For those of you who would prefer to listen:
Good riddance; This week. This month. This quarter. September has historically been the worst month on the calendar for stocks. It sure lived up to its reputation this year. On to October and Q4.
September was bad for bonds too. Yields jumped as the Fed doubled and even tripled down on its commitment to combat inflation at all costs. Demand has been destroyed. That is precisely the Fed’s goal. The costs are racking up. Significant damage has been done to the capital markets. The Dollar has spiked against every foreign currency. Rising yields and the strong Dollar have a chokehold on the Market. Asset prices have collapsed as buyers retreat. 2022 has been a year like few others in modern history. A reprieve will come if and when the Fed relents. The Market has sounded the alarm.
This was a wild week for rates and currencies. It sent global stock markets haywire. The British Pound Sterling fell to $1.03, its lowest level against the US Dollar in history. The new administration led by Prime Minister Liz Truss, announced a series of tax cuts and increased spending that sent shockwaves through the system. This was the most aggressive tax-cut plan coming out of London since Margaret Thatcher occupied 10 Downing Street in 1988.
The British plan to borrow more in order to pay for the tax cuts. The Market believes a borrow and spend plan lacks fiscal discipline. This, as Great Britain and the rest of Europe stare directly in the face of recession with elevated inflation. The controversial British tax plan drew criticism from the IMF, Moody’s and the White House. The IMF (International Monetary Fund) urged Prime Minister Truss to “re-evaluate” the tax cuts, warning that this action will likely trigger a cost-of-living crisis. “Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy.” The British pushed back. They’re going to do what they’re going to do.
At first, stocks and bonds sold off aggressively in response to the tax cuts. Yields soared, taking bond prices down. It created a great deal of stress in the system. The Bond turmoil in the United Kingdom led to the Bank of England (BOE) stepping in and buying bonds in the open market. That was a complete reversal from its rate hike and tightening campaign, which is similar to that of which the Fed is undertaking in America. The jump in rates made government borrowing costs surge. The BOE wanted to put a stop to that. The British central bank suspended the planned start of its bond selling next week and started buying long-dated bonds in size, describing it as “whatever scale is necessary.”
News breaking that the BOE was buying bonds sent a charge into both bonds and stocks around the world on Wednesday. The yield on the 10-Year Treasury hit 4% for the first time in a decade and a half earlier in the week but reversed hard as bonds rallied. Stocks rallied too, putting an end to the 6-day slide on the S&P. The rally only lasted a day. Selling picked back up to close out the month and the quarter with concerns that inflation will linger, the Fed will break the Economy and the whole world will end up in recession. The end to Q3 saw a complete buyers’ strike for stocks.
The British Pound has declined 17% this year against the Dollar and has been cut in half since 2007. The Pound Sterling was trading as high as $1.70 in 2014. For perspective, a property in London listed at 5 Million Pounds would have cost $8.6 Million in 2014. It’s basically even at $5 Million this week.
A strong Dollar is a great tool for foreign travel. Both the Euro and British Pound are at multi-decade lows, with the Pound touching a level never before seen. The Euro is now below parity against the Dollar. European vacations are on sale. A 40 Euro bottle of wine in Paris would have cost $53 in 2014. It costs $47 now. A hotel in London at 600 Pounds per night would have cost $1,020 in 2014. It cost $618 this week. Currencies don’t normally move this fast or this frequent. It’s a sign of stress and confusion. That’s a theme in 2022.
As beneficial as the strong Dollar is for trips, it’s terrible for overseas sales. We will see the impact as Earnings Season begins again in October. The US Dollar is up 21% against a basket of foreign currencies. Roughly a third of the S&P 500 revenue comes from outside the United States. It is estimated that every 1% change in the Dollar has a -0.5% impact on S&P 500 earnings. That means that Q3 earnings will face an approximate 10% headwind to sales growth overseas. That is yet another pressure that the Stock Market faces in 2022. The Stock Market needs the Dollar to stop rising at this meteoric rate for it to find a bottom.
September also brought one of the most devastating hurricanes in American history. The west coast of Florida was hammered with winds up to 150 mph and rain approaching 30 inches in some regions. Economic damage estimates vary, but the cost of recovery from Ian could exceed $70 Billion. 2.5 Million customers in Florida were without electricity. It is so tragic to see so many people’s lives turned upside down overnight. Fires out west and flooding in the southeast; America keeps facing emergencies. It will likely exacerbate food inflation too.
Florida orange production was already expected to be poor. The Department of Agriculture said that orange production was already estimated to fall 13% to the lowest in over 55 years. That was before the storm. Tropicana and Minute Maid shut down their facilities in anticipation of the hurricane. They are still assessing the damage.
Over 2,000 flights were canceled, and 14 oil rigs were shut down in anticipation of the storm. Florida’s biggest seaport in Jacksonville, as well as Port Canaveral, joined Port Tampa Bay in shutting down completely. They are expected to re-open this weekend. Disney World closed Wednesday and Thursday. The park re-opened Friday to a smaller crowd. To put things in perspective, the state of California averages 22 inches of rain for the year. Many regions in Florida got that in less than a day. Returning to normal will take time, if ever.
Back to the Market: The path of least resistance has clearly been lower. The Fed has been stubbornly steadfast in its war on inflation. It is committed to killing it at seemingly any cost. The Fed policy is completely choking off demand. The Housing Market reflects it. The Stock Market reflects it. The American Consumer reflects it. Until the Federal Reserve releases the choke hold, this stage of the cycle will remain volatile and pressured.
Things are incredibly oversold. But oversold does not mean the selling pressure is over. We haven’t seen extremes in negativity like this in years. This week had only 3% of S&P 500 stocks above their 50-day moving average. Only 16% are above their 200-day. This is extremely rare.
In the case of sentiment, never. For the second week in a row the American Association of Individual Investor Sentiment Survey recorded over 60% of recipients said they were negative about the Stock Market for the next 6 months. There have never been back-to-back 60% Bears in the history of this survey which began in 1987. The extreme readings in breadth, momentum, and sentiment raise the odds for at least a potential relief rally. It just hasn’t happened. There have been few places for investors to hide in 2022.
This has been a relentless bleed lower but no capitulation. Wednesday appeared to be a reversal in the making, but that proved short-lived. Earnings are likely to play an increasingly bigger role in the next move for the Market. Expectations have come down. Are they down enough? The Street is now looking for S&P 500 EPS to increase 3.2% for Q3. That is down from 9.8% at the start of the quarter. Ultimately, it’s earnings that drive stock prices. Wherever the low ultimately ends up being, chances are very high that it doesn’t stay down there very long.
I say sayonara to September. We now enter the strongest seasonal period for stocks. October tends to bring bottoms before a year-end rally. 2022 is clearly not normal. But there’s a lot of bad stuff already priced in. A reprieve is way overdue. Any sign that the Fed even thinks about pausing to reassess the situation and the damage they’ve done would likely lead to a powerful rally. It’s pretty bad out there. We haven’t seen things like this in quite a while. We are still on the defensive. But everything gets hit in a Bear Market.
Given the oversold condition, the crowded Bearish sentiment and even the Fed’s position, one has to think about what needs to happen for things to be less bad. One has to ponder about the possibilities of the other side of the trade. Remember, it takes 2 to make a market.
This firm has been around since 1975. I’ve been here the last 20 years. We’ve seen a lot. We’ve been through a lot. Tough times don’t last. Tough teams do.
Hang in there. We’ve got this.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
