For those of you who would prefer to listen, I put together an audio podcast for your listening pleasure.
Summer volatility sure has a grip on the Market. It’s been that way all year. A 20% decline for the first half of the year was followed by a 19% rally midway through August. The Tech-heavy NAS was up over 20%. That rally stalled a week ago, but saw a second wind this week, only to be turned back again. It came to a screeching halt on Friday and reversed lower. The Dow fell 1,000 points. The S&P was down 3.3%. The NASDAQ was down 4%. The Friday sell-off was driven by activity in a small Rocky Mountain town called Jackson.
Jackson Hole is a large and majestic valley in western Wyoming. It is bordered by the jagged peaks of the Tetons, close to Grand Teton National Park and Yellowstone. Jackson Hole is known for skiing, fishing, mountain biking, rafting, camping, quaint restaurants, and wildlife. You probably don’t think of it with visions of a bunch of bankers. But a bunch of bankers were there this week. In fact, they make a pilgrimage to Wyoming every August. The Jackson Hole Economic Symposium has been an annual event held in this Wyoming town since 1982. It is one of the longest-standing central banking conferences in the world. The conference is sponsored by the Federal Reserve Bank of Kansas City. Jackson Hole was selected for a reason. Then Fed Chair Paul Volcker loved fly-fishing. Organizers knew this location would get him to attend. At 6 foot 8, with cigar in hand, Paul Volcker loomed large. 3 years since his passing, Paul Volcker still does.
Jackson Hole is home to beautiful landscapes, topography, and rare wildlife. You might be lucky enough to see a moose strutting through town; I did when I was there. It was a memorable moment to see the big antlered beauty make its way down Main Street. This week you could see the bankers stroll, sit, hike and talk economics. For a couple of days, it might have looked more like Wall Street. Bankers aren’t known to be wild. They might not be as interesting to look at as a moose, either. But they certainly made an impact while there, and have influence in the behavior of 4 notable animals that feed on central bank rhetoric. This week the Bears and the Bulls, and Hawks and Doves converged on Jackson Hole too.
The Federal Reserve has what’s known as a dual mandate: Price stability and maximum employment. Pricing has been anything but stable of late. We’ve been dealing with sky-high prices not seen since the 1980s. The Fed has effectively declared war on inflation. Unemployment is at 5-decade lows. Most companies still can’t find enough workers. The Labor Market is out of balance. If that changes, the Fed might have more reason to pause. Right now, they do not. Fed Chair Powell’s goal was to convey the central bank’s resolve to push inflation down closer to its 2% goal, even at the risk of raising that 3.5% unemployment rate and stalling the Economy. Friday, he made it quite clear he’s not backing down.
The Fed Chair said Friday they plan to fight inflation until the job is done. He’s been saying it for a while. The Market had not really believed the Fed’s resolve on this subject. It is still pricing in actual rate cuts next year, as if the central bank will flinch with a recession. “Without price stability, the Economy does not work for anyone,” said the Fed Chair. Prices have not been stable. They’ve been anything but stable. He said, “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 is far worse.
Fed Chair Powell invoked Paul Volcker, who had the guts and temerity to whip inflation at any cost 4 decades ago. Powell said that proof that inflation is coming to an end is required; Not the anticipation of proof. The Market did not like that. Powell showed some guts when many Market participants have considered him weak. He was definitely not weak today. Powell has been considered a Dove throughout his tenure at the Fed. Friday he was a complete Hawk. Volcker was the ultimate Fed Hawk. It should be noted that while Paul Volcker’s legacy is widely positive and popular today, he was not popular at all back then.
The Bond Market has been unsettled. It’s been working hard this week to price in these anticipated events. Yields jumped which, as you recall, takes down Bond prices. The Bond Market has been pricing in more Fed pressure, despite the risks of an economic slowdown and even recession. The yield curve remains inverted. The 2-Year yield is higher than every maturity date thru 2030. The 2-Year yield has now round-tripped back to where it was at what’s perceived to be the Peak Cycle Inflation earlier in the Summer. That tripped up the Stock Market then. We shall soon see whether it does it again.
The benchmark 10-Year Treasury yield moved quite a bit too. It’s back above the 3% level. But it’s nowhere near its highs from June. Same goes for the 30-Year Treasury, which anchors the back-end of the yield curve. This flattening of the curve is the Bond Market saying the Fed will keep hiking the overnight rate to fight inflation but will ultimately result in recession. The only question is whether this landing will be soft or hard. The Stock Market was much more giddy than the Bond Market heading into the meeting. The Fed chair sure changed that with a clear reality check. The disconnect between the Bond Market and the Stock Market seems to have been resolved. The Stock Market thought a Fed pause was coming with inflation peaking. The Bond Market did not. The Bond Market was right. The Stock Market limped into the weekend, quite humbled again.
This War on Inflation is going to take more time. The War in Ukraine led to soaring prices, most notably in food and energy. Rents have been stubbornly high too. The price of Crude Oil has fallen nearly 30% since the Summer highs, with WTI below $100 per barrel. That’s led to gas prices falling for 70 straight days. That’s a really good thing. They’re still higher than they were a year ago. And Natural Gas prices just hit 14-year highs in America. The cost to cool or heat your home keeps climbing. It’s far worse in Europe. Europeans have been importing American Natural Gas at record rates in response to Russia’s actions. That will keep prices high for a while, particularly with a cold winter, both here and abroad, ahead.
Housing has also cooled big time. New single-family home sales have declined 38.5% over the last 6 months. That is the largest since 1980 and the 2nd worst on record. Demand for mortgages fell to 22-year lows. 5%+ mortgages buy a lot less house. The average American homeowner has their house representing nearly 70% of their overall wealth. People feel richer when their house goes up in value. The reverse is true too. The reverse is happening now. There’s also been a big jump in electricity prices, driving roughly one in six American households to fall behind on utility bills. This is a big deal. It follows AT&T’s announcement earlier that its customers are failing to make its monthly payments with increasing frequency. That’s a clear economic slowdown signal right there. That’s an example of the pain the Fed said households can expect to feel.
Back to the Market: The recent price action is reminiscent of another Bear Market rally. They tend to be the most powerful. Bear Markets are notorious for sucking people back in, thinking the worst is over. They prove to be fake-outs. It’s tough to see a bullish theme right now. That, in and of itself, can be quite bullish. The Market is definitely going to bottom before the data does and the Fed moves. It’s just that there are so many issues yet to be resolved. That has us staying defensive. The herd continues to be very negative. It’s not as negative as it was in mid-June, which had sentiment more sour than even during the Financial Crisis. It was that bad.
A case can be made that the June lows prove to be the lows for the year. We can see that and have not ruled it out. But the dynamics at play are still quite unsettled. The inverted yield curve is that flashing yellow light of caution, a warning which we heed. We have been navigating this rocky terrain all year. Bears and Bulls come with this territory. We’re familiar with this environment. We’re getting through it.
Get ready for a choppy September. We know what to do. We’re ready.
Have a nice weekend. We’ll be back, dark and early on Monday.