Research.LeutholdGroup

With overwhelming concerns about inflation, overheated economic growth, and Federal Reserve tightening, any good news is mainly perceived as “bad news.” Reports showing strong consumer spending, healthy industrial activity, better housing numbers, or solid job figures only raise fears that the Fed will be forced to lift interest rates higher for longer. It’s a tough environment for investors. Typically, evidence of “economic health” is a good thing. Until the Fed blinks, however, and inflation anxiety moderates, news that is ordinarily good will be “bad.”

Read this week's Major Trend update. 

We’ve heard no references lately to the famous “Fed Model” for stock market valuation. We think we know why: The model’s usual proponents probably don’t like its current verdict—which is that stocks are far more expensive than at the early January market peak.

Just a few unrelated concepts to end a turbulent week.

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Over the years, I’ve never tried to “figure out” what the Fed would do. Rarely spent much time adding up the number of doves versus hawks comprising the board. Didn’t find much value in parsing “Fed Speak,” carefully examining changes in the minutes from the last meeting, trying to reconcile widely diverging opinions among the multiple speeches of current members, and certainly never did a deep dive into the dot plots. Turns out, that was a mistake!

Read this week's Major Trend. 

What a year! Runaway inflation, surging bond yields, a rebirth of the Volcker Fed, a persistent bear market, widespread recession fears, a European War, and rising China/U.S. tensions. Not to mention—yet another booster shot, the passing of a 70-year-reigning Monarch, unprecedented heat, floods, fires, tornadoes, hurricanes, and, of course, mid-term elections in a country with massive political strife.

This year it’s been popular to say the Fed will hike interest rates until it “breaks something.” Has that not already happened? Pull up charts of the Japanese yen, the British pound, and the euro, among others. And stateside, the Fed has broken one of economists’ favorite toys: the Phillips Curve.

Yields have been on an upswing all year, and based on Federal Reserve comments, they may go up for the balance of 2022 and perhaps into 2023. Nevertheless, a host of factors suggest yields are getting more and more “out of bounds” with historical norms, and a “rate peak” is probably nearing.

The CPI figures were hotter than expected and point to more Fed intervention. Barring a 2020 collapse in the price index, year-over-year figures are going to remain high for quite some time.  

See this week's MTI update...

Inflation plays a part in nearly all economic cycles. Once a new recovery gains footing, inflation starts rising, overheat fears intensify, policy officials respond, and bond yields increase. However, significant inflation—the type that becomes the centerpiece of an economic expansion—is a rarity.

Despite a bear market, small-cap stocks have essentially been market performers this year. The S&P 500 is off by 17.8%, while the S&P 600 Small Cap Index is about the same (-18%). The Russell 2000’s YTD loss of 19.8% is nearly equivalent, even though it contains a more significant portion of low-quality companies. Overall, small caps have been resilient as the Bear growls, and, hopefully, that’s a good sign they could again be the leaders once the Bull takes charge.

While the market moves back into sell-off mode, everyone seems to be waiting for the inevitable hammer to drop on earnings. If and when that happens, does it give us any insight about performance prospects? Or does it just make forward P/E ratios less attractive?

Aside from a couple specialized approaches, 2022 is shaping up as the second-worst year for “multi-asset” investing since at least 1973. It seems money printing supported more than just the equity subset.

If a new bull began in June, the August 31st “super-oversold” signal would be the first ever during the first three months after a bear market low. In 1962, such a reading occurred in the bull’s fourth month—which is probably why some analysts are now using that year as a possible analog for the rest of 2022.

In January we put it bluntly: “Longer-term time cycles don’t line up for a prosperous 2022.” Not only is it a mid-term election year, but also a Shmita Year. Eight months later, the S&P 500 loss through August has exceeded 10% for only the twelfth time since 1926.

Since our July report, market action felt like the pivot had already occurred. However, according to our latest update, numerous measures have moved away from levels that would support a pivot. In other words, the eagerly-awaited Fed pivot has been pushed further out.

We take a look at the impact of past corporate-only tax hikes versus tax hikes of any type (personal income, corporate, capital gains). The gist is, there isn’t much difference at all.

