Weekly Market Review N°7
09/05/2022
by Alessandro Gherzi
To many Jerome Powell, the Federal Reserve’s Chair, evokes childhood memories by taking the mantle of the Pied Piper of Hamelin, that by playing his pipe lured rats away, the story goes that as he played rats followed and ended up drowning in the Weser river. For years our favorite piper Jerome led markets in the direction he wished and markets participants devoutly followed, and why wouldn’t they as over the last decade the S&P only knew one direction and that was up. Issues started surfacing at the end of 2021 when he started, ever so slightly, to take away the punch bowl and as countless experiments with, coincidentally rats, show once you do that subjects start reacting irrationally and become desperate for a fix. Comparing rodents to human beings is ludicrous, however that’s exactly what happened this week and it is extremely perilous for markets. Markets lost faith and confidence in Powell and are no longer willing to be led to the river, this time not to binge drink but to drown. The rats are jumping ship. Powell and his colleagues at the Fed have done their best in trying to control inflation by mere speech and little action, now their are paying the price and are seen as having plenty of bark but little bite. So what actually happened and why does it matter? The consequences of not having an obedient following and rather be faced by market participants in mutinous mode is a game changer and it is not us saying it, markets spoke loud and clear. As always, let’s try to give some structure to proceedings and progress in chronological order, as this was an action packed week.
Markets lost faith and confidence in Powell and are no longer willing to be led to the river, this time not to binge drink but to drown.
The week opened with an innocuous CNBC Survey, and you might rightly say “so what, who cares?”. Usually one wouldn’t pay the slightest attention to it, but reading between the lines it was evident that discontent was beginning to sprout. The reputable folk surveyed expected an aggressive “rate hiking, balance sheet slashing” Fed over the next 16 months, with most respondents believing that the process will end in a recession. The economic impact of the most aggressive double-barreled monetary tightening cycle in the post-Volcker world will be something markets haven’t experienced in at least five decades and will reverberate loud and clear for years to come and we doubt it has been properly evaluated and discounted by markets. Too many variables, complexities and unknowns for us to get our heads around. What CNBC Survey participants forecast is for the Fed to run a total of $2.7 trillion off its near $9 trillion balance sheet over two and a half years, more quickly than previously expected, and this is extremely significant as the correlation between the Fed balance sheet and the performance of equities is startling. The quick pace of tightening and the stubbornness of inflation lead the majority to believe the Fed will not achieve a soft landing, with over half saying that a recession is now unavoidable.
Monday and Tuesday were as expected relatively quiet days, the calm before the storm so to speak. All eyes, ears and all sensory systems for that matter were laser focused on Powell who’s, quite literally, every breath is at nauseam dissected and analyzed by market pundits and participants. On Wednesday, Powell was set to take center stage, as he usually does, following the FOMC (Federal Open Market Committee) monetary policy decision. In line with market expectations the Fed increased its benchmark interest rate by half a percentage point, the most aggressive step yet in its fight against a 40-year high inflation. The 50 basis points rate hike was the first in 22 years, marking the first time the Fed has boosted rates at consecutive meetings since June 2006, and it will be surely followed by another one, at the very least of the same magnitude, in June. With formalities and the FOMC announcement out of the way, half an hour later Jerome spoke and the market listened, or better as we will later discover, didn’t. Overall he did an admirable job, sounding confident and reassuring, looking like he had everything under control. Frankly we haven’t seen such an emboldened Fed Chair in a while, he was back to his best, the fearless leader that dragged the world our of the mud during the Covid lows.
Markets were all over during the day, opened negative at -1%, then rebounded in early morning trading to +1%, just prior to the Fed announcement turned flat, didn’t like the rate hike news so back to -1%, but cheered at what Powell had to say spiking up considerably and closing the day at +3%. So what did he actually say? Well nothing out of the ordinary, he kept it on script stating that; “inflation is causing hardship”, “we’re strongly committed to restoring price stability”, “the American economy is very strong and well-positioned to handle tighter monetary policy” and
Monday and Tuesday were as expected relatively quiet days, the calm before the storm so to speak.
stressed that he foresees a “soft or softish” landing. Markets frankly didn’t care for most of the above but something caught their ear and caused a violent knee jerk, rip your face off rally, that coincided with the following statement “Seventy-five basis points is not something the committee is actively considering”. There was fear that the Fed would be overly aggressive in the face of a tight labor market, obtuse inflation and an overall strong consumer during it’s June meeting and it was music to the market’s ears when Powell took a 75 basis points hike off the table. What happened next was key not only to how markets performed this week but to how they are likely to fare going forward, remember the Pied Piper analogy?
There was fear that the Fed would be overly aggressive in the face of a tight labor market, obtuse inflation and an overall strong consumer during it’s June meeting and it was music to the market’s ears when Powell took a 75 basis points hike off the table.
