January 27, 2022
Good morning,
It looks like yesterday morning’s rally was just a pre-Fed meeting drift and not a stronger, lasting shift away from correction mode for the markets. The tantrum continues I suppose. I haven’t used that word to describe this month’s market decline but I do think that’s what we seeing. Tantrum – anger (sometimes extreme and uncontrollable) rooted in the removal of something the aggrieved has become dependent on for happiness; a toy, a drug, money.
Of course uncertainty is way up around higher inflation and how fast the Fed will respond to it. And I think the market has been trying to discount these known unknowns each day for the past few weeks. But I think there is something else here as well. The Fed punch bowl, the largest infusion of raw cash into global markets by central banks around the world, the Fed Put – it’s all gone. And the market is throwing a tantrum.
I view yesterday’s sell-off following Powell’s comments as more tantrum. It wasn’t what he said – which contained no surprises – it was what he didn’t say. There was no dovishness, no sign of any willingness to take care of risk takers, as this Fed has been known to do. No hint of a Fed put. Fortunately this month’s tantrum has been centered on the most speculative areas where so much of the stimulus ran to. The meme stocks, the bankruptcies issuing new shares, crypto – they have been crushed, that money has been vaporized. Thank God, maybe now we can get back to normal risk-reward relationships in capital markets.
Why should we expect this market, with record valuations from record central bank stimulus, to maintain the high valuations after the free-money stops flowing? I think this is what this correction is all about – a multiple compression. Markets are resetting valuations in a no-more-free-money world.
As a risk manager, I think aligning portfolios with prevailing trends is essential for success. The biggest trend of the past 2yrs has been the cyclical bull market following the cyclical bear market that was ushered in with Covid-19. The normal life cycle of a bull market in a normal economic expansion follows a pattern of more frequent and deeper corrections as the bull ages. Corrections, by definition are followed by the resumption of the bull – defined as higher highs followed by high lows (think zig-zag to the NE corner of the page of a chart of index prices). The trend officially changes when a new high is not attained before a lower low is made (the zig-zag rolls over and heads E or SE). For the record, a bear market trend is defined as a lower low followed by lower high and order is important.
This month’s correction has been sooner and deeper than all the others that have preceded it over the past 2yrs. Damage has been done, and in some of the most speculative areas of the market, the bull market there is dead – I doubt many of these names will make the 80 and 90 percent moves upward to set new highs anytime soon. But, for the broader market not in La-La-Land, the bull may not be officially over. If this market’s correction is bottoming – and it still may be, even with yesterday’s shenanigan’s – then it is too early to call the bull market officially over. I’ll let the professional technicians make that call ultimately, and it will be dependent on the bounce following this correction, and how high it can go.
My opinion, and I’m not front running the models- they are smarter than I am, we’ve seen that already. But looking ahead, I believe that there will be a bounce to this month’s correction, I just think that multiple compression for the broader market will put a wet blanket on the bounce. I doubt the S&P 500, for example, will bounce back to higher highs. I expect to evaluate the bounce, whenever it finally comes, and determine then if a trend change has occurred (according to the model) and set portfolio’s trend alignment.
Sounds ominous, but I don’t think it will be. Bear markets have lower return characteristics and higher volatility, are not fun, but rarely decimate portfolios. If it comes, we just have to adjust our expectations to much lower returns than we’ve had recently. Personally, I think this period will be defined something like this – The removal of free-money neutered the Bull, but TINA (There Is No Alternative) de-clawed the Bear. Single digits as far as this eye can see.
Be well,
Mike