The stock market rally from the June low failed to break through its 200-day moving average on August 16th, and the S&P 500 has since fallen on tough times. The market advance was seemingly clipped, and the Bears again ruled! The decline began during the preamble leading up to Jackson Hole, and the S&P 500 completely collapsed after Chairman Powell’s hawkish speech reiterated the Fed’s resolve to bring inflation under control. The index dropped by about 9% from its recent high and is more than 18% below its all-time high.

Read this week's MTI update...

The contemporary economic and financial market cycle has been a weird one. It began with the biggest post-war bust in both real GDP and employment, followed almost instantaneously by a boom! It has been characterized by unprecedented use of monetary and fiscal stimulus, the lowest bond yields ever recorded in U.S. history, chronic supply-side shortages, the highest inflation in 40 years, and one of the speediest and most aggressive Fed tightening cycles

Read this week's MTI update...

With inflation still ravaging the U.S. economy and the leader of the Federal Reserve about to take center stage to inform everyone what he will do about it, investors should remind themselves that “disinflation” probably still rules. Yeah, you read that right.

See this week's MTI update...

It’s yet another Fed week. Monetary officials meet in picturesque Jackson Hole, Wyoming, for some scary talk about fighting inflation, hard-line commitments to raise interest rates, and frightening possibilities about an imminent recession. 

The scene in our neighborhood in the last two summers has become one of relaxed and well-tanned professionals out in their yards overseeing home improvement and landscaping projects. No surprise: Not a single one has told us they’re less productive when working from home!

As inflation rages and real economic growth decelerates, investors share legitimate concerns about the direction of company earnings. Undoubtedly, profit growth will slow; businesses are simultaneously dealing with declining unit sales and margin pressures. In the coming year, the question is, will corporate earnings significantly collapse or simply moderate to a sluggish (but still positive) growth rate? That is, are profits poised to “Poof” or “Purr?”

Read this week's Major Trend update. 

Who’s correct? The Federal Reserve is talking tough on inflation, indicating its fight is far from over and multiple rate hikes are yet forthcoming. The bond market, though, has turned decidedly dovish: The 10-year Treasury yield peaked in mid-June near 3.5% and has subsequently eased by about 75 bps. Moreover, the one-year breakeven rate (the bond market’s embedded one-year-forward inflation expectation) collapsed from 6.3% in March to 3.0% today. Indeed, the recent decline suggests the inflation outlook could soon be back near the Fed’s 2% target.

Old timers will recognize our title as a twist on Ronald Reagan’s clincher in the final 1980 presidential debate with Jimmy Carter.

We recalled Reagan’s line while preparing for today’s 40th anniversary of the great 1982 secular stock-market low. Investors in the S&P 500 have earned an annualized total return of +12.4% since that trough, about two percentage points above the long-term average.

An early mentor told me, “When your management style starts to reduce productivity, apply less management!” Fiscal authorities should consider that advice.

Both the headline and core CPI are better (lower) than expected. We see more signs of peak inflation as oil prices, supply chain issues, wage pressure and capacity utilization start to moderate.

Not all sectors are created equal. Some influence the direction and thrust of the stock market more than others. The Technology sector, however, has historically had an unparalleled impact on the overall performance of U.S. stocks.

Read this week's Major Trend. 

At the beginning of the year, we liked the chances for the “Donut Portfolio” to break its 10-year losing streak against the S&P 500. As a refresher, the Donut holds six of seven key assets in equal weights. The S&P 500 is excluded—a decision probably only suitable for allocators who are self-employed. 

Many technicians contend that the rebound off June’s lows triggered a bear-market-killing “breadth thrust.” Several gauges we monitor to capture this phenomenon contradict that claim. None has reached a threshold that is extreme enough to qualify as a thrust.

The theory of “contrary opinion” is important to market analysis, but so is an understanding of its limitations. When investor-sentiment surveys dipped sharply in late January, we warned that the declines (which are usually signals to “buy”) might instead mark the beginning of an important trend change. 

Our recession indicators have continued to deteriorate. Given the stagflation backdrop, the Fed’s tightening cycle is very likely to end in a recession.