The Week Behind

It is hard to undersell how poorly equities performed last week. All the major indices tallied significant losses. While Treasury yields retreated from new highs, the NASDAQ did not escape the wreckage, falling 4.78%. The Dow notched a 4.79% loss, giving up 30,000 for the first time in 17 months. Not to be outdone, the S&P 500 lost 5.79%, closing below 3,700. 

Highlights:

• U.S. FED raised interest rates by 75bps, marking the largest hike since 1994.
• The Swiss National Bank (SNB) raised rates by 50bps, marking the bank’s first hike in 15 years. 
• The XLE (SPDR Energy ETF) entered a correction, plummeting 15% in 3 sessions.

All major indices were on pace for a positive week until Thursday’s open as equities digested the 2nd and 3rd derivative effects of decisions coming out of the FED and SNB. 

As per the FED, the ramifications of 75bps (slowing growth) all but guarantee a FED-caused U.S. recession. Given the context, it doubles as proof that inflation is firmly in control of the FED. The very same FED created to control inflation by mandate.

With respect to the SNB, their surprise hike paints a clearer picture of a coordinated tightening cycle that elevates recession risks on a global scale. This message was made clear as the SNB made it clear they could not “rule out… further increases in the SNB policy rate… for the foreseeable future to stabilize inflation…”. Furthermore, the SNB is apparently “also willing to be active in foreign exchange markets as necessary.” 

In short, the actions of the FED and SNB, while necessary to fight inflation, increased the risk of global recession catalyzing the sell-off.

The Bear Finally Mauls Energy

The last safe haven in the market was finally mauled by the bears. While the XLE’s 15% drop is only considered a “correction”, some of its constituents – Diamondback (FANG), Devon (DVN), Coterra (CTRA) – entered a bear market dropping over 20% in only 3 sessions. One theory cites rumors the EU is pressuring Ukraine into a negotiated settlement with Russia to increase energy supply ahead of winter. While this may be true, I think it has more to do with profit taking ahead of the long weekend absent any upside catalyst in the face of elevated global recession risk, which, as we discussed last week, would decrease the price of oil.    

The Week Ahead

Courtesy of Juneteenth, we have a shortened trading week. If the bond market cooperates, given the intensity of last week’s selling, an argument can be made for a small bounce. Last Thursday featured a 30-1:declining-advancing. We are near rebalancing. Perhaps, there will be a little bargain hunting and bottom fishing? On the other hand, we could also talk ourselves into testing S&P 3,500, a popular call among analysts, by continuing to sell on the same/related news. 

• Tuesday: Existing Home Sales (SAAR)
• Wednesday: Fed Chair Powell testifies on monetary policy at Senate Banking Committee; Chicago Fed President Bullard is scheduled to speak
• Thursday: Initial and continuing jobless claims; PMI; Powell testifies at House Financial Services Committee
• Friday: Final for UoM Consumer Sentiment Index and 5-Year Inflation Expectations; New Home Sales (SAAR) 

I think we are back to a “good news is bad news” scenario. We want data to come out that shows FED action is working in the form of cooler housing data and even an uptick in unemployment (so long as it stays below ~4.1% as per new SEP projections). 

[R]ecession or [r]ecession

With the benefit of hindsight, this bear market is 9-months old, which is a little above average. Historically, stocks have declined 24% when the economy avoids a recession and 35% when coinciding with recession. Year-to-date (YTD), the S&P is down 22.9%, NASDAQ is down 30.98%, DOW is down 17.75%. If the U.S. avoids recession, history supports that equities are near a bottom. If not, history suggests there is more downside. The 35% decline statistic includes the DOW’s ~54% drop during the Great Financial Crisis (GFC) and the S&P’s ~34% during COVID. I do not think this macro is comparable to either, but that does not mean we will not revisit.

The biggest call to make right now is whether the U.S. enters a recession. I think we’re in one now. For me, the question turns to the severity: Big [R] or little [r]. 

While the current sentiment is overwhelmingly negative, justifiably so, we could witness a rapid turn if Russian supply returns and/or China meaningfully reopens their economy. Both promise to alleviate supply-side inflation. The former would be felt almost immediately via reducing costs of energy and transportation, simultaneously increasing the share of wallet consumers can save or spend. However, the longer these headwinds remain, the worse the recession calculus. While I think it is still a longshot either resolves quickly, either would move the dial in a meaningful way. 

Finally, A Belated Happy Father’s Day!