Market Forecast For the Week of January 31, 2022: A Head Fake Awaits Before The Correction Resumes Into Early February

FORECAST: The S&P 500 rebounds slightly on a continued short squeeze but then begins another leg down into the correction. I expect the S&P to rally only to 4500 before falling again to around 4160. What had begun as a normal consolidation on modest volume and volatility has become a high volume and high volatility correction and the reason is simple: global investors are weighing whether the two largest economic policymakers are both making mistakes and dooming the global economy to flat or even negative growth in 2022.

On January 19 the market had been trending lower in a run-of-the-mill consolidation as it hit the mid-December lows, and then came the Biden afternoon press conference. From there investors digested the fact that Biden was giving an implicit mod to Federal Reserve hawkishness by failing to hone to the inflation is transitory mantra. Biden didn’t use words like temporary or short-term to describe inflation, but rather treated it as a problem requiring action to keep it from becoming “entrenched.” Powell astutely held to this line and thus shielded himself from the inflationistas who had been lambasting him for failing to act hawkishly in the middle of the Delta/Omicron pandemic waves.

The market has reacted to this one-two punch of hawkishness with mind-numbing volatility, and such volatility portends further downside rather than a true bottom. Fed hawkishness marries Chinese myopia regarding COVID restrictions in creating an ugly backdrop for global growth. The financial markets had been disjointed through mid-January but are now speaking with one voice of fear over such policy mistakes. The $US has risen against both majors and EM currencies and this reflects growth fears but more profoundly it becomes a self-fulfilling prophesy since roughly 40% of global trade is in $US and any $US strength reduces the GDP of importing nations. Copper and Gold have fallen off their bullish track due to $US strength while oil is raging ahead as the market awaits clarity on Russian threats to the Ukraine. Here Biden has inadvertently stoked inflation as his strong reaction to Russia implies energy supply uncertainty. So inflation is high and the market is debating whether it comes down strongly this year and thus relieves the Fed of actually having to be hawkish and raise rates more than 3 times.

The cause for strong optimism rests on actual inflation trends. Inflation expectations are tethered to the 2% plus range despite bond market volatility, and the disinflationary impulse from globalization continues apace as the US, Europe and China have tamped down the trade rhetoric from the hysteria of the Trump years. And while the Fed has signaled that OE is ending in March and QT will someday start, they also noted that rather than selling bonds they will let their existing bonds mature, to the great relief of fixed income markets. Bank credit continues apace to grow the US economy and the simple effects of coming off the high base of 2021 ensures that inflation comes down going forward. I believe the Powell will not act hastily and the Chinese will come to their senses regarding letting Omicron spread and that will burn out fears of a global recession. Earnings optimism will then return and power the markets back to old highs in February.

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 aggregate cross-border bank claims are rising at a modest 3% clip (based on increase in Q3 2021 of $228 billion), indicating contagion risk remains 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.

On Friday I added to my position in Titan Machinery (TITN). My other current market positions include a moderate cash position, Amgen (AMGN), American Express (AXP), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the levered ETF UPRO.