In comments last week, we found that the S&P 500 (SPY) was range-bound, but “it may be prudent to step back and risk exposure” due to signs of weakness such as rising credit spreads and a weak growth outlook. However, I did not anticipate the speed and intensity of the fall. We are down 8.7% since last Thursday. The reason is obvious. Rising credit spreads indicate greater financial stress, while a weak growth outlook means more economic stress. Then, you have the Fed hiking more than you expected and taking an even more drastic stance, despite the sharply slowing in many parts of the economy, which are just starting to rip through the system. Today’s remarks will consider this issue in more detail. read below….
(Please enjoy this updated version of my weekly commentary published June 16thfrom 2022 Power Stocks Under $10 Newsletter,
First, let’s review last week…
The S&P 500 is down 8.7% in the past week. More losses occurred on the Nasdaq, which was down 9.4% and the Russell 2000, which was down 10.7%. Another notable development was the action in Treasury yields. The 2-year yield hit a new high of 3.45% and the 10-Y hit a high of 3.48%.
There are 2 problems here. One is that rates are at their highest level since 2011. And, it’s not necessarily the level but how we got there — in accelerated growth with rates more than doubling in the first six months of the year.
This will blow away any business/industry/business that rely on low living rates. Just look at crypto and all leveraged players.
In most economies, it can be absorbed with minimal collateral damage as growth in other parts will offset the weakness. This is not the case in a fragile economy like today.
The second problem is that the yield curve is flat as shown by the tight spread between 10Y and 2Y. This is proof that the market is pessimistic about the economic outlook.
Earnings and Rates
If you somehow lose your mind and decide to watch CNBC every day from Monday to Friday from 9:30 to 4 p.m. amidst all the noise and time-out, in terms of affecting market prices. Items will be important.
-> Earnings and Interest Rates.
Earnings are straightforward, and it’s self-evident to any investor why this and its trend matter.
Rates are tricky because there are so many factors involved. On the short-end, it is subject to the discretion and influence of the Fed. The longer the period, the higher the market’s assessment of other factors such as inflation, economic growth, political stability, etc.
But, rates and their trend play a big role in determining the market’s multiples. Right now, we are in a state of deteriorating earnings outlook while contracting manifold due to higher rates.
This is the reverse of what we experienced in 2020 when stocks climbed steadily with an improving earnings outlook and the Fed kept its foot on the accelerator and firing the fiscal policy bazooka.
2 bad triggers
Over the past week, we found 2 catalysts to push rates higher (and lower multiples). In turn, it is the main contributor to the sell-off.
CPI came in above expectations. Inflation continues to rise, and the rise in food and energy prices is worrying. Then, the Fed came out and was faster than expected with a 75 basis point increase, and Chair Powell focused heavily on gasoline and energy prices before saying it had succeeded.
High prices have 2 solutions. One is to reduce demand by inducing a recession. The second is to invest in new supplies.
In terms of energy, reducing demand may be a short-term solution but in the case of gasoline over the long term would have to involve more supply or capacity. Assuming the Fed is successful in inducing a recession, will we short-circuit a much-needed CAPEX cycle in energy production?
The combination of falling earnings and rising rates is poison for equity prices, especially when they are falling and rising at a faster rate.
Our nascent bullish case (RIP) since late May rests on this assumption of China coming back -> earnings growth and inflation turning a corner -> falling rates.
Both were wrong. We cut our losses and mitigated risks but should have acted more aggressively while bearing the brunt of the loss.
At this point, I don’t see a catalyst for things to change beyond just a major capitulation in the markets, a Fed pivot, or a turning point in oil and gas prices. And, as you’ll see in our portfolio discussion, I really don’t think the latter is crazy.
What to do next?
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Chief Growth Strategist, StockNews
Editor, POWR Stock Under $10 Newsletter
Shares of SPY were trading at $367.56 per share, up $0.91 (+0.25%) on Friday afternoon. Year-on-year, the SPY has declined by -22.37%, while the benchmark S&P 500 index has gained 2% during the same period.
About the author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for almost a decade. Their goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist and Editor of StockNews.com power growth And $10. power stock under Newspaper. Learn more about Jaimini’s background, with links to her latest articles.
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