For those of you who would prefer to listen:
There’s been some turbulent price action throughout the Market in August. It’s been felt in stocks, it’s been felt in bonds, it’s also been felt in commodities. Trends reversed hard from earlier in the year, when prices had generally risen. Some assets have moved at faster paces than others, particularly in Mega Cap Tech, which shot up like a rocket ship in 2023 after being sent cascading back to Earth last year. Most other areas in the Market have experienced more muted gains heading into this Summer. Then July turned to August. Across the board, prices stopped going up in August. Not even the AI revolution could keep stock prices elevated.
America was supposed to fall into recession. A debt ceiling crisis was avoided with much less damage than anticipated, though a credit rating downgrade occurred. The former has thus far been avoided and the latter was taken very much in stride. The Market has largely been in celebration mode. That said, despite America’s economic resilience and the innovative growth theme of Artificial Intelligence, the thing that’s been hanging over the Market’s head all year has been that pesky inflation. It has surely shrunk. But it’s still there.
Inflation was on the menu in Jackson Hole, Wyoming this week. The Kansas City Fed has held its annual summit in the Rocky Mountain town for 5 decades. Jackson Hole is known for skiing and fly fishing. Wildlife thrives in the region with Moose, Wolves, Buffalo, and Elk cruising the terrain. Bald Eagles can be spotted there too. This week brought more creatures to the countryside, namely Hawks and Doves, Bulls and Bears. These creatures are well known on Wall Street and play a significant role in the Market.
Bulls and Bears need no introduction to this audience. Though a Bull Market reflects prices going up and a Bear Market sends those prices down, it’s never been confirmed how those names came to be. The most common explanation for the terms is that Bulls attack with horns thrusting up while Bears attack with claws striking down. There’s also a plausible explanation for the Bear derived from fur traders a couple of centuries ago. Those early traders would sell skins ahead of time, before obtaining them. The traders hoped to buy the fur from trappers at a lower price than what they’d sold them for and keep the difference for profit. It’s similar to shorting a stock, where you sell it first with hopes to buy it back at a lower price. Thus, “Bears” became synonymous with a declining market. It’s of course a tale, but it’s interesting fodder, nonetheless.
All eyes were on Fed Chair Powell in Jackson Hole this week. You may recall, last year’s speech triggered a 4% Stock Market decline on that Friday, which ultimately resulted in a 20% free fall into October’s Bear Market low. I sure remember it. It was a speech remembered for the term “Pain.” The Fed Chair shot down any hopes that the Fed would “pivot” from its aggressive rate hike policy to one that was less restrictive. Remember, the Fed has a dual mandate of price stability and maximum employment. Unemployment has been near 5-decade lows. But prices have been anything but stable. He said last August, “Without price stability, the Economy does not work for anyone,” He went on to say, “restoring price stability will take some time. It will bring some pain to households and businesses.” That was a big statement, which was a new tone from this Fed Chair. These are the unfortunate costs of bringing down inflation. Powell made it clear; The alternative was far worse.
Fast forward a year, inflation has come down significantly. And there hasn’t been as much pain as the Fed Chair anticipated. Economic growth has shockingly expanded at an impressive rate since that speech, while the unemployment rate has stuck to record lows. The Stock Market rallied like it was 1999 again, almost taunting the Fed’s resolve to fight inflation. But the Fed Chair has maintained his hawkish stance. The term Hawk is used to describe aggressive monetary policy to kill inflation, while Doves are considered softer and peaceful. This week, there was no mention of pain. There was no mention of rate cuts either. And perhaps most important, there was no mention of Mission Accomplished. The war on inflation continues.
The Fed has been navigating a tough challenge with little precedent for success. It’s trying to bring down inflation without killing the Economy. A soft-landing is the goal. That’s no easy task. So far, it’s been much more successful than anticipated. But it’s not there yet. The Fed has a serious labor conundrum. Unemployment is at 3.5%, the lowest levels since the 1960s. Chair Powell says unemployment needs to rise to 4.5% to get inflation down. The problem is that’s nearly 2 Million American jobs that would be cut. That’s the pain he referred to last year. It appears that pain got pushed out to later this year, which would really be felt next year.
