Market Forecast For the Week of May 2, 2022: Equities Rally But The Result Will Be Another Haunting Headfake

FORECAST: The S&P 500 rallies to 4125 and enters a trading range as investors assess whether interest rates have peaked. I expect the consolidation to end by next week as bond vigilantes slake their thirst for higher interest rates and send equity bulls running for cash and dropping equities to new lows. The overarching dual bear market in bonds and stocks will persist for at least another 10% drawdown (i.e., S&P 3700) at which point the market will have fully discounted all the atrocious trends to date. That opens the door for the bulls to wrest control and initiate a new bull market, assuming new trends of an atrocious nature don’t emerge.

For the moment bond vigilantes are keying off the Fed’s stated intention to raise rates but also betting the Fed is motivated by reasons unstated. The Fed fears high inflation but either consciously or unconsciously seeks to curb what the pro-business community sees as disturbing trends working against profit margins. These include the declining work ethic and the belief in curing inequality by raising the cost of doing business via state harassment and regulation. These leftward trends combine grossly with strong consumer balance sheets, the strong dollar and pent-up demand to create a stagflationary mindset, which the Fed is determined to break.

I see the Fed’s terminal rate at 3.50%, well above current inflation expectations that run at 2.5 - 3%. A positive real rate at the shortest end of the yield curve ensures inflation declines because it cools down the labor market and the affluent consumer simultaneously, with the added result of a punishing recession in all but name only. Democrats can do little to stop the Fed either procedurally or through jawboning since inflation clearly hurts the working class more than the affluent. And while equity bulls hate the result, they are similarly conflicted as they have long complained the Fed’s policy of easy money drove inequality and went on for months too long.

Earnings estimates are bound to decline as debt-financed spending declines & the $US bulldozes currencies from economically weaker nations. The supply disruptions caused by Putin’s invasion are equalled now by China’s moronic zero-COVID strategy, which will persist until vaccination rates increase significantly. Corporate America is thus caught between a Fed raising financing costs and a global economy reeling from supply disruptions. The bear market will only end with a washout where investor confidence hits a nadir and no one is left to sell. That feels close, assuming the trends at present are as bad as it gets.

Unfortunately there are other risks too. Wild commodity swings increase the potential for financial contagion, which is also a significant concern as dollar shortages may emerge due to sanctions on Russia’s Central Bank and several commercial banks. Talk of financial contagion is enough to send equities careening.

On Friday I sold my incremental position in the levered ETF UPRO which I had initiated Thursday, Consequently my current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.