Read My Lips
The Credit Strategist Blog
Nobody should be surprised by today’s market drop, which reversed yesterday’s knee-jerk reaction to Jay Powell’s statement that the Fed isn’t planning any 75 bp hikes. Rather than focus on that comment, investors should have read Mr. Powell’s lips (or simply listened to his words). The rally was an overblown reaction to an extremely remote possibility (this bunch raising rates 75 bps? LOL), an exercise in self-torture by a hyper-neurotic market with too much time on its hands before yesterday’s Fed meeting. This crazy risk-on/risk-off trading action is common when market regimes shift, which is precisely what is happening as the Fed tightens policy at the fastest pace in decades. Investors took the time to do the math overnight and process Mr. Powell’s comments and realized that more pain is coming. Aside from the Fed’s mealy-mouthed approach to QT (why is it waiting three months to start full-blooded QT that at $95 billion a month would be barely more than 1% of its balance sheet?), the Chairman made it very clear that the Federal Funds rate will be closing in on 2% by July 4th. That’s an unprecedented increase over the first six months of the year that was unanticipated when the year began. Spiking rates are decimating the best laid plans of holders of stocks and bonds. The last 12 years deluded both groups into thinking that buying obscenely valued stocks and negative yielding bonds offered risk-free returns instead of return-free risk (except for the few nimble enough to sell at the top). Now they know the truth. Before they learn deeper truths, they should protect themselves by reducing exposures. Assets are still expensive with the S&P 500 trading at 19x earnings (16x is more appropriate and grossly inflated earnings are going lower) and bond yields are going higher. Markets like these illustrate why the buy-and-hold mantra is highly overrated. Investors are much better served by active management that reduces risk when assets are expensive and increases exposure when assets are cheap. You don’t have to stand and get run over by a steamroller, especially when you can see the steamroller coming from a mile away. That steamroller is the Fed driven by structural inflation driven by many forces beyond its control (higher energy prices and labor costs among other things). Interest rates are being reset higher and won’t go back down until economic growth slows significantly (i.e. we have a recession). Markets are telling us they are not priced for 3%, which tells you how fragile they and our debt-gorged economy really are. Unfortunately we aren’t anywhere near 3% yet so asset prices have further to move to where the puck is going to be, not where it is today. Until they do so, investors should continue to fade rallies like yesterday’s. There will be more of them because bear markets aren’t sated until they pull in as many victims as possible.