CWS Market Review – June 14, 2022

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It’s Official. We’re in a Bear Market

Yesterday was a terrible day for Wall Street. The stock market plunged, and it looks like the battle to defeat inflation will be a lot more difficult than many folks had originally anticipated.

On Monday, the S&P 500 lost 3.88% which made it the index’s second-worst day of the last two years. If you’re really into market history, it was the 161st worst day since 1928. In the entire S&P 500 on Monday, only five stocks closed higher.

More importantly, the S&P 500 closed below the 20% drawdown line which is the traditional definition of a bear market. At today’s market close, the S&P 500 is down 22.12% from its all-time high close reached on January 3 of this year.

Today was the lowest close for the stock market in more than 17 months. At one point, the stock market was up 26% during the Biden presidency. Now that’s all gone.

What driving the selling? The answer is easy. It’s the same thing that’s been happening, only more so. Inflation has spooked Wall Street and traders now believe the Federal Reserve needs to keep raising interest rates. To give you an example, since Friday, the yield on the two-year Treasury jumped from 2.83% to 3.45%. The two-year is often seen as a proxy for the market’s opinion for where rates ought to be. The two-year yield is now at a 15-year high.

Again, what we’re seeing is risky stocks getting slammed while more conservative stocks are down but not by nearly as much. On Monday, the S&P 500 Low Volatility Index fell by 2.97% while the S&P 500 High Beta Index dropped by 6.54%. The tech-heavy Nasdaq Composite is now down by one-third since November.

What’s really happening is that many stocks are giving back gains they never should have had in the first place. To give you an example, shares of Moderna (MRNA) are now trading at one-quarter of their value in August. Shares of Zoom (ZM) are down more than 80% from their high. Netflix (NFLX) is off by 70% just this year, and we’re not even at July 4!

Everything seemed so easy before that meddling inflation showed up! The bull market that recently ended was one of the fastest on record, and it was the quickest ever to double. Now the bill has come due.

Over four trading days (Wednesday to Monday), the losses got progressively worse. On Wednesday, the S&P 500 lost 1.1%. Then on Thursday, it fell 2.4% followed by another 2.9% on Friday. Today was the market’s best day of the last week, and that’s still a loss of 0.38%.

I’m pleased to say that our conservative-oriented Buy List keeps chugging along. Since June 1, the S&P 500 is down by 8.92% while our Buy List is off by “just” 7.30%. I know it sounds odd to point out that we’re down but by less, but that’s where a lot of long-term outperformance comes from. Our stocks are generally much higher quality and that protects them during a storm like this. I’ve used this quote before, but it’s a good one from Shelby Cullom Davis: “You make most of your money in a bear market; you just don’t realize it at the time.”

Worst Inflation Since 1981

What spurred the bad news on Friday was another troubling inflation report. There had been some hope that we might see some evidence that inflation had cooled off during May. Well, that didn’t happen. The government said that consumer prices rose by 8.6% in the 12 months ending in May. That’s the highest inflation rate since December 1981.

Digging into the details, the picture is not encouraging. Instead of cooling off, it seems that inflation is getting worse. The monthly rate of inflation increased from 0.3% in April to 1.0% in May. That’s the second-highest monthly rate of the last 10 years.

At that rate of inflation, if you’re paid in dollars at a fixed rate for one year, that means you effectively work one month of the year for free, and that doesn’t include taxes. Inflation is also taking its toll on wages. Last month, inflation-adjusted wages fell by 0.6%.

It’s true that food and energy have been driving much of the inflation, but the core rate also remains stubbornly high. For the 12 months ending in May, the core rate of inflation increased by 6.0% which was higher than expectations. For the month, the core rate increased by 0.6%. To give you an idea of how much things have changed, the core rate of inflation for the 12 months ending in February 2021 was just 1.3%.