Powell said the Fed would “proceed carefully” with any further rate hikes. That’s a signal that another pause could come at their September meeting. But the Fed Chair gave no indication that rate hikes are done. The Market currently assigns just a 20% probability of a rate hike in September, but 60% likelihood of one in November. It’s a tight spot they’re in. The Fed is committed to combatting inflation, but it has to recognize it has done a great deal of work towards that end already, and time is needed to work through the system. They run the risk of doing too much and forcing America into a deeper slowdown than the one already in place. Getting from 9% inflation to 5% was seemingly the easy part. Getting from 5% to 2% is much harder. The big question is, what do you have to give up to get there?
Chair Powell used the metaphor of navigating by the stars under cloudy skies to describe the challenge they face. I sure get it. These 2020s have been anything but clear vision. There’s some serious irony there. And there’s no sign of much clarity anywhere on the horizon. That goes economically, politically or socially. Stars are the data relied on to make informed decisions. Celestial navigation meets the Digital Age. But it doesn’t always work. In the absence of data, you rely on experience and instinct. Natural intelligence is still a really important thing that doesn’t seem to get us much fanfare. The captain of the ship is responsible for all. Great captains are willing to go down with the ship.
The Market has definitely been in motion. August triggered correction mode. This week brought a potentially important event. There was what’s known as an “outside reversal” on Thursday. It’s when the Market or a stock spike higher, but then reverse lower, failing to hold the gains and closing the session at the lows of the day. Outside reversals also have the highs and lows exceed the previous day’s levels. It’s not Bullish. It’s actually the opposite. Outside reversals tend to be Bearish. It is often an indication that a trend change is at hand. But it doesn’t always lead to an extended Bear Market price action.
We all know how the Market can mess with investor psychology. In fact, it’s sort of designed to do so to achieve true price discovery. Here’s the psychology of an outside reversal day:
Investor enthusiasm sends a stock or the overall Market immediately (and usually appreciably) above the previous day’s high price. It’s generally buyers reacting to news and the fear of missing out, which creates a sort of buyer’s panic. But the strength is fleeting with just that initial emotional morning charge. Prices stop going up and start to fall. Buying freezes. Selling takes over. The enthusiasm turns to skepticism as prices fall below the previous day’s high. Pessimism turns to fear as buyers are immediately underwater and prices fall below the previous day’s close. Now all buyers for the previous 2 days are sitting on losses in what feels like an instant. This happened Thursday on good news out of Nvidia, the Market darling and undisputed leader in AI. A blowout quarter from Nvidia was not enough to revive the strong bid under Tech stocks and the AI theme, which has been the dominant driver this year. When stocks stop going up on good news, that gets our attention.
The fact is what worked in July has largely not been working in August. Tech has been for sale. That is new. “Buy the dip” switched to “sell the rip.” The major indexes closed in the green to head into the weekend. That cushions the blow a bit. But there’s still plenty of unfinished business that needs to be attended to.
A government shutdown in October is looking increasingly likely. There’s not much that political parties can agree on. Congress is still on recess through Labor Day. Our government representatives will have only 12 legislative sessions before government funding expires September 30th, the fiscal year-end. The Treasury Department has been issuing bonds in large quantities to help shore up its reserves, which were near depleted during the Debt Ceiling negotiations. Treasury may just be trying to raise funds ahead of another political showdown. It’s putting upward pressure on yields, a dynamic that also reflects the risk that Fitch warned against in last month’s credit rating downgrade.
This, on top of a natural economic slowdown after feverish consumer spending for much of the year to get out and about following the extended lockdown fatigue from Covid. Travel and Entertainment had a revenge tour the Summer of 2023, which is coming to a close. In addition, earnings growth has stalled, and the Street still expects a re-acceleration of growth into year-end, which looks to be at risk. Retailers have reported some sluggish sales numbers and the American Consumer is already pretty levered. The Market is showing some clear signs of speedbumps ahead.
It’s also incredibly important to remember that we have operated in an artificial Market environment for a decade and a half with free money and zero interest rates. The result was asset bubbles and multiple boom-bust cycles. Remember when there were negative interest rates? That was never normal nor healthy. Money is free no longer. In 2020, there was over $18 Trillion in negative interest rate securities, accounting for nearly 1/3 of the Global Bond Market. Today, 80% of the Global Bond Market yields over 4%. What a difference. The Bond Market is a legitimate alternative to the Stock Market and borrowing costs are significantly higher than they used to be. Higher rates matter and the effects are still being worked through the Market.
We expect the price action to remain a bit choppy as the Market works through all of these issues. We know how to navigate choppy waters and have many resources, celestial, experiential and instinctive in nature. We don’t get motion sickness. We know what to do.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
