Markets are in a buy loop

This week, investors are once again thinking that the Federal Reserve Bank will soon be pivoting away from its hawkish interest rate hikes. It is the same old song of misplaced optimism that has fueled the last few bear market rallies. Enjoy this one while it lasts.

Last week, I advised investors that the S&P 500 Index decline to the 3,550 level and then reverse higher. “I will use that behavior to purchase stocks. If we continue higher, buy some more,” I said.

I was off by a mere 20 points (the S&P 500 hit 3,570 last Friday). On Monday, stocks soared with all the indexes climbing almost 6% in an epic “V” shaped bounce.  As I said in my last column, “Bear market rallies, of which we have had several this year, can be powerful. The October-into-November time period could be an ideal time where we could see another such relief rally. 

Driving markets higher is another spin on Fed easing. This time traders are betting that the U.S. jobs market is starting to weaken, pointing to the number of job openings in August, which declined by more than one million, according to the Job Openings and Labor Turnover survey (JOLTS) data. Friday’s jobs data dampened some of that euphoria.

Non-farm payrolls data for September 2022 came in at a 263,000 increase, which was a bit higher than the 255,000 jobs expected, while the unemployment rate dropped to 3.5% versus 3.7% expected. Average hourly earnings were up 0.3%, in line with forecasts. Although the results were statistically insignificant, it gave traders an excuse to take profits from the week’s healthy gains.

Another key barometer, the Institute for Supply Management’s (ISM) manufacturing survey fell to a 28-month low in September as high interest rates and inflation dented growth. To the markets, bad economic news is good news for stocks.

The thinking is that the race to raise rates by central banks worldwide (the U.S. included) has been overdone. The decline in growth of global economies is happening far faster than anyone expected and if that’s true, a pivot by the Fed will come sooner than expected.

The bulls are already pointing to the U. K’s rate shock, which forced the British central bank to support the markets and trouble at Credit Suisse, a major European bank, that is worrying European regulators. Over in Australia, their central bank hiked interest rates less than expected.

All of this has created a ‘buy loop’ where bad economic data was signaling to the bulls that the terminal Fed funds rate (4.25%-4.50%) is as high as interest rates will go. That led to a declining dollar, stable-to-lower bond yields, and rising equities, as bears covered their shorts. I suspect this story could carry the markets higher into mid-November.  However, don’t expect markets to move straight up. Each economic data point (like the jobs report) will provide an excuse for traders to move markets up or down, but overall, the trend will be your friend. Dips should be opportunities to buy.

I favor beneficiaries of a declining dollar and lower bond yields to outperform in this kind of environment, focusing on precious metals, especially silver. Technology, communications services, consumer discretionary, financials, utilities and the Kathy Wood stocks will fill out my list.

Last week, silver soared 8% before profit taking set in. Oil was not far behind.  However, make no mistake, this is simply another bear market rally. The Fed will continue to warn markets that their buy loop is a work of fiction. As one Fed head put it, “don’t mistake market volatility for market instability.” Markets will continue to ignore them.

At some point, sadly, investors are going to realize that bad economic news and slower growth truly are going to be bad news for the stock market. Then, the buy loop will become the doom loop, but that will require a few weeks to sink in.

In the meantime, I expect stocks to give back about half of last week’s gains. I am looking at the S&P 500 Index falling back to around 3,650-3,675 (give or take), before again bouncing higher mid-week.

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.