This blog serves as a follow up to our previously released Q2 Investment Themes, as well as an update on what we are seeing and our current outlook.
Here are the top three things we are covering in this month’s blog:
- We are about to enter the second stage of the current energy crisis, and it may be worse than the first. This means inflation will likely continue to stick at very high levels in the U.S. while continuing to make new highs in Europe. The impact of the energy crisis and Fed tightening has thrown the economy and corporate earnings into recession.
- As we warned last month, the Fed and central banks around the world would eventually have to capitulate and get even more aggressive on rate hikes and jawboning the markets. The final straw was Fed Chair Jerome Powell making a very hawkish statement at the annual global central bank meeting in Jackson Hole.  Powell has joined numerous other Fed members and European Central Bank members by finally relenting and indicating that fighting inflation, even at the risk of creating a recession, is necessary. The stock market immediately sold off on the “surprise” news.
- The June – August bear market rally is now over. The final numbers will show the S&P 500 jumped 19% off its lows and the Nasdaq jumped 25% off its lows before both rolled over and headed back down. Sharp rallies are a normal condition of bear markets. For context, during the Tech Wreck of 2000 – 2002 the Nasdaq had seven bear market rallies of more than 20% before prices rolled back over and headed to new lows each time. Included in those seven rallies were three face-ripper moves of 41%, 43% and 51%.
The 2-month bear market rally in stocks that started in the middle of June, officially ended in the third week of August after Powell’s hawkish statement. The S&P 500 (SPX) remains in a bear market and the index finished down -3.97% for the month of August. The Nasdaq performed similarly to the SPX for the month of August. Big Tech continues to be the favorite place for investors to hide, and for retail traders to speculate, however, the end of the recent bear market rally will likely lead to greater pain in tech in September. The Nasdaq finished down -4.47% for the month of August. The Dow performed similarly to the SPX for the month of August, although with slightly less volatility. The Dow finished down -3.93% for the month of August. Small Caps (the Russell 2000 or RUT), outperformed the SPX as bottom pickers and retail traders speculated the Fed would pivot and the bear market was over. This led a massive short-squeeze in small cap stocks as hedge funds bailed on their bearish bets. However, like the Nasdaq, the spike up in small caps will likely be met with a sharp drop down now that traders realize the Fed is not going to pivot any time soon. The RUT finished down -2.08% for the month of August.
The World Index (ACWI) performed similarly to the SPX for the month of August. European and Chinese stock markets are still in downtrends, and emerging markets are starting to feel the pain of a sharply rising dollar. The ACWI finished down -4.44% for the month of August.
Oil prices came down in August, but the rate of decline from the June highs has flattened out, which is indicating a probability that prices may increase in September. The possible tailwinds are persistent demand and the White House running out of reserves to manipulate prices. Energy prices continue to be the key factor in inflation and central bank policy. For the month of August, the price of oil dropped -3.85%, but the internal structure of the price action is indicating a potential jump in prices in September.
Commodities price index (DBC) finished slightly for the month of August. As has been the norm this year, some commodities have dropped in price, while some have stuck at higher prices. The biggest issue currently is the price of natural gas in Europe and the price of oil globally. The EU has declared an energy crisis as many Europeans get crushed under massive increases in their utility bills. Meanwhile, the White House is running out of oil reserves to try and manipulate prices down in the United States. The commodity index finished down -1.53% for the month of August.
Gold finished down for the month as the dollar rallied and speculators jumped on board the stock market risk-off train. However, with the bear market rally in stocks now over, it’s likely that gold performs better in September than it did in August. For the month, gold finished down -12.18%.
As is often the case, the bond market was right as Jerome Powell capitulated at Jackson Hole. The Ten-year yield (TNX) finished the month of August at 3.15%, up from the 2.60% to start the month. Longer dated treasury yields (a measure of interest rates) rallied in August as bond traders predicted the Fed would have to maintain a hawkish, tightening stance on interest rates. 
The 2nd GDP number for the second quarter (Q2) of 2022 printed -0.6%, which was as slight revision from the 1st GDP print for Q2 last month which came in at -0.9%. The negative number continues to confirm the U.S. is currently in a recession. Remember that two consecutive quarters of negative GDP define a recession, and we’ve already had Q1 confirm a negative number on the 3rd (and final) print. Note that the final Q2 GDP number will not be announced until September, but it is likely that the final number, when it is pronounced, will confirm that we are currently in a recession. Projecting forward, our analysis is that GDP will bounce back a bit later in 2022 on a quarter over quarter (QoQ) basis , but will continue to decelerate on a year over year (YoY) basis. All this adds up to a Quad 4 outlook for the next four quarters. As a reminder, Quad 4 means a period of decelerating growth along with decelerating inflation.
Inflation continues to be the most important financial issue on planet earth. Historically high prices have been crushing consumers all year, and will continue to crush consumers through the rest of the year. The Fed and global central banks have no control over supply. Until we see real structural fixes in the global supply chain, more effective and production-friendly political policies, and some type of resolution to the Russia-Ukraine war, the higher absolute readings on inflation will persist. The net result will be an ongoing drag on the global economy. Europe is the most afflicted region currently due to terrible energy policies, and European consumers are dealing with record-high natural gas prices. Although we project CPI to decelerate as we plunge deeper into recession, the real numbers will still be double and triple the historical average.
Once again, it bears repeating last month’s key theme:
The impact of stubbornly high real inflation numbers, along with a slowing economy, will keep the Fed and other central banks stuck between a rock and a hard place. It will cause the U.S. and global economy to grind and drag at best, or fall into a steep recession at worst.
- The June – August bear market rally in stocks is over. Stock prices have resumed their downtrend, and interest rates have reacquired their uptrend.
- We are entering the second stage of the current energy crisis, which will last deep into Winter, and will likely bring more pain to consumers around the world than the first stage of the crisis. The economy has entered a recession in Q2 2022, and it’s likely the recession will continue, or the economy will “drag and grind” for the next four quarters.
- This summary point from last month is still valid and ongoing: the Fed, along with other global central banks, have boxed themselves into a corner. They cannot risk stimulating stock markets without stimulating inflation, and they have already plunged many major global economies into recession. The Fed is stuck between a rock and a hard place as they try to navigate a soft landing. We expect more verbal gymnastics and jawboning of the financial markets by the Fed throughout the rest of 2022.
- An additional point: we expect stock and bond market volatility to increase in September. In addition, some commodity prices like oil and natural gas may stay stubbornly high. We expect gold to find a bottom and start moving up in the latter half of the year as foreign investors hedge against crashing currencies and traders put on a “flight to safety” trade. The dollar will likely stay strong for the foreseeable future as the euro, yen and yuan continue to crash. Real-estate prices are decelerating and starting to come down, and mortgage apps and housing construction have turned down as well. And finally, retail spending is plunging, and business inventories are piling up as consumers feel the crush of higher prices, less government bailouts and higher debt. The Fed has also been tasked with “crushing the jobs market”, so retail sales are not likely to get better for months or longer. All these factors mean that taking a diversified, hedged and cross-asset class approach to investing can help you navigate the multiple storms blowing through the global economy and financial markets.
We hope you have enjoyed getting a deeper look into our investment research and look forward to providing this to you each quarter going forward. Thank you from the entire Konvergent Team!
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