Introduction
The markets have seen a really nice bounce in the last few days, with uncertainty lifting following the US midterm elections, and CPI data coming in cooler than expected.
But how far then this go? When does the steam run out, and how will we know when the tide is turning for real?
The Story So Far
As we know, a bear market is a 20% drawdown in the market; with a bull market being a rise of the same magnitude.
We have seen plenty of potential breaks in the negative momentum 2022 has brought, but clearly this has never held, with bad news usually following the good, or uncertainty finding it’s way back to the minds of investors and institutions alike.
June stands out as the clearest example. We saw lows in the S&P of $3,606.9, with many analysts suggesting this was low enough, and if inflation could get back under control, then the good times were back on.
Sadly not the case.
September was another moment. The seasonally worst month of the year for markets brought pretty widespread negative performance for investors, leading many to suggest that October would be the month we saw things turn around, with October being the most typical month for bear markets to end.
This would’ve been roughly in line with the 11-month average duration of a bear market, but with no improvement in inflation, and volatile earnings reports, we didn’t have a conclusive bottom in the market.
So now we find ourselves in November, with signs of declining inflation, reduced uncertainty, and positive sentiment within some sectors of the market, are we there yet, or is another foot still to drop?
Are We There Yet?
As always, we don’t know until it happens. With inflation metrics such as CPI or PPI being such lagging indicators, we really need some sustained drops in inflation to really know if we’ve peaked, or if some variables are just making the top-line number look a little more appealing.
Geopolitics continue to be a major negative variable within the market. If you compare global society to a year ago, there’s no denying we’re in a worse place, with continued war in Europe, energy markets in turmoil, cost of living crises galore, and high turnover in our political landscapes.
If we want to get back to all time highs, we need to see a resolution to this. Progress needs to be made at a diplomatic level to find a workable solution in the near term, otherwise tensions and hostilities cannot be removed from the minds of citizens and investors alike.
The Fed, and their cohorts worldwide, will of course play a vital role in how the economic situation plays out. Talks of a pivot in rising interest rates have excited markets before, but for this to become a reality, and to stay a reality, the Fed will need to be sure that inflation is coming down in a meaningful way towards their target level of 2%.
The prospect of stopping the rise in rates too quickly, causing the inflation to pick back up again, is an almost unthinkable notion for Fed members; with vivid memories of lingering stagflation in the 1970s.
Fed Chair Powell has made it clear that he will continue to press until sure the job is done, and if this is overcooked; then stimulus can be applied to heal the damage.
So what is he actually looking at?
CPI, PCE & PPI- some of the Fed’s favourite inflation indicators
Slowdown in hiring from business- via JOLT numbers
Monthly payroll figures
The difficulty is how these variables are all lagging indicators, meaning that we won’t see the true impact of rate increases until a month or so after.
What do people think?
This approach has not been received universally well, with a large percentage of the market pleading for a slower, and less aggressive, approach. Elon Musk, Cathie Wood, and numerous other notable analysts and figures in the financial world have echoed such calls.
The pros and cons of either solution will not be fully understood until well into the future, but paying close attention to the data, and remaining flexible will be essential.
My take is that markets are digesting and observing so much more information and analysis than we’ve seen for a long time. Rhetoric from the Fed can move markets day by day, and the number of variables we consider are probably at the maximum we’ve ever seen.
Historically markets have always been about 6 months ahead of the wider economy, and with cracks emerging in the employment figures, spending volumes, and investor confidence, a lot of the heavy lifting has already been done.
Possible Outcomes
I’d like to think the Fed will not have much more to do, but the question is how their heavy front-loading will impact consumers, and consequently companies. We haven’t seen particularly large drawdowns in earnings just yet, so it’s very possible that another leg down is likely, but whether and how markets are pricing this in will be the key question.
The next 6 months are going to be critical.
Either we see a change in the damaging inflation data, leading to a more relaxed and passive role for the Fed, or they remain an ever-present and influential part of our investing decision making.
The next variable is how markets respond to the impact consumers will soon feel from rising interest rates. If this has been priced in, then we may see a spree of earnings report beats, leading us back to the good times, or we could see a continued revision of earnings estimates, taking us down further.
As always, if you’re a smart investor, you’re thinking 5-10 years beyond either scenario, and have diverse and resilient enough a portfolio to withstand either scenario.
Quality companies outperform during recessions, and most importantly survive the hardships which companies with poor cash-flow simply cannot.
Make sure your money is working hard for you, but also make sure you’re giving it the best chance to succeed in all outcomes, we live in uncertain times.
Disclaimer- Investments can fall and rise. Capital at risk. Any information in this content should not be construed as investment advice.