Market Forecast For the Week of January 24, 2022: Another Rout Before The Fed Rescues The Bulls On Wednesday
FORECAST: The S&P 500 continues its correction to 4300 as global investors debate whether the Fed is making a mistake in turning so hawkish so quickly. The likeliest course for the Fed is to take slow and gradual steps in normalizing, which would support equity valuations and a continued bull market since corporate earnings growth remains robust per Wall Street bottoms-up analysts. For now however, the bears are in control as the market worries the Fed will announce not just interest rate hikes coming in March but also quantitative tightening. I expect when it convenes in the middle of this week the Fed will clarify that QT is not happening anytime soon and in consequence the bulls will roar back and carry the market back to old highs.
The debate between bond vigilantes and inflation doves has resulted in disconnects both within and across asset classes. While rates backtracked modestly as equities swooned and the VIX soared what commodities did was simply consolidate previous gains. With gold, copper and oil in solid bull markets the likelihood of profoundly rising interest rates or QT is small. And with inflation expectations falling precipitously clearly the bond market is of two minds. The currency markets are also giving mixed signals, reflecting the debate. Risk-off sentiment is clear but there are no indications of a steep drop in global growth, as the € and some EM currencies have weakened but both the Yen and Yuan have rallied. The Yuan can’t rally if global growth is falling off a cliff since China’s trade surplus depends in large part on exports, while portfolio inflows depend on confidence the Chinese economy will grow while monetary policy eases modestly. The logical inference from financial markets is that both global growth and liquidity remain moderate and supportive, and the market simply awaits the Fed to announce its intentions regarding QT.
Fears of Vladimir Putin seizing Ukraine are receding as it becomes obvious he has already marginally improved his stature by dividing the US & Europe while showing Ukraine it can destroy normality at will. The strong reaction by Biden this weekend ensures nothing happens since Putin has no incentive to risk everything when he is gaining ground globally while maintaining his grip domestically.
Financial risk remains a concern but dollar shortages have eased. While China’s property crisis hasn’t triggered any fallout among global banks yet, cross-border bank claims to the non-financial private sector (e.g., real estate) are high according to the most recent BIS data. So the global financial markets need the Chinese Communist Party to finesse the troubles at Evergrande et al, which the CCP is incentivized to do since Chinese retail investors have money at stake. But overall the most recent BIS data shows a decrease in Q2 2021 of $308 billion (although due to comparisons with Q2 2020 it registered as a slight increase of 2% year on year), indicating contagion risk is now only a modest concern. EM debt repayment remains murky for badly run nations (e.g., Turkey, Argentina) but moderate global growth is buoying export confidence in major EMs. Fortunately there has been no major chatter regarding concentration risk or counterparty risk at large financial institutions.
My current market positions include a moderate cash position, as I significantly increased my position in the levered ETF UPRO on Friday. My other holdings are: Amgen (AMGN), American Express (AXP), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Starbucks (SBUX) and Titan Machinery (TITN).