The Skies Have Not Cleared Yet.

Over the past few weeks, the macro environment has generally become “less bad” and that does justify some kind of a rally, but it’s important not to confuse “less bad” conditions with actual “good” ones. It’s also important not to mis-interpret year-end seasonal factors and positioning, combined with a sudden burst of optimism, with the implication that this has sown the seeds for a sustainable rally and an end to all this volatility. We saw in full technicolor (mostly red) last week that it has not. Not yet. When the day finally arrives when the Fed stops hiking rates, that’ll doubtless be one big negative out of the way. But the question will then become; “just how bad is the economy?” And the answer could well be along the lines of; “pretty damn bad”. Even if the Fed stops hiking interest rates after the December or February meeting (far from a sure thing), economic growth will likely continue to roll over and corporate earnings will remain under pressure. A stagnant economy and falling earnings do not create a good environment for stocks. In that scenario, earnings are likely to be depressed until the Fed finally pivots and starts cutting rates again to stimulate the economy in an environment where it feels inflation is at least mostly under control. Mid 2023? End of 2023? 2024? Who knows? I’m not trying be a complete Debbie Downer here. Some good things are happening and there’s been a tangible improvement in market conditions in recent weeks - but this stuff had been aggressively priced in to stock prices already and we got an acute reminder last week that there are still plenty of major obstacles for risk assets including still-rising interest rates, slowing growth, still-high inflation and falling earnings, not to mention China COVID, the supply chain, Ukraine and the cremation of crypto. The problem is that there's still enough good news to eventually mean more bad news. The current Catch-22 for stocks is that if the economy is too strong, it means more inflation and more Fed tightening, thereby hurting stock valuations. If the economy is too weak, it can mean lower earnings, thereby hurting stock valuations. Ending up on that narrow strip of middle ground is going to be very tricky. The skies have most certainly not cleared yet. Much of last week was spent playing a waiting game before next week’s avalanche of critical data (see THIS WEEK’S UPCOMING CALENDAR, below) and, as has been the case lately, when the market is awaiting something to give it a renewed sense of direction, it tends to just sink steadily lower while it waits. US equities tumbled early in the week as a better-than-expected report on the state of the services sector raised more “good news is bad news” concerns that the strong economy will prompt the Fed to keep increasing interest rates to bring down inflation. Market interest rates jumped, tech stocks got pounded again, bond prices fell and the so-called “fear index”, the VIX (see LAST WEEK BY THE NUMBERS below) spiked 8% in a day. There was also a consistent drumbeat of caution from major bank CEOs last week, including those of Bank of America, Goldman Sachs, Morgan Stanley and others at the Goldman Sachs Financial Services Conference, throwing micro-economic fuel onto what had previously been a mostly macro-economic-driven fire. We learned that the rate of wholesale inflation of raw materials is broadly heading in the right direction, if a little more slowly than the Fed would ideally like. Data released last week showed the Producer Price Index (PPI) rose 0.3% in November, a little higher than expected but no higher than the month before and was up 7.4% from a year ago, easing from 8.1% year-on-year in October. Core PPI, which excludes volatile food and energy prices, also climbed 0.3% and was up 4.9% year-on-year, down from a rate of 5.4% the month before. The market is very much on edge ahead of next week’s Consumer Price Index (CPI) retail inflation report on Tuesday morning. Any indication that prices remain elevated and that inflation is proving to be more sticky than the recent narrative has led us to believe could be very damaging. This market narrative, that the Fed seems to have finally broken the back of inflation, had been the dominant one for the last few weeks but doubts certainly began to creep in last week and if this is just the latest example of an Emperor with no clothes like all the other false starts of 2022, things could get ugly. The very next day comes the announcement of the Fed’s final interest rate hike of 2022, with a half a percent increase all but certain, but with the tone and nuance of Chair Jay Powell’s ensuing news conference likely to prove critical to the market’s reaction. And then the day after that, we will hear from the European Central Bank (ECB) on what they are doing with interest rates over there. Strap in, this could be a frenzied week one way or the other. As I constantly have to do every few weeks, I do want to emphasize that for investors with significant time horizons (15/20 years +), we are experiencing what could be a once every 10-20 years buying opportunity, regardless of any gloomy stuff you may be hearing or reading (including in this very weekly review sometimes) regarding the medium term outlook for stocks. As I have said before, real-time market declines are always painful and possible future declines always seem scary to contemplate. But past declines never fail to look like (often missed) golden buying opportunities. And what we are going through right now will one day be a past decline. We don’t know exactly when this will be, but we do know that many people will one day look back on now and wish that they had taken greater advantage of the prevailing circumstances. OTHER NEWS Recession right now? I don’t think so .. I referred to “recession truthers” in last week’s report who are absolutely desperate to tell us how we are already experiencing a recession as we speak and it was another bad week for their highly flawed case. In the context of an economy that’s adding a quarter of a million jobs or more every month, we learned that over a third of the jobs which have been lost this year have been in the tech and media/communication services sectors which only employ about 3-4% of the national workforce (but which get all the self-pitying air-time in the media). The American consumer is still spending like crazy, as evidenced by monster Black Friday spending data and we will learn more about this when the monthly retail sales number comes out this week. None of this is remotely close to recessionary and nor is the fact that one of the most reliable signs of the arrival of an actual recession, the credit card 30-day delinquency rate, remains at barely above 2%. It’s at its lowest levels since 50 Cent was spending his time in da club in 2003 and got to close to 7% during the last proper recession in 2008. All of which is not to say that we can’t move into a recession in 2023 or 2024 as all this data could well deteriorate quickly, just that we are not there yet. China’s Zero-COVID policy over? .. China is lifting its most severe COVID restriction policies following an outbreak of protests against the strict controls. Lockdowns would continue but should now only apply to more targeted areas - for example, certain buildings, units or floors as opposed to whole neighborhoods or cities being shut down. Areas identified as high-risk could come out of lockdown after five days if no new cases are found. Several cities in China have endured months-long lockdowns even with only a handful of cases having been found. People with COVID can now isolate at home rather than in state facilities if they have mild or no symptoms. They also no longer need to show tests for most venues and can travel more freely inside the country. Schools can remain open with student attendance if there's no wider campus outbreak. The general sense is that this is all considered likely to help propel a r… This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit simonbrady.substack.com