The Truman Show

The Credit Strategist - October 2022

The S&P 500 is well on its way down to the 3400-3500 level I’ve been forecasting all year.  The question remains whether it will head even lower on the back of further Fed tightening since the market is within spitting distance of that level.  In addition to further Fed tightening, which alone could push the SPX to the very low 3000s, earnings are now proving to be worse than the optimists expected.  Recent reports from NKE, MU, NVDA, FDX, CCL and RCIII and news of slowing orders for AAPL’s new iPhones added to earlier negative reports from large retailers like WMT and TGT and other companies suggest that SPX earnings are more likely to come in closer to $200 rather than higher numbers being bandied about. NKE was the latest consumer products company to report excess inventory that will have to be liquidated at low prices (TGT had a similar problem), debunking talk about consumer strength (which is also belied by rising credit card balances and shrinking savings).  NKE stock is off almost $100 (60%) from its all-time high a year ago when bulls were trying to convince everybody else that we weren’t in the midst of an epic stock market bubble.  As one of the premier brands in the world, NKE sends a troubling signal as we head into the final quarter of 2022.  Santa may need more than seven elves to save the market this holiday season.

The most likely source of a reprieve for stocks is an end to Fed tightening because earnings are clearly deteriorating, but such a reprieve is still very unlikely until early next year.  The one factor that might force the Fed’s hand is the historic volatility in in bond and currency markets which is capable of causing systemic damage.  Whether the UK bond market is sufficiently important systemically to cause the Fed to change course remains to be seen; my view is that it is not, but we cannot be certain because like all markets it is interconnected with other markets and could trigger an accident.  But for the moment it appears to have stabilized and we are going to need much larger disruptions than we’ve seen thus far in Treasury and MBS markets to push the Fed to abandon its inflation fight.  As things stand, the Fed is only likely to pause early next year and wait to see the effects of having raised rates by more than 4% in 2022 before deciding its next moves.  Inflation remains stubbornly sticky.  August core readings were slightly higher than expected, leaving the Fed little breathing room.  The Fed made its bed and it is going to have to lie in it for quite a while.

            Investors looking for opportunities in stocks need to be extremely careful regardless of how events unwind.  Virtually all stocks are inflated in value by real interest rates that are still negative.  It would be a positive development if the “buy-the-dip” mentality that dominated markets since the Great Financial Crisis and especially since the pandemic could be broken since it lacks any foundation in fundamentals. But bad habits are hard to break and there remains enormous social and media pressure to jump back into the market at the least sign of optimism.  I trust readers of this newsletter will prove smarter than to do that.  So far this year, dip buyers have been punished with the S&P 500 dropping 1.2% on average in the week after a one-day loss of at least 1%, according to Dow Jones Market Data.  The momentum-driven nature of markets are a key component of the unhealthy changes in market structure that accelerated over the last decade that diminished the importance of fundamental analysis and overall market intelligence, leaving markets unprepared for the consequences of the profoundly flawed policies described in this publication every month and elaborated in Edward Chancellor’s brilliant book The Price of Time (which is discussed at length in the October issue of the newsletter). 

            Right now, most asset classes are losing value as the cost of money recovers from negative real rates.  Stanley Druckenmiller was correct when he told the Seeking Alpha (a conference title that is ironic at best in view of how the institutionalization of investing has destroyed returns and especially alpha) that “the risk/reward of owning assets doesn’t make a lot of sense” right now.  Bonds and stocks are simultaneously experiencing their worst performances in decades, something that happens in markets experiencing extreme stress.  The asset that looks most interesting to me right now is gold, which looks very cheap under $1700 (I view gold as a generational long-term investment not as a trade).  Gold is the anti-fiat currency and the asset that represents the antithesis of modern central banking practice.  To invest successfully over the long run, one is better off focusing on a north star like gold than riding the momentum wave created by central bankers.  To the extents one engages in the latter, the British pound and Euro will eventually start to look interesting but they are going to fall further first (the pound to parity with the dollar and the euro to below 90). But otherwise, cash remains the best alternative right now (six month to two-year Treasuries finally offer respectable yields on cash) as all asset classes are like to keep deflating until the cost of money stops rising.