Monday, September 26, 2022

Morning Note: Taking the Fed at Their Word

No fewer than a dozen (voting and non-voting) Fed board members will be speaking this week... It'll be interesting to see which, if any, of them will waiver from their hawkishness -- as, indeed, they continue to tighten the monetary screws on an already weakening economy.

Many a pundit seems to take them at their word; that there'll be no relenting till 2% inflation is achieved... Like we keep saying, sure, 2% is doable, either simply through base effects (i.e., rate of change from a year ago point where inflation spiked), which is more or less meaningless (by itself unsustainable), or by tightening till the economy truly buckles into a deep recession. 

But even in the case of the latter, given the structural underpinnings we've been discussing the past couple of years, a sustainable 2% inflation rate is simply not within the realm of reasonable probabilities.

So, no, we also take them at their word... Meaning, while indeed you've heard "we won't waiver till our 2% target is achieved." However, if you're listening, you've also heard "we'll ease off when we're convinced inflation is moving toward our 2% target."

The latter makes far more sense to us than the former...

Meanwhile, and among many other things, Italy's seeing a major political shift, the policies of the new UK government are, perhaps counterintuitively (as they are indeed steps that'll likely (ultimately) attract investment), pounding the pound lower, and Japan proceeds with policy that undermines its already historically-weak currency -- save for last week's intervention that boosted it for all of a couple days.

Here's a 5-day chart:

Skimming through the financial media and commentary from the punditry over the weekend, and... well... let's just say it's getting palpably bearish out there, and understandably so... However, in terms of the day to day market action, while falling markets make some sense right here, we need to remain very cognizant of the fact that a not-small amount of today's volatility has as much (if not more) to do with short-term speculating/positioning than it does anything fundamental.

Here's from the firm we leverage for their expertise in how underlying options action impacts overall market movement. This gets weedy, so I'll bold where they get to the bottom line:
This massive volume is purely short term speculative activity. It's at best betting on very short term market behavior, and at worst quasi-gambling. In our view this is not some large pension funds or asset managers closing up huge downside hedges on a random Friday.

This excessive shortest term expiration volume also exacerbates volatility. We speculate that the 1.2% ramp into Fridays close was tied to puts being closed – but those puts could have very likely just been added earlier in that AM. For example if you are long puts that expired Friday, once the market starts to rally you have to quickly jump to close your position or risk a loss – and this creates a chase to close 9/23 expiration positions.

Those 9/23 expiration put deltas being flipped around are just as real as longer term deltas, but they have way more gamma. Therefore any hedging associated with high general market movement invokes more, and faster, hedging.

We think it's critical for market participants to be aware of this dynamic to place both trading action and options data into context.

Amid a rising chorus of doomsayers, renowned market veteran and author Sam Stovall emerged yesterday on Bloomberg with what we believe is probably a more realistic depiction of what we're up against... 

I.e., this will sound very familiar:
"This will be a bear market accompanied by a recession, but I don’t think we’re headed for a mega meltdown,” Stovall said in an interview. “We may have to wait until the first quarter of 2023 until the final low is finally in place.”
The rest of the article offered up an I think pragmatic narrative as well:
Of course, the bearish environment is also creating factors that long-term bulls can lean on.

Going back to 1995, this nine-month rout has sent stocks into it's third-longest run of extreme pessimism, data compiled by Ned David Research show. But in the year following prior streaks of such bearishness, the S&P 500 has rallied 20% on average. Adding to the longer-term optimism is the hope that the sooner the Fed hikes interest rates to the point that would combat inflation, the sooner it can start to ease up.

“For long-term investors, these are the opportunities that we sit and wait for to buy equities at advantageous prices,” Eric Diton, president and managing director of the Wealth Alliance, said by phone. “Bear markets don’t come along that often.”

Asian equities tanked overnight, with all of the 16 markets we track closing lower.

Europe's leaning red so far this morning, with 9 of the 19 bourses we follow trading down as I type.

US stocks are mixed to start the session: Dow down 94 points (0.31%), SP500 up 0.05%, SP500 Equal Weight up 0.03%, Nasdaq 100 up 0.
62%, Nasdaq Comp up 0.68%, Russell 2000 up 0.19%.

The VIX sits at 31.01, up 3.64%.

Oil futures are up 1.14%, gold's flat, silver's up 0.25%, copper futures are up 0.28% and the ag complex (DBA) is up 0.69%.

The 10-year treasury is down (yield up) and the dollar is up 0.20%

Among our 35 core positions (excluding options hedges, cash and short-term bond ETF), 17 -- led by MP Materials, cyber security stocks, Dutch Bros, uranium miners and ag futures -- are in the green so far this morning. The losers are being led lower Brazil equities, energy stocks, emerging market bonds, utilities stocks and Asia Pac equities.

"You have to look at real fundamentals, not at what policy makers want to happen. The willing disbelief of people can carry on for a long time, but eventually it is overwhelmed by the market."

--Colm O'Shea

Have a great day!


  1. Thanks for today's updates.
    What is your opinion about Jeremy Siegel? He is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania in Philadelphia, Pennsylvania. It is interesting that he mentions on CNBC today that Fed Powell should apologize to the American people for the very poor monetary policy.

    1. I read Dr. Siegel's book Stocks For the Long Run early in my career. Always respected him, disagree at times with his theses... The point he's making today is that the Fed is hiking into an already disinflationary environment... which is technically correct (coming off of these high inflation prints)... Frankly, it's hard to argue with him... If the Fed truly means what they say (when they say 2% inflation before we let up), they will indeed tank the economy... However, as I said above, they also say they'll ease when inflation's moving in that direction -- the latter is what I happen to believe... Siegel also points out that the Fed is largely culpable for why we're in this fix... That's largely true... but there's also rising populism, deglobalization, etc., that are structurally-higher inflation factors as well...

    2. Great feedback. Many thanks!