The Week Behind

To start last week, the major indices were at inflection points. The FOMC minutes sparked a rally that carried into the weekend: the DOW added 0.77%; the S&P 500 ~2%; and the NASDAQ, last week’s outperformer, gained ~4.5%. 

Highlights

• Both the US2YR and US10YR broke and closed above 3%. Multiple yield curves inverted temporarily, which many believe predict future recession.
• Idiosyncratic growth companies – quality semiconductors, biotechnology, and technology – found some traction, suggesting some comfort around quality companies that promise to grow above-trend in the event of a recession.
• The VIX, the volatility index and “fear gauge”, closed below 25, the lowest level since June 7th.  

Last Week’s Rally In Perspective: Questionable Catalyst and a Puzzling Backdrop

Questionable Catalyst

Last week’s rally came on the coattails of the FOMC minutes, coinciding with higher treasury yields and a stronger-than-expected job’s report, neither of which, in my view, are positive for stocks. 

To specify, the FOMC minutes released were from last month’s meeting. They did not reveal anything new. When we got this news the first time, we rallied hard, only to give it all back the next session, and then some more in the following weeks. 

Broadly, volume was relatively weak on the up-days. This smells of short-covering. While all bounces start with some degree of short-covering (or a short-squeeze), it isn’t until the longs (big institutions) join the party, normally catalyzed by a change in the macro, that you can have any confidence this bounce is “the” bounce. Maybe last week provided the former, but I have no evidence for the latter.    

Puzzling Backdrop

Holding all else equal, stocks tend to perform better when interest-rates are lower. However, assuming rates rise gradually, stocks and rates can rise simultaneously. Nonetheless, it is puzzling that the NASDAQ, the most interest-rate sensitive index of the majors, strongly outperformed alongside a reversal in yields. 

While the strong job’s number bodes well for recession calculus, it certainly emboldens the FED to hike 75bps at July’s meeting. Given my view quantitative tightening (QT) is the root cause of the bear market, I think the negative forces of QT outweigh the positive forces of a strong job’s market. For those that disagree with that assessment, I would point to the fact QT has the impact of cooling the job-market. 

The Week Ahead

Before the big banks properly kick off earnings season on Thursday and Friday, the market will hear from PepsiCo (PEP) Tuesday and digest June CPI on Wednesday. 

Aside from company specific details, PEP will provide some insight on aluminum (commodity) prices and a general look at the snacking market inhabited by a number of consumer staple companies. In short, if we get a bad number or market response, then it’ll be hard to hold out hope for other consumer staple stalwarts that performed relatively well in June. 

The big banks have been big losers this year. They continue to find new ways lower as looming recession exacerbates concerns regarding the quality and growth of lending books. Personally, I think these concerns are overblown. Both consumer and corporate balance sheets are stronger than in previous periods preceding recession. If the FED stress tests hold any credence, the banks themselves are in a similar position of relative strength. Given the disconnect between the performance of bank stocks and the apparent strength of their businesses, I theorize bank stock prices are currently reflecting the sentiment surrounding the businesses and consumers they lend to as opposed to the underlying bank they represent ownership of. Consequently, I am more focused on the price reaction in context of the earnings than I am the content of the earnings. If banks can find their true bottom, it could signal that sentiment surrounding those they lend to – U.S. businesses and consumers – has bottomed as well.    

Finally, the odds on favorite to be this week’s main event: June CPI. For May, we recorded Headline 8.6%, a new high, and Core 6%, another MoM decrease. I have heard some market commentators call for a 9-handle on Headline (Headline to be at least 9%), but given the rapid decline in commodities – both food and energy – in the last 2 weeks of the month, I disagree. Not sure if it dips below 8.6%, but I’ll take the under on 9%. Concisely, I think the market really only cares about the Headline: anything below 8.6% will be welcome with additional buying; anything above it will be met with strong selling.

“A” Bottom or “The” Bottom

Sub-8.6% Headline will reinvigorate the argument for peak inflation, which implies we could soon discuss peak QT. Despite outstanding earnings revisions, a cool CPI would represent a potential material change in the macro and path of QT. It would be a constructive first step in attracting institutional money back into the market, transforming “this bounce” into “the bounce”. No one rings a bell at the bottom. In my view, we’ll only know if “a bottom” is “the bottom” when the FED declares victory and removes some pressure from the QT-gas pedal. By that time, we’ll probably be 5-10% above the lows, but that does not disqualify you from investing then and participating in the next 80% up. I say this to encourage patience. I think many of us are subconsciously expecting a “V” shaped recovery as we witnessed with COVID. That is not the norm. More likely, this recovery will be a “U” with a much slower and less linear pattern upward.