Bulls battle bears for control of the markets
The equity averages have been trading just below the highs of the year all week. Those who are betting on a kinder, softer Fed in the months ahead believe stocks can move still higher from here. Others believe financial markets have moved too far, too fast.
No matter what you believe, price will tell you where we are going, at least in the short term. Younger traders are having a ball as their bosses suck up some sun on the beach during this heavy vacation month. August is a traditional low-volume period where the pros can easily push around stock prices at their whim.
In this kind of environment, retail investors can get chopped. Meme stocks, for example, are rising or falling 10% a day in a revisit of last year’s craziness. Familiar names like AMC, GameStop, and Bed Bath and Beyond are experiencing great gains followed by equally substantial losses. The same could be said for commodity, alternative energy and even retail stocks.
The macroeconomic data this week revealed that the economy continued to grind higher, inflation lower, and labor continued to gain. None of this information could give additional ammunition to either the bulls or the bears. The latest Fed news was the release of the Federal Open Market Committee meeting notes for last month, which were deemed to be slightly less hawkish. Participants appeared to suggest that although there will be more rate hikes in the pipeline, the pace could slow depending upon data.
The U.S. dollar seems to have formed a short -term bottom and has bounced more than 2% versus a basket of currencies over the last five days. And it appears the greenback will move even higher next week. The interest rate yield curve is still exhibiting an inversion where short-term rates are higher than long-term rates. In fact, the curve is deepening and lengthening. For many investors that means the chances of a recession continue to climb.
On August 27, 2022), The Federal Reserve Bank of Kansas City will hold its online, annual economic symposium in Jackson Hole, Wyoming. Many Fed watchers will be focusing on what Chairman Jerome Powell, who is scheduled to speak Friday morning at 10 A.M., may say about Fed policy. Given that the Fed’s stance on interest rates is fairly clear, the hope is that we may get some additional information on the Fed’s announced plan of Quantitative Tightening (QT).
In June 2022, the Fed’s almost $9 trillion balance sheet of U.S. Treasuries and mortgage-backed securities began to be sold down. Those asset sales will be ramped up in September to as much as $95 billion a month. However, policymakers have been vague on how these sales will impact the credit market alongside their aggressive rate hiking program.
We know that the Fed plans to reduce the balance sheet by $2.2 trillion by the end of 2024. Two Fed research papers published last month guessed that this size reduction in the balance sheet could be equal to an additional 74-basis-point hike in the Fed funds rates.
What we don’t know is how this will impact borrowing costs, financial conditions, and market functioning. The bears believe that QT has not yet been priced into the markets. The bulls argue that there is so much unused money sloshing around in the credit markets that the Fed’s plans will have little impact on credit.
Some readers have asked if I have changed my cautious stance on the market given that the S&P 500 Index surpassed my target level of 4,100 to 4,200. The short answer is no. I still expect the markets will give back most, if not all, of this rally, but it won’t be a waterfall decline. My uncertainty centers on how high buyers could push the market in the short-term. Bear market rallies can rip your head off if you aren’t careful. I am watching the 4,300 to 4,310 level for a sign of where we are going in the short, short-term. If we break that level to the upside on the S&P 500 Index, we could see a buying panic ensue that could carry the S&P 500 up another 100 to 200 points from here.
However, if we test and break down below the 50% retracement line we reached last week, which was around 4,220, then the next stop could be 4,185. I estimate the wholesale dump will begin in September (if not by the end of August), I expect a series of declines, followed by relief rallies, that ultimately end up with a bottom sometime in October.
Bill Schmick is registered as an investment advisor representative of Onota Partners, Inc., in the Berkshires. Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.