Depression may again give way to euphoria
- Our Equity Model’s 6-month forecast for the S&P 500 decreased but remains positive, at 5.4%.
- Our Short-Term Risk Model gave a closing Buy signal on Sep 26. The models dictate that we re-invest in the market.
- For the second time this year, investors expect inflation to ease, which would fuel a rebound.
The market has been “bipolar” this year. It convinced itself in mid-summer that the Fed had won the fight against inflation – and stocks rallied. But the Fed dashed these hopes with its continued hawkish stance – and stocks plummeted. The S&P 500 dropped by 9.2% In September, while the NASDAQ-100 plunged by 10.5%. Meantime, inflation remains extremely high, but will inevitably begin to decline just like commodities have (see Economic Update) – this might serve as the trigger for market rebound.
The S&P 500, 1 Year
Economic Update
The market has been “bipolar” this year – periods of euphoria gave way to bouts of depression. It convinced itself in mid-summer that the Fed had won the fight against inflation – and stocks staged a strong rally. But the Fed dashed these hopes with its outsized September rate hike – and stocks have plummeted. From its August-16th peak, the S&P 500 plunged by almost 20%.
Meanwhile, the Fed’s message this year has been consistently hawkish, and has not changed one bit:
First half of 2022
The Fed is determined to combat inflation. The market: “This is bad!” The S&P 500 plunges 20%.
Mid-summer of 2022
The Fed is determined to combat inflation. The market: “No, inflation will drop!” The S&P rallies 17%.
Aug-Sep 2022
The Fed is determined to combat inflation. The market: “This is bad!” The S&P 500 plunges 20%.
October 2022
The Fed is determined to combat inflation. The market: “Inflation will now drop!”
Even if these bipolar tendencies are understood, it is still difficult to make money in this market. A manager must look forward: where will the market move next? In order to answer it with reasonable probability, accurate enough forecasting models are needed – which we at MCM believe we do have. Our process remains strictly model-based, and my comments below simply provide a narrative around it.
After insisting that “inflation is transitory” during most of 2021, the Fed turned 180 degrees in December by adopting a hawkish message: it was now concerned about inflation and would combat it. It began acting on the message only in March of 2022 by raising its Funds rate. This delayed response allowed inflation to rise unchecked for a while, to its peak of 9.1% in June of 2022, its highest in 42 years. But it began to ease since then, to 8.3% in August of 2022:
Inflation Rate, 25 Years
Commodities and Inflation
The Fed’s tightening policies combat rising commodity prices, and after a lag, inflation. The Fed’s actions broke the bull market in commodity prices by early summer – nearly all commodities began to fall. For example, the WTI crude oil fell to around $80 per barrel from its $120 peak in June, and is now back to its year-ago level:
WTI Crude Oil, 1 Year
Some other commodities experienced even sharper declines, including base metals:
High Grade Copper, 1 Year
Inflation has been largely driven by commodity prices. Commodities began to fall in late spring, and this meant that inflation would follow suit, with some delay. This would also mean that the Fed would have won the fight against inflation, and further tightening would not be needed – the Fed would be “out of the way.” Apparently, many strategists believed that inflation would begin to ease by mid-summer. The Fed out of the way would mean significant market upside – this was the reason for the mid-summer rally.
But this forecast was wrong – or at least, too early. In his August-26 speech in Jackson Hole, Chairman Powell made clear that the Fed doesn’t yet see inflation easing. He stated that restoring inflation to its 2% goal “will take some time and requires using our tools forcefully.”
10-Year Treasury Yield, 1 Year
The bond market mirrors commodities in reflecting the expectations about inflation and the Fed. The 10-year Treasury yield has just peaked at 4% and began to fall, now at 3.6% (see chart above). Bond traders are betting, once again, that the end of tightening is near. We’ll see the next inflation report on 10/13.
Positive Economic Effect
Exchange energy prices have been falling since the early summer, as I described above – and this has been reflected in retail gasoline price, with a short lag. The national average price of regular gas fell to $3.7 in September, well below its June peak of $5:
Stability of gas and food prices is very important to consumers. The recent price drop is beginning to have a positive effect on consumer confidence (which leads spending). The Conference Board’s confidence index increased in September for the second consecutive month, to 108:
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