This blog serves as a follow up to our previously released Q3 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 quarterly update:
- Inflation will remain elevated on an absolute basis into 2023, which means the Fed will probably not pivot and move to stimulating risk assets for at least the first half of 2023. Our research indicates that we are likely heading into four straight quarters of economic slowing. In other words, the Fed is being forced to raise interest rates as the United States goes deeper into recession.
- Global currency, stock and bond markets are experiencing greater volatility, in aggregate, than any other time this century. Many currencies around the world are experiencing a crash against the dollar, which is continuing to prop up the dollar even as the United States plunges into recession.
- The U.S. bear market in stocks is ongoing, but we may see some October surprises ahead of election season (surprise policy decisions, creative news announcements, and likely some corporate buybacks at the end of October/beginning of November). However, there’s a good probability that stocks remain in a bear market until at least the end of the first quarter of next year. The theme for October earnings season will likely be warnings of higher inventory, lower consumer spending and shrinking profit margins, followed up by decreasing Capex spending or production cuts. Warnings of one form or another have already come in from Walmart, Target, Apple, Nvidia, Micron, FedEx and others. The theme for January earnings season may be huge layoffs and massive cost-cutting. This means we are still at the front-end of feeling the full weight of an economic recession.
Market
The S&P 500 (SPX) resumed its bear market downtrend in September, making new lows for the year. Any counter trend bounces are being met with renewed selling. The SPX finished down -9.61% in September and down -6.27% for the quarter. The Nasdaq performed slightly worse than the SPX in September, but slightly better for the quarter. Tech stocks continue to be the bottom picker’s investment choice every time there is a “Fed Pivot Imminent” rumor, which accounts for the Nasdaq’s slight buoyancy in the quarter. The Nasdaq finished down -10.26% in September and down -4.96% for the quarter. The Dow Jones performed slightly better than the SPX in September, but slightly worse for the quarter. Investors like blue chip stocks as a safer haven during steeper selloffs like September, but they also like speculating on growthier stocks during bullish bounces. The Dow finished down -10.26% in September and down -8.51% for the quarter. Small Caps performed slightly better than the SPX in September and outperformed for the quarter. The RUT benefited from a series of short-squeezes and speculative buying binges during the quarter, but if the bear market worsens as we expect, then the RUT will likely under perform the SPX. The RUT finished down -8.67% in September and down -3.65% for the quarter.[1]
The MSCI World Index (MSW) performed slightly better than the SPX in September, but under performed for the quarter. Red hot inflation in Europe, falling currencies around the world, and the early stages of economic recession hit the world harder than the United States. The MSW finished down -8.87% for September and -7.08% for the quarter.[2]
Commodities price index continues to drop as the Fed and central banks around the world target inflation with increasingly tighter monetary policies. In addition, the relentless rise in the dollar throughout the quarter put a headwind in front of commodity prices. Remember that commodities are priced in dollars, and the higher the dollar goes, the less dollars it takes to buy the same amount of each commodity, therefore commodity prices drop. In other words, the Fed is putting the double-whammy on commodity prices by causing a slowdown (crushing demand) and increasing the value of the dollar. The DBC finished down -6.68% in September and down -4.82% for the quarter.[3]
Gold was impacted negatively by rising real yields (interest rates) during the quarter. However, the increasing volatility in world currency markets, along with the deepening global recession and geopolitical uncertainty, is causing many global investors and central banks to buy gold as a hedge.[4] Gold finished down -2.18% in September and down -7.19% for the quarter.[5]
Longer dated treasury yields (a measure of interest rates) rallied throughout most of the quarter, including a big rally in September. Bond traders continue to react to the ongoing and emphatic hawkish language coming from the Fed by selling bonds. There are occasional bouts of rate drops (bond buying) on “Fed Pivot” hopes, but the overall uptrend in rates and downtrend in bonds is still intact. The Ten-year yield (TNX) briefly touched 4% (3.97% on September 27), and finished the month of September at 3.83%, up from Aug 3.15%, and up from 2.88% to start the quarter.[6]
Oil prices were pressured throughout the quarter by a big drain of the Strategic Petroleum Reserves.[7] In addition, oil was negatively impacted by both a rising dollar and deepening global slowdown. The triple whammy against oil feels a bit like all the king’s horses and all the king’s men have fired everything they have at oil in order to get prices down. The big drop in the dollar has riled up Saudi Arabia and OPEC, who, of course, like higher prices. So OPEC is jawboning about big production cuts in order to keep prices elevated.[8] The situation is starting to escalate into a price war between OPEC and the Fed. This is on top of the currency war (the Fed is inflating the dollar and crushing foreign currencies) that is starting to escalate between the Fed and global central banks. Oil finished down -8.24% in September and down -27.55% for the quarter.[9]
Economy
The 3rd and final GDP number for the second quarter (Q2) of 2022 printed -0.6%, which confirmed the United States is in a recession, as we speculated back in the Spring.[10] Projecting forward, our analysis is that GDP will bounce back a bit in the third quarter on a quarter over quarter (QoQ) basis, but will continue to decelerate on a year over year (YoY) basis.[11] Note that 2/3rds of GDP is personal consumption, and our projection is that consumer spending is about to drop off a cliff.
