What an exciting Friday it was, with one of the biggest up days for US stocks in the past two years. Which really is saying something.
There were two major forces at work.
The first and perhaps the more powerful was that the market was simply over-sold in the short term. Meaning, that it had got ahead of itself, just for the moment, in terms of pricing in aggressive rate hikes and a looming recession. The market was vulnerable to some short position squaring, and then bulls looking to buy the bottom, combined to deliver a rock star day!
The second factor was the fundamental economic justification for this frenzied buying activity?
The main economic story for this huge up day was that buried within very negative data on sentiment there was some hope on inflation. This is a big stretch. Overall consumer expectations for inflation remain elevated, and the actual outlook for inflation is that it continues to rise. Perhaps through 10%. Even if energy prices were to stabilize at current levels and that is highly unlikely.
The further economic bull argument used on the day is one we have seen several times before. It is a bizarre twist that makes its proponents feel smarter than the vanilla readers of economic data. It is now being strongly toted that one should buy stocks when we see such severely negative economic data. Because bad economic performance makes it less likely that the Federal Reserve will continue to hike interest rates aggressively.
The above ‘double twist with pike’ economic argument fails on two fronts.
Firstly, a slowing economy will not reduce inflation at this point as the inflation curve is supply-disruption driven. As a result of on-going Covid complications, the opportunity for fattening profit margins this brings, and the fresh supply chain disruption from the Ukraine war.
We do not have inflation from over-heating inflation, as it is the historic norm, and so neither a slowing economy or the raising of interest rates will significantly impact the on-going inflationary pressures at work in the global economy.
Secondly, the Federal Reserve Chairman has already stated clearly, adamantly, that his interest rate hikes will cause economic pain, but this is accepted by him as part of fighting the inflation threat. Jerome Powell has made it clear he will continue to raise rates until inflation is tamed, even with the associated economic pain this will bring.
The argument that weakening economic data is now a good thing for stocks is entirely false and a misplaced premise.
It does sound clever to many a Wall Streeter however, and on that basis there will likely be continued buying in the short term. One cannot help thinking though, that the big money, the massive funds of the world are already a little ratted by recent declines and will see this rally, if not here then a little higher, as a great opportunity to exit into liquidity that may not have been there on the first wave down.
We have argued for defensive play since the first week of the year, and continue to do so. Hopefully this rally in equity markets gains a little more traction for better levels to exit longs, but at any point where the market begins to fall back in on itself I would not be slow in selling yet again.
By the way, the University of Michigan Consumer Sentiment Index, going since the 1950’s, hit a record low on Friday?