So far, the accepted wisdom now is that the Fed has the ability to fine-tune the interest rates to create a “no landing” scenario.
The first step is to accept the “Recessionista” narrative that if the Fed is willing to execute the fastest rate rise ever it won’t stop even for collateral damage to the economy.
I am one of those who believe that the current level of interest rates is just right for the level of our current economic activity, and the Fed should just hold steady.
That does not mean that there won’t be fear that the Fed killed the golden goose. A negative narrative that could take hold is jobs will shrink, businesses will go bankrupt, and the stock market will return to a bear market correction testing 3800!
“The only thing to fear is fear itself” Pres. Franklin Delano Roosevelt
What do I mean by “Recessionistas”
There are still more than a few thought leaders who look at the interest rate inversion and feel certain that a recession has to happen. Inversions always precede a recession, that is the accepted wisdom. The stock market hasn’t agreed and still doesn’t; people are still sitting on a pile of money. Economists have been saying that the consumer has run out of pandemic money for over a year, yet the money is still in their pockets. As long as people are employed, spending is strong, and it is demand that will keep inflation stubbornly high. So while Powell is likely done raising he isn’t likely to take rates down even if we slide into recession. This is where the “Recessionistas” aka bears come in. Right now market participants are cheering on the lower growth numbers, bad news is good news. As the stream of data continues to confirm lower growth and lower goods prices the bears will harp on the notion that the Fed will not come to the rescue. I have to admit that this is likely to be true, we will likely see higher weekly unemployment numbers, and we will see lower inflation data. We will also likely see that Q3 GDP revisions go lower, so at some point, bad news will be bad news. What if I am wrong, and the consumer stops spending? We have already seen a string of retailers report bad numbers, quite a few in fact. We have also seen some retailers in the same space do well, despite “shrinkage”, and of course, the high-end always does well. but let’s say the consumer stops going out to bars and restaurants, or to see the movies or Taylor Swift, well then you have an actual recession. We could have predictions of a poor Christmas season to boot. Either way, at this point can be fuel for a recessionary narrative. I don’t believe the consumer is going to stop spending, but they could slow spending a bit, weekly unemployment can go up a bit, and pretty soon you have a drumbeat of bad news incrementally, and the fear of a recession is coming. In the end, the interest rate inversion where the 2-Y is higher than the 10-Y will be the punchline to the bearish argument. Fear can take hold quicker than you think, so we could still see some rough waters this month, maybe including the beginning of October. Until we see that Q3 numbers were just fine, the economy isn’t cratering, and inflation is coming down just the way the Fed wants it to. In the end, the current rate level is perfectly fine for our economy. The key will be the Fed’s patience in not raising rates further and accepting a 3% inflation rate without openly saying so. I don’t believe Powell will raise, as long as inflation doesn’t spike uncontrollably, then he will have no choice. Right now, objectively things are going in the right direction, but if the CPI or other measurement shows stronger prices that could be enough to throw the market into turmoil. A move up here and there is to be expected nothing goes up in a straight line. So, right now I am bearish, not because I ultimately see a Fed-induced recession, but only that the narrative is likely to move to bad news is bad news, and good news will bad news going forward.
My view presents a short-term negative and a medium-term positive view of stocks
As it stands right now I still believe that we end the year at 4800 or higher. However, I am seeing data that could be used as a bearish argument. As you may have gathered if you have been reading my weekly analysis for a while, narratives drive stocks. If the bears can point to new data that can support their narrative it will undermine the growth stocks that have been leading the rally. Here are some quick statistics from last week that can show you what I mean. It might get tedious so just do a quick peruse of the italicized text then go to the next bolded headline, if you are impatient.
Headline PCE, which slowed to 3% in June, bounced back to 3.3% in July—in line with expectations from economists. On a monthly basis, the overall PCE index showed price growth was about 0.2%.
July’s headline inflation was driven by a 0.4% uptick in prices for services, while costs for goods decreased 0.3% even though food prices increased 0.2% and energy prices rose 0.1%. Lower goods prices are great but they aren’t the problem, services costs are and they are continuing up higher. The average consumer is focused on gasoline and food prices, which can affect inflationary expectations.
The July reading of the core personal consumption expenditures price (PCE) index, which excludes the more volatile food and energy costs, showed price growth rose to 4.2% on an annual basis from the 4.1% recorded in June. While that 4.2% matched forecasts from economists it is still higher.
Personal consumption is higher which means higher rates are not lowering demand. Personal-consumption expenditures ticked up 0.8% in July from 0.6% in June and higher than the 0.7% growth forecast by economists surveyed by FactSet. When adjusted for inflation, spending was up 0.6% in July from 0.4% in June.
