Market On Open - Tuesday 7 May

Market On Open - Tuesday 7 May
“When The Fed Cuts Rates, Equities Be Like … “ // Photo by Kym MacKinnon / Unsplash

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Transient? Again? So Soon?

by Alex King

In 2021, the rising inflation in the US that followed unprecedented monetary stimulus was deemed “transitory” by the Fed, justifying the preservation of ultra-low base rates for a lot longer than may have first been expected. Given the meteorite-level damage wreaked on the global economy by the impact of Covid-19 - at many levels; deaths and long-term sickness meaning less productive and less consumptive capacity, behavioral changes meaning that folks spend less time indoors in stores and offices even once lockdowns ended, and broken supply chains causing producer-side inflation up and down the value chain - perhaps the Fed was right; perhaps better to keep fueling the economy at the risk of inflation. Ultimately, inflation is bad for poor people. Rich people can either benefit from it - because they set prices - or can be sheltered from it - because they can afford higher prices and because they can do fancy things like hedge their equity positions when market downturns come along. Poor people can just afford less. On the other hand, rising GDP and rising comparative GDP vs. other countries is generally speaking a good thing for all participants in that country’s economy; the US has emerged from Covid with high levels of consumer wealth, record equity prices, rock-solid corporate balance sheets, so, if gas is too expensive for those who can least afford it? That may prove to be a downside worth trading from the perspective of DC and, indeed, Wall Street.

This time though?

At the moment the Fed is performing various feats of linguistic and statistical gymnastics to explain that inflation is just fine, sure it’s not coming down as quickly as hoped, but it’s just fine. It will get there. Transitory.

Well, maybe. If we look at the behavior of the S&P500 and the Nasdaq since their respective all time highs in April (S&P) and March (Nasdaq), we can argue about causation and correlation but the facts are:

  • After hitting those ATHs, each index started to dump
  • Each index rallied after the dust settled on FOMC (my own guess is because Powell signaled a reduced rate of QT and a modicum of QE - taken together that means more liquidity in the system which means risk asset prices up, all other things being equal - but this is just a guess of course, the cause could have been unseasonal levels of relative humidity in southeastern Kansas).
  • Each index rallied further on a weak NFP print Friday (my guess being because this meant that monetary policy looked still too tight so the prospect of further easing = more liquidity was bullish).

So whatever the causation, if you just follow price you would say - sure does seem like the market is looking for easier monetary policy in order to keep rallying. Or put another way, it’s not really about earnings right now, it’s more about the liquidity.

At some point though, inflation does have to look like it is getting under control with the dials at the Fed set in the current positions - else the Fed will have to change the dial, and not for the better from a risk asset perspective. If you stand back and look at the macro data right now, what you see is inflation a little higher than expected and GDP growth a little lower than expected. That’s not a wonderful look and it has the potential to set the Fed up for a more hawkish approach to life - and that has the potential to drive risk asset prices back down.

You know that personally my belief is, just watch price; anticipate, don’t react. That doesn’t mean go through life with your eyes closed. It means be aware of the surround sound so that if a market reversal hits - to the upside during a bear market or to the downside during a bull market - that surround sound can help you work out whether the reversal is likely to have legs or just be a small countertrend move. For now I think the selloffs from the March/April 2024 highs to the 19 April lows were small countertrend selloffs. And even if we get another selloff soon - down to around the 2021 all time highs maybe - that can still be a countertrend correction, setting up for a new bull leg up. My basic expectation is that we remain in a bull market. But if we see talk of the Fed hiking? It’s time to dig out the hair shirt from Q1 2022, ditch the La Croix and start drinking filtered pondwater, first hedging (to see if it is all just some kind of Wall Street joshing at the expense of the poors) and then going net short with our old friends SQQQ, SPXU, SDOW, TZA and so forth. In order to keep the money rolling in whilst everyone around is heading for the hills.

For now, the bull is alive. But it pays to keep ones’ eyes open. So that’s what we’re doing.

And with that in mind, without further ado, let's get to that daily market analysis. As always we cover all four primary US equity indices (the S&P500, Nasdaq-100, Dow Jones-30 and Russell 2000); bonds (TLT), volatility (the Vix), oil (USO) and sector-specific ETFs. We provide long- and short-term insight daily and we include coverage of leveraged ETFs which - if you have gotten sharp at the rotation and hedging methods we teach - can be used to very good effect. All of this features daily in the pay version of this newsletter.

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