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David Rosenberg: Investors should get defensive as markets unravel


Jerome Powell has obliterated the expectation that he will pivot next year to rate cuts

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United States Federal Reserve chair Jay Powell’s comments at Jackson Hole on Friday reignited the selling pressure in equities. The S&P 500 that day posted its largest decline since mid-June and its seventh worst day for breadth (-492) during the past 10 years.

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Beyond heading into a seasonally unfavorable time for stocks historically, equities also have to contend with an acceleration in quantitative tightening (which doubles in size in September). Against this backdrop, we believe investors should be positioned defensively. The next obvious source of support for the S&P 500 is the 50-day trendline at about 4,000.

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It wasn’t just the decline of more than three per cent on Friday (the worst session in four months) in the major U.S. averages, all three dropped four per cent for the week, which turned out to be a real roller-coaster ride. All but five stocks in the S&P 500 closed lower on Friday, as did all 11 sectors, with the cyclicals taking the biggest beating.

There is a lot of air underneath this thing, too, considering that the S&P 500 is still up nearly 11 per cent from the mid-June lows, principally on this misperception that the Fed will soon pivot and then cut rates next year. That expectation has been obliterated. The futures market is pricing a 70-per-cent chance of a 75-beeper next month … and the rates market has repriced itself for a 3.8-per-cent funds rate by February 2023, up from 3.3 per cent at the beginning of August.

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The yield curve remains deeply inverted, at -35 basis points for the 2s/10s spread, and that is a sure-fire recession signal. All Powell did in terms of throwing the bulls a bone was say, “At some point, as the stance of monetary policy tightens further, it will likely become appropriate to slow the pace of increases.” Small consolation.

Does this mean going to 50-basis-point increments from 75 bps? Big deal. The Fed is still bent on tightening into an inverted curve, which was last done under Paul Volcker in the early ’80s when the economy embarked on a severe double-dip recession.

It pays to note the equity market’s technical picture after last week’s drubbing. The uptrend line from the June lows has been violated and is under pressure. Despite a few attempts, the S&P 500 met stiff resistance in the recent rebound at key technical levels. Volumes rose on the NYSE and Nasdaq on Friday, meaning the institutions were selling all day long and not attempting to buy any dips. This makes sense since “Don’t fight the Fed” should work in both directions.

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‘Don’t fight the Fed’ should work in both directions

David Rosenberg

And the breadth of the market turned really bad, with four losers to every advancer on the Nasdaq and that ratio topped 6.5 on the NYSE. Best for investors right now to be trimming back on their winners and simply start dumping stocks that aren’t working.

This is no time to be a hero, with the Fed warning everyone that more “pain” is on the way. The Fed we knew under Alan Greenspan, Ben Bernanke, Janet Yellen, and even Powell in 2019 either paused or pivoted into the sort of squishy-soft economy and the troubled market we have on our hands today.

Even a year ago, Powell gave a spirited defence on why inflation would prove to be transitory, and he and his brethren have pulled a “180.” That was just a year ago. He’ll pivot again this time next year, but the “pain” has to be felt first, and that is code for “recession” (and bye-bye to the stock market “punch bowls”). At least for the near and intermediate terms.

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It must be said that, unlike the Donald Trump era, Joe Biden’s team has absolutely no problem with what the Fed is doing right now. The political cover for Powell is there. This all means we are back to risk off. Once the recession becomes universally accepted and priced in, and once the Fed does end up cutting rates and steepening the yield curve into a positive slope (who can dare own the banks in this environment?), the bottom will be in for good.

Don’t bother timing it. Know that it will happen and that the best days for equities happen after the Fed is deep into the easing game. At this point, that may not be until the second half of 2023 or perhaps even later.

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As for the here and now, one must feel for those folks who plowed US$11.7 billion (net) back into equity mutual funds these past two weeks. Buyers’ remorse is bound to set in. We are heading into September, which is by far the seasonally worst month of the year, and it’s the only month with the black mark of negative mean and median performances.

We have an economy that is either flat on its back or mildly contracting, depending on the macro measure used. The bulls go on about earnings season and the better-than-expected 8.5 per cent year-over-year expansion in Q2, but strip out energy, and that trend becomes -2.2 per cent. And real rates going up, courtesy of the Fed, means one thing and one thing only: P/E multiple expansion.

This bear market rally met its maker last week (his name is Jay). To quote Dandy Don from the blowout Monday Night Football games in the 1970s, “Turn out the lights, the party’s over, they say that all good things must end.”

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on Rosenberg’s website.

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