In economics, the Wealth Effect suggests that people spend more as the value of their assets rise. The inverse is true as well, so with prices falling in real estate, stocks and bonds (while prices go up in gas, food, and many other consumer items), the United States middle class is feeling much less financially secure. This is showing up in the overall trend of consumer confidence. In addition, we are still at the front end of real estate prices beginning to plummet. In the month of August (as reported in the end of September), home prices experienced the first sequential drop since March 2012.[12] And the intermediate-term outlook is getting worse.[13] Therefore, the Wealth Effect dissipation is likely still in the very early stages and set to implode over the next year.[14] This will likely lead to significantly more cautious consumer behavior for multiple quarters, which will impact both GDP and corporate earnings. 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.[15]
Nothing has changed with inflation. It continues to be the most important financial issue on planet earth. So, it bears repeating: 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 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. 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, which is tightening into a deepening global recession.[16]
Summary
- Inflation will remain elevated on an absolute basis into 2023, which means the Fed will probably not pivot this year or early next year. Our research indicates that we are likely heading into four straight quarters of economic slowing. There will likely be no help from increased consumer spending any time in the next year because we are headed into a crushing Wealth Effect dissipation for multiple quarters. The drop in consumption will not only hurt GDP, but also corporate earnings. We may even experience a “death spiral” of lower consumption leading to lower corporate earnings leading to corporate layoffs leading to even less consumption. It may not be until we get massive corporate layoffs and stock market capitulation that the Fed relents and pivots back to an accommodative monetary policy. If this does end up being the scenario for a market bottom, the earliest we project the possibility of it happening would be 6 months from now, or around the end of Q1 2023.
- Global currency, stock and bond markets are experiencing greater volatility, in aggregate, than any other time this century. Many currencies around the world are experiencing a crash against the dollar, which is continuing to prop up the dollar even as the United States plunges into recession. This is starting to create a currency war between the Fed and other central banks, and a price war between the Fed and OPEC.
- The U.S. bear market in stocks is ongoing, but we may see some October surprises ahead of election season (surprise policy decisions, creative news announcements, and likely some corporate buybacks at the end of October/beginning of November). However, there’s a good probability that stocks remain in a bear market until at least the end of the first quarter of next year. The theme for October earnings season will likely be warnings of higher inventory, lower consumer spending and shrinking profit margins, followed up by decreasing Capex spending or production cuts. Warnings of one form or another have already come in from Walmart, Target, Apple, Nvidia, Micron, FedEx and others. The theme for January earnings season may be huge layoffs and massive cost-cutting. This means we are still at the front-end of feeling the full weight of an economic recession.
- Having a hedged and cross-asset class approach to investing can help you navigate the multiple storms blowing through the global economy and financial markets. This type of strategy will increase in importance as we go deeper into a global recession, and as volatility and uncertainty increase across financial markets, the global economy and major governments and political organizations.
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!
[1] Slide 3
[2] Slide 4
[3] Slide 5
[4] https://internationalbanker.com/brokerage/gold-buying-once-again-on-the-agenda-for-central-banks/
[5] Slide 6
[6] Slide 8
[7] https://www.forbes.com/sites/rrapier/2022/09/07/the-strategic-petroleum-reserve-is-at-its-lowest-level-since-1984/?sh=79a06fea77c7 and EIA chart: https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCSSTUS1&f=W
[8] https://www.forbes.com/sites/rrapier/2022/09/07/the-strategic-petroleum-reserve-is-at-its-lowest-level-since-1984/?sh=79a06fea77c7)
[9] Slide 9
[10] https://www.bea.gov/data/gdp/gross-domestic-product
[11] Slide 11
[12] https://www.zerohedge.com/markets/housing-bubble-has-officially-burst-case-shiller-records-first-drop-home-prices-2012
[13] https://www.zerohedge.com/personal-finance/mortgage-application-pace-plunges-25-year-low-housing-recession-deepens
[14] Slide 12
[15] Slide 13 & 14
[16] Slide 15