Market Forecast For the Week of September 12, 2022: Irrational Exuberance Trumps Autumnal Sobriety As The Fed Quietly Watches

FORECAST: The S&P 500 rises in the latest installment of the bear market rally that began in June. An exuberant ride to 4200 level marks the high as investors then take stock and respond to persistently higher interest rates and a depressingly inverted yield curve. The index eventually tracks back down to a retest of the 3900 level, as only a shockingly low inflation print tomorrow can prevent the bear market resuming as September unfolds with shorter days and sober spirits.

This summer’s rally will prove a failure after the Fed delivers another 75 bp rate hike next week while signaling continued data dependence. Rising interest rates during an economic deceleration warrant lower valuations but the addition of a raging $US driven by terrible policies and politics across Eurasia and Latin America guarantee a steep drop triggered by complete capitulation by the bulls. For now that seems far off as the bulls make the case that inflation expectations remain modest and the Fed is bound to recognize that sooner or later. Follows that the Fed hikes rates but supposedly signals complacence with the disinflation that began two months ago. While this is plausible it ignores the lagging effect of inflation and labor market dynamics on earnings, which are set to decelerate for an extended period as firms respond to the new macro environment.

The $US’s dual role as reserve currency and transaction currency for 40% of global trade makes it the inverse metric for global GDP and so deadly for the MNCs who make up the S&P benchmark. Earnings estimates still don’t  reflect that risk as my latest tally of the top 100 firms shows estimates actually rose last week and average out to 1% growth this fiscal year and over 9% growth next. This despite the marked drop in earnings quality, which is worsening for 40% of firms compared to just 15% reporting quality improvements. Since earnings quality has long been an objective predictor of future earnings the analyst community is likely inertial to the macro changes that can only yield lower earnings, sales and compressed margins. That is the formula for lower valuations, which likely bottom out as the S&P 500 hits 3400 in October.

My current positions include a fairly large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which nets to a meaningful short position in equities.