S&P 500: Bull Case Has 2 Problems
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Since the beginning of October, the market has performed better as a “bull case pushed investors into the market. We previously laid out the case for a strong short squeeze around the lows of September, stating:
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NAAIM Index Less Than 40
The ensuing short squeeze ultimately produced one of the most significant gains on record, with the S&P 500 surging over 5% single day. As we noted, such gains have two primary features. First, they are generally only seen during bear markets. Secondly, while they tend to come in the latter stages of bear markets, they don’t historically denote THE bottom.
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As noted, we expected the rally from the September lows, as discussed in that previous post. However, what was critical was our concluding statement.
That remains our positioning currently, as there are two primary issues plaguing the
The Fed… And the Fed
While investors chased the market, hoping the Federal Reserve will concerning its monetary policy, the reality is likely substantially different. Such was a point we discussed in
Fed Funds and Bear Markets
Notably, the bull case for a pivot is built on the idea of the Fed ceasing its rate hikes. However, a that would support higher asset prices would require two primary monetary policy changes.
As the chart shows, these periods of zero rates and monetary accommodation fuel asset prices higher. Periods of balance sheet contraction and higher rates lead to market sell-offs.
Fed Funds + Balance Sheet Contractions vs S&P 500
Currently, even if the Fed does slow or stops hiking rates, there is NO indication they are about to reverse course from a policy regime to an one.
In fact, just yesterday, from the Wall Street Journal confirmed the same. To wit:
In other words, the most significant challenges to the bull case remain the Fed not cutting interest rates and the Fed not engaging in
Playing The Probabilities
While the history of financial interventions and market performance is quite evident, there is always a possibility
Yes, it is possible the bull case could mature if the economy avoids a recession, earnings stabilize, and inflation falls. However, given the lag effect of restrictive monetary policy and demand destruction, the risk of a recession is elevated. As such, earnings have not adjusted nearly enough to account for the reduction in consumer demand.
SP500-Forward-EPS-Drawdowns
More importantly, the “ of monetary tightening has yet to reflect in the economic data. While the economy is slowing somewhat, employment has yet to contract. Already, we are seeing a sharp decline in CEO confidence as more companies lay off workers and institute hiring freezes. As shown, such eventually translates into higher unemployment, slower economic growth, and reduced expectations for future earnings.
CEO-Confidence vs Jobless-Claims
As noted, anything is possible. However, as investors, we must for the current economic environment. The Fed hikes rates to quell inflation by creating in the economy. Such will lead to higher unemployment, slower economic growth, and reduced earnings. All of which are not supportive of higher asset prices or elevated valuations.
Yes, the market could defy fundamental realities and front-run the Federal Reserve to the next round of monetary accommodation. However, given that strong market rallies curtail the Fed’s efforts, the bull case may keep the Fed in a restrictive mode longer than anticipated.
It seems to us that the bull case may be too far ahead of reality. If that is true, being a little more cautious and selling rallies may hedge the risk one final leg lower in 2023.
