Uncertainty is the name of the financial market game
Last Wednesday, if you somehow had a hunch that the consumer price index (CPI) was NOT will show signs of cooling but instead surprise on the upside to bring Core CPI to its highest annual rate in four decadesone would have expected the markets to fall on Thursday.
And you would have been right until about 11 a.m. when the markets not only returned to equilibrium, but continued to post strong gains. The intraday range for the S&P 500, from morning lows to closing highs, was around 5%.
Surely the biggest angst for markets this year has been the path and stickiness of inflation, so it’s hard to make sense of Thursday’s market reaction, even though Friday returned some of the gains.
Was it the ingenious work of economists and analysts, who pored over the details of the CPI data to uncover good news? It sure doesn’t look like it. We wouldn’t call the inflation report terrible, but it certainly wasn’t good. There were signs of lower prices in several asset categories, but used car prices rose, defying the wholesale pricing trend that typically dominates this category. Airline prices, which had fallen, rose slightly. House prices have risen, although we don’t know if this category will elicit a market reaction, given that it tracks house prices with a multi-quarter lag – as house prices are rolling, that should follow at some point. Services inflation has been high as wages are rising. Overall not a good CPI report, so why such a happy market on the day of the data release?
We’ll let you in on a secret: no one really knows why the market goes up or down on any given day. Of course, we or anyone else with an opinion on the market can slap him a narrative that sounds logical, plausible… even compelling. But the truth is that the market is made up of millions of participants with different characteristics, different reaction functions to various news or data, and different risk appetites. And some of these millions of participants come together at a price that one is ready to sell, and the other buys a given security. Oh, and the mood of these participants changes from day to day. For example, there is a small relationship between the daily performance of the S&P and the weather in New York. (Okay, I just checked the weather network and this week is looking sunny, which is good news.)
Day-to-day market moves are random at the best of times and when the market is in the tenth month of a bear, these random moves are greatly amplified. The VIX index, which measures the implied volatility of options on the S&P 500, remains subdued from past periods of market stress, with many expecting a reading above 40 as a potential sign of capitulation (as it may be). measure). However, there is no denying the uncertainty of this market.
A metric we’ve used over the years is to measure the number of fully bullish or bearish days for the S&P 500. A rising day is the rise of 90% of the members of the index on a given day; conversely, a low day is when 90% drop. This year there have been 30 such trading days, all up or down. It’s on track to be the most all-or-nothing days in at least 20 years. It’s also worth noting that ten of those 30 days happened in the last month alone. The market seems to be at the height of uncertainty, which could be good…or bad.
Here’s what we know
Let’s look beyond the day-to-day market fluctuations for a moment to get some perspective. This is what we know, and if we know it, so does the market:
- Inflation, unsurprisingly, is proving stickier and has so far shown little sign of falling back from high levels. That being said, most forward-looking indicators that have warned of a rise in inflation to current levels show signs of an upcoming reversal or decline in inflation. Remember that inflation is slow to react, which can lead to more expectation than the market is comfortable with.
- The risk of recession is high and rising. China’s growth has slowed, Europe may already be in recession due to energy and slowing global trade. The Canadian economy is doing well but is starting to slow down. The US economy is doing better than most, but is also starting to show signs of slowing down. A recession, which is bad, would also dampen inflationary pressures, which is good. Would the good be more positive for the markets than the bad? It depends on the recession or the slowdown in global growth. A good thing is that various economies are already in different stages of slowdown; a much better context than in 2008 when all the economies slowed down simultaneously. By the time slowing growth potentially takes hold in North America, other economies may already be on the mend. This out of sync slowdown is pretty much a good thing.
Revenue estimates are too highor say roughly Everybody. This is widely known and at least partially integrated. The S&P 500 saw its forward price/earnings multiple drop from 21x to 15x. The TSX is trading at a paltry 11x, Europe 10x and Emerging Markets 10x. Those valuations, roughly at 2020 lows, certainly price in potential earnings weakness.
The markets have integrated all or part of this news, even if that sounds pessimistic. US 10-year bond yields rose from 0.75% to 4.00%. Futures forecast a peak federal funds rate of 4.9% in the first quarter of 2023, or nearly 175 additional basis points of increases. The S&P 500 is down -25%, the TSX -17%, Europe -23% (-28% in CAD), Japan -9% (-23% in CAD) and Emerging Markets -34% (-27% in CAD). BOJAT).
These are all “known knowns” and shouldn’t raise too many fears about the future. It’s the surprises, good or bad, that will drive the markets forward. Could already sticky inflation turn out to be even stickier than the market expects? Yes, but it could also start rolling. Either way, the markets will move down or up respectively. A mild global recession probably wouldn’t be bad for markets, but if it were more severe it would be, and if it was milder it would be a pleasant surprise. Earnings estimates could fall, but companies have benefited from inflation as there are also positive surprises.
Impact on portfolios
We agree that the way forward is highly uncertain, with the magnitude of day-to-day swings clearly supporting this view. We don’t know when the bear will bottom out: history and experience tell us that bears always feel like they last a long time (time flies during bulls and lags during bears). This may be the case when inflation, the root cause of this bear, starts to improve. Or maybe it will just end, and a month later a story will gain traction as to why it ended when it did.
We know that falling stock and bond prices mean we are getting closer to the bottom and future risk is diminishing. A good way to think about it is that the S&P 500 at 4,800 in January was much riskier than at 3,600 today. We remain neutral with our equity allocation – it doesn’t seem right to add hope for the moment that surprises turn positive, but it doesn’t seem right to hoard cash either. points, in both directions. Hopefully the weather forecast remains sunny for NY – any little bit will help.
Source: Charts sourced from Bloomberg LP, Purpose Investments Inc. and Richardson Wealth, unless otherwise noted.
Any opinions expressed herein are solely those of the authors and do not represent the views or opinions of any other person or entity..