Look for the Fed to Hike by 0.75%

The Federal Reserve is meeting again in Washington. The policy statement is due out tomorrow at 2 p.m. Yesterday afternoon, the stock market got another shock when the Wall Street Journal reported that the Fed was considering raising interest rates by 0.75%. I should explain that when the Wall Street Journal reports that the Fed is considering something, you can be pretty sure this is coming from the top.

A string of troubling inflation reports in recent days is likely to lead Federal Reserve officials to consider surprising markets with a larger-than-expected 0.75-percentage-point interest-rate increase at their meeting this week.

Before officials began their premeeting quiet period on June 4, they had signaled they were prepared to raise interest rates by a half percentage point this week and again at their meeting in July. But they also had said their outlook depended on the economy evolving as they expected. Last week’s inflation report from the Labor Department showed a bigger jump in prices in May than officials had anticipated.

The Fed was also shocked by two recent reports showing that consumers are starting to expect higher inflation. This is why inflation is so difficult to fight. It becomes a self-fulfilling prophecy. Once consumers expect it, they get it.

Before the WSJ scoop, investors had been expecting an increase of 0.5%. In fact, the Fed basically said so. In May, Fed Chairman Jerome Powell said that the Fed was not “actively considering” larger increases. Apparently, that’s all changed. One week ago, the futures market pegged the odds of a 0.75% rate hike at 4%. Now it’s at 94% and a slew of major Wall Street investment houses say they expect to see a 0.75% hike tomorrow. The Fed hasn’t done a 0.75% hike since 1994.

I’m glad to see the Fed finally realize the problem is more acute than they had initially believed. The problem is that the Fed’s main tool is short-term interest rates. That’s a very blunt tool. The Fed thinks it can enact precise fine-tuning with rate hikes. They think they’re using scissors when they’re really using an axe.

I think there’s a very good chance that we’ll see another 0.75% at the Fed’s next meeting in July. That would bring the Fed’s target range to 2.25% to 2.5%. How high will the Fed go? That’s a good question. The place to look is long-term rates. I would guess that the Fed wants to make the yield curve flat, even a little negative. With the 30-year yield at 3.45%, that means the Fed could go as high as 4% within the next six to nine months.

The larger story remains the same. The Fed overreacted to Covid by lowering rates to the floor. That radically changed the math on Wall Street as high-risk stocks became no-brainers. There was a big bull market in everything risk. Not just riskier stocks, but also crypto and NFTs. Higher rates are tripping up all those high-risk, high-volatility sectors. In less than two months, the price for bitcoin has been cut in half. Bitcoin is now down 69% from its peak. Remarkably, this is only its seventh-steepest correction in the last 12 years.

The Low in the Presidential Election Cycle

I’m not much of a fan of historical patterns in the stock market, but I’ll highlight one for you today. The stock market has traditionally reached a low point during midterm years in the presidential election cycle. As it turns out, this is one such year and the midterm elections are less than five months away.

I’ve crunched over 130 years of data on the Dow Jones Industrial Average and found that the low point of the presidential cycle comes on September 30 of the midterm year. Historically, the 15 months prior to September 30 of the midterm have been pretty blah for stocks.

However, after September 30, the stock market has done quite well. From September 30 of the midterm year until July 22 of the pre-election year, the Dow has gained an average of 19.3%. That’s more than half of the market’s entire gain coming in less than 11 months.

Here’s what the average presidential election cycle has looked like:

That’s the average of 125 years of the Dow. I set the chart to start at 100 on January 1 of the post-election year.

My point is not about timing the market. Rather, it’s that there tend to be broad cycles in the stock market. Though we’re in a painful bear market, this too shall pass. In fact, we’re seeing excellent bargains right now.

Last week, we had a very strong earnings report from Science Applications International (SAIC) which is our #2 performing Buy List stock this year. The company beat earnings and raised guidance.

That’s all for now. The stock market will be closed this Monday in honor of Juneteenth. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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Posted by on June 14th, 2022 at 7:37 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.