U.S. government data on Friday showed a larger-than-expected gain of 187,000 nonfarm payrolls in August, but the prior 2 months had significant downward revisions totaling 110,000 fewer jobs than initially reported, putting the 3-month average job growth near 150,000 (the lowest level in 3 years). The unemployment rate jumped to 3.8% from 3.5%, while the labor-force participation rate rose 0.2%, for its first increase since March. Even the monthly gain in average hourly earnings slowed. What I am saying here is that even though on the surface this was accepted as “good news” it wasn’t good news for the economy. There is no cause for panic because at 150,000 jobs created are still strong enough to provide a job to anyone who wants one. Also, the higher Worker Participation Rate is great news. It means that more workers are entering the workforce driving down labor costs as we saw this month with lower average hourly earnings slowing.
So in summary
We are seeing less job creation and stubborn inflation data in a lot of the above statistics. The market chose to see the brighter side, that employment is finally coming down because that is what the Fed wants. However, higher employment isn’t the driver of inflation, it is the demand-pull of job openings that is thought to drive wages. We made progress there with 8 million job openings when it was at 10 million for the longest time, still 8 million is a lot. So jobs are coming down and inflation is moving down but not enough. So did the market really see the bright side? The Nasdaq closed down a few points, while it was much lower most of the day, and the S&P 500 closed flat. I think there is more turbulence ahead until we see more progress on the inflation front. I am taking the accepted wisdom here in expecting inflation to move into the 3% level. If that happens and Q3 earnings are positive that should set the tone for a good year-end rally.
So what did I do this week?
As you can tell from this long harangue and apologies for the tedious numbers I am probably as bearish as I can be. So I hedged – A LOT. This is the most I’ve ever hedged, so likely the market will make a fool of me and go straight up this week. There is really no big economic news to speak of so it is possible. Next week we’ll have the CPI on September 13 and of course the FOMC meeting on September 20. I don’t know what could set off stocks to the downside, but I do know that the VIX almost broke under 13, back towards the 52-week low. That shows a heck of a lot of complacency, and the S&P 500 is above 4500 and not too far from the recent high. At this point, and in my humble opinion, the beat of butterfly wings could set off an avalanche of selling. Also, all the senior traders are back from sailing the Mediterranean and will want to book all the gains for this year in case anything happens.
As I was saying, I have about 30% of my trading account in hedges and only 10 percent cash. My portfolio is still up for the week because I had a number of biotechs move up very nicely, and I took profits – hence the 10% cash. So I trimmed Cerevel Therapeutics Holdings (CERE), Apellis (APLS), Axsome (AXSM), and Casava (SAVA). These were all call options I will hold onto my equity and hope that if the market does come down, I will add to those long-term positions. I bet you are wondering what I hedged on. Well, I got long on the VIX. This means that if the VIX goes up, and likely to that 17 level from 2 weeks ago, I will do well there. Also, Since I believe that inflation is not going down without a fight, higher rates, not even a lot, let’s say the 10-Y bond goes back above 4.20% or perhaps fear that recession is coming and it falls under 4%, either way, I see the S&P 500 inverse ETF (SPXS) and the Nasdaq-100 inverse ETF (SQQQ) rising, meaning the Nasdaq-100 and the S&P 500 would be falling. If the market does the opposite, I will probably trim off some hedges, take a small loss now, and hold the cash.
I did get long on a commodity chemical company Olin Corp (OLN). OLN announced that the CEO is resigning (most likely the board asked him to resign). He will stay on for 6 months to help with finding a replacement and helping with the transition. On that news, the stock fell 12%. In my estimation, the board is unhappy because sales are slowing in the chemical business. Besides commodity chemicals they make ammunition for small arms, they own the Winchester brand for consumers, and they do supply the military. Needless to say, there is a huge demand for ammunition of all sorts. If I were the new CEO, I’d be trying to figure out how to get into the 155 mm artillery and solid rocket motors business. If I were an activist I would get on the board and demand that they sell this division to an entity willing to invest in it, and just sell the other pieces off, or take the whole thing private through private equity. I’m not an activist or private equity guy, so I’ll just buy some stock and see if someone steps up.
I also sold Snowflake (SNOW), Meta Platforms (META), and Alphabet (GOOGL) Call options for nice gains, which I bought on Monday. Then took those sweet profits and used that cash to over-index (which I am starting to regret) on the hedging side.
Okay, that should hold you over. The most important principle of the Cash Management Discipline (CMD) is that cash is the cheapest hedge and that it gives you optionality. I am usually early in my “big predictions” by 2 weeks, so there’s probably still time to take some profits by trimming off positions, which I will continue to do. I don’t believe the sky is falling and there will be no recovery. I want to have a nice slug of cash to pick up some bargain stocks. Short-term bearish, medium-term bullish, not sure where I will be in 2024, but you all will hear about that process for the rest of the year. Good luck.