through Wednesday saw only 53 signals (26 buys/27 sells).
And the breakdown of buying is a small data set, but something should catch your eye… energy has shrunk:
Energy has been the biggest driver of market buying since the new year. But since mid-June, selling has rocked that sector.
So peak inflation may be getting here.
The Fed is working hard to get this ship righted. And should we get some clarity and direction, the market will find its footing.
I believe we will consolidate sideways for a while – possibly through Q3. Then Q4 will see a lift in equities, especially growth stocks.
After all, if the market predicts a recession and is wrong, growth stocks have nowhere to go but up. Money will flood into beaten-down sectors.
I don’t necessarily see a recession. I see ghost tightening, and I see it working. So while positivity and happiness are nowhere to be seen, let’s not give in to despair.
While we may not have had a smooth ride so far in 2022, there’s still a path forward for markets to improve.
Editor, Outlier Insights