The tug-of-war between bulls and bears continued throughout July & August, with U.S. equities initially trending higher, only to pull back towards the end of the month. All in all, it was still the more bullish investors who gained the upper hand over the hot summer months. Both stocks and bonds recorded gains between July and August, although the vast majority of market segments remain down year-to- date.
What’s driving markets? Sentiment. After a historically weak first two quarters, markets responded with a surprisingly strong rally but it came off extremely negative sentiment. The middle of June the RSI (Relative Strength Index) dropped below 30 (indication of a very oversold condition) and by the time the rally finished moving the S&P 500 from 3600 to 4300 the RSI was over 80 (over bought).
The news flow that comes over the course of time won’t disappear overnight, and the markets are responding by moving very quick and moving largely based on sentiment.
We are seeing these whipsaws in volatility which isn’t a big surprise, but in these times, its encouraged that one should always take a view of the markets on how they will act in a normalized environment and it’s so important to not extrapolate extremes.
A normalized environment is when not near as many people are paying huge attention to the markets and it’s pricing out economic and corporate activity in a very logical way.
Extreme markets that we have seen essentially since February of 2020 are those markets that have very sharp reactions. When markets are treading lower and going down, investors notion is that ‘it’s going to go off the cliff.’ Conversely, when markets are going up, the notion is its ‘going to the moon.’ What investors sometimes do to their detriment is they extrapolate off these extremes and they pay most of their attention to the market when they’re feeling highly emotionally charged and as we know, that is a mistake.
After a rather bullish start to September, equity markets fell sharply this past Tuesday after August inflation figures came in above expectations. This important number is largely in part to why my monthly newsletter in a week later than normal. Clearly, financial markets were caught off guard by inflation numbers that, unlike last month, showed little sign of slowing this time. Granted, headline inflation fell from 8.5% to 8.3% year-over-year. However, core inflation surprised on the upside, rising from 6.1% to 6.3%. And more importantly, the median price increase for the consumer basket in August – a measure designed to monitor underlying inflationary pressures – rose to nothing less than a new record high.
At this stage, there is little doubt that the U.S. central bank will opt for a 75 bp hike, as did the Bank of Canada last week. Rather, it is the intentions of Fed policymakers for the next six months that remain in question, but according to market projections as of today, these could be revised upwards.
In sum, while we can still anticipate a gradual slowdown in inflation over the coming year, Tuesday’s numbers show that the journey will be full of obstacles and will likely see the Fed lift its policy rate into restrictive territory. Against this background, we should expect a continuation of the high volatility regime that has been ongoing for several months now.
As we move into September and the Fall season, who will win the next round? It’s impossible to know with certainty, but in order to get some clarity, I wanted to provide you an overview of what we are paying most attention to today as it relates to the CPI and the Fed, the Global Macro Environment and my thoughts on equity and fixed income markets moving forward.
No one knows for sure what the future holds, and that includes the most bullish, the most bearish, and us. This is always the case, which is why diversification is the only real key to success in long-term investing. It is even more true today, given the unprecedented, complex, and sometimes even contradictory nature of the economic backdrop. We simply cannot ignore the fact that a growing number of leading indicators we follow closely have recently turned yellow, and even red. Moreover, it now seems clear that a return to more accommodative monetary policies will, at best, take time and, at worst, involve a recession.
Thanks for taking time out of your busy day to enjoy our monthly commentary.