After a strong rally on Wednesday there was an expectation that markets had perhaps turned, US stock futures were green, a certain degree of optimism and good vibes were filtering through. It was all on the surface, the market reflected and repositioned after the FOMC decision and Powell’s speech and the sentencing was unequivocal. Futures on the federal funds rate priced in on Thursday an approximately 75% chance of a 75 basis point tightening by the Fed at next month’s policy meeting, a day after Powell, as you recall, ruled out such a move. Fed funds futures didn’t listen to Chair Powell, trust was lost, his credibility shattered. Optimists look away, our suggestion would be for you to stop
reading this at once. Thursday was beyond brutal, completely erasing a rally from the prior session in a stunning reversal that delivered investors one of the worst days in the last two years. The Dow pared over 3%, the Nasdaq sunk 5%, its lowest closing level since November 2020. Both of those losses were the worst single-day drops since 2020. For equities this change in fortune is quite extraordinary and rare, but a loss of confidence in the Fed is also one for the history books. The stalwarts of markets that held up indexes up of late all crumbled, with Meta and Amazon falling 6.8% and 7.6%, respectively, Microsoft dropping 4.4% and Apple sinking 5.6%. The pain was widespread and Thursday’s sell-off was broad, with more than 90% of S&P 500 stocks deep in negative territory. Over the last 10 years, that’s 2425 trading days, there have only been 14 instances with a worse daily return for the S&P than Thursday’s 3.7% plunge. To make matters worse for markets and tech stocks in particular, was the 10-year Treasury yield, that unsurprisingly surged back above the psychologically important 3% mark, hitting its highest level since 2018.
Sure there were other factors contributing to the rout, however we shouldn’t look much past the loss in conference in Powell and his employer. To add fuel to fire, dark clouds were gathering over the pond and on the same day the Bank of England raised interest rates to levels not seen in 13 years and hinted to possibly more aggressive action at the next meetings. This was echoed across the English Channel with the European Central Bank hiking rates by 25 basis points with worrisomely 3 of 9 members of the Central Bank voting for a 50bps raise and complaining of persistent inflation. The leitmotif of the Fed, ECB and BoE is that they are all losing control over inflation. If Powell and Treasury Secretary Yellen both spoke this week of a soft landing, their more straight talking colleagues in Europe and the UK are openly complaining about being unable to prevent inflation and are openly admitting that we are de facto entering a stagflationary (low growth, high inflation) environment, with recession firmly on the cards. A white flag is being raised as Europeans in particular don’t think they can engineer a soft landing and expect inflation at 10% by year end. Shocking numbers indeed but supply side disruptions and a geopolitical conflict are pretty immune to monetary policy. Things are perilously turning in Europe, German manufacturing for instance plunged a shocking 4.7% vis-a-vis expectations of a 1.1% decline, if these are not dire numbers we don’t know what are. If we think matters are worrisome in Europe and the US, let’s spare a though for Turkey that came out with a shocking 69.9% inflation reading this week, admirable how they bothered report the decimals, guess every little counts, although a nice round 70% number would have grabbed more headlines. Joking aside all these central banks, bar the Fed, are expecting gross domestic product to contract in the following quarters, undermining further the Fed’s credibility. Parroting “all will be just fine” and promising a soft landing has discredited Jerome the Piper, with rats let alone human beings, willing to be led to drown.
Unless supply chains heal rapidly or workers flood back into the labor force, equity rallies are likely on borrowed time as Fed messaging will have to turn more hawkish as the times of hiding behind a fig leaf are truly over. Talking of employment, the last relevant piece of macro news of the week came on Friday, when the Bureau of Labor Statistics reported that the U.S. economy added slightly more jobs than expected in April amid an increasingly tight labor market. In a snapshot nonfarm payrolls grew a fraction above estimates as did the unemployment rate standing at 3.6%, slightly higher than what the market expected. The key in the report was the average hourly earnings number as that is a very strong inflation gauge, closely monitored by the Fed. The metric grew 0.3% for the month a touch below the 0.4% estimate and also crucially on a year-over-year basis, earnings were up 5.5%, about the same as in March but still below the pace of inflation. Perhaps early signs that at least in the USA inflation might be cooling, as in tandem with earnings we are seeing used car prices, freight and rail and core CPI inflecting downwards. There were also interesting clues coming from corporate earnings suggesting that discretionary spending is trending down and hence the consumer is starting to feel fatigued and unable to match the breakneck speed of inflation, and is hence pulling back spending on frivolous items to still be able to afford the essentials.
Shares of Etsy, Shopify, eBay, Wayfair, Poshmark, Farfetch and a number of other e-commerce retailers plunged this week, echoing the waning momentum and downbeat outlook set by Amazon a week ago (as you might recall the company logged the slowest revenue growth since the dot- com bust in 2001). Sure the above had to navigate tough Covid pandemic-era comparisons, but the magnitude of revenue and earning misses are notable and the stock reaction gut wrenching. To throw some numbers in Wayfair, the online furniture retailer dropped 26% after reporting wider than anticipated losses and fewer active customers, Etsy and eBay dropped 16.8% and 11.7% respectively after issuing weaker-than-expected revenue guidance and Shopify fell nearly 15% after missing estimates on the top and bottom lines.
Something idiosyncratic needs to happen for crypto to reverse trend and to finally decouple from equities.
Cryptos have been loyal to equities and led by Bitcoin plunged markedly this week. The positive news that the Luna Foundation acquired $1.5 billion in BTC to bolster the reserves of its stablecoin, bringing it closer to its goal of accumulating $10 billion BTC hence becoming one of the largest holders of the cryptocurrency, did little to curb losses. Luxury brand Gucci announced that they will start accepting Bitcoin for payments as early as this month, if in a bull market this would have made a difference now it didn’t stem the bleeding in the slightest. Something idiosyncratic needs to happen for crypto to reverse trend and to finally decouple from equities.
It’s a tough market regardless of the asset class, and to wash our hands and leave a legendary heavyweight figure bear the brunt of your insults, in the words of billionaire hedge fund manager Paul Tudor Jones “You can’t think of a worse environment than where we are right now for financial assets. Investors should prioritize capital preservation for virtually anything.” …don’t shoot the messenger
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Alessandro Gherzi | CFO STIMA
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