2022.06.21 19:30

By raising interest rates, the Fed poured cold water on the red-hot markets and finally chilled investors’ enthusiasm. What’s next for asset prices? Work in Progress

With the Fed’s hawkish hammer pounding the financial markets, the selling pressure coincided with events unseen since 2008. Moreover, with the work in progress to reduce inflation poised to push asset prices even lower, I’ve long warned that we’re likely far from a medium-term bottom. For example, I wrote on May 31:

Performance Of Major U.S. Indexes

Performances of Global Assets

To that point, the S&P 500 reversed sharply over the last several days, and the Goldman Sachs Small Cap Equity Insights Fund Institutional Class followed suit.

For context, the S&P GSCI contains 24 commodities from all sectors: six energy products, five industrial metals, eight agricultural products, three livestock products, and two precious metals. However, energy accounts for roughly 54% of the index’s movement.

Please see below:

GSCI Daily Chart

To explain, the green line above tracks the S&P GSCI, while the black line above tracks the S&P 500. As you can see, hawkish rhetoric and a 75 basis point rate hike had their desired effect.

Furthermore, I warned on Apr. 6 that higher asset prices are antithetical to the Fed’s 2% inflation goal. In a nutshell: the more the bull gores, the more inflation bites. I wrote:

Speaking of which, the fundamental thesis continues to unfold as expected. For example, Fed Chairman Jerome Powell said on Jun. 17: “The Federal Reserve’s strong commitment to our price stability mandate contributes to the widespread confidence in the dollar as a store of value.” Moreover, “The Fed’s commitment to both our dual mandate and financial stability encourages the international community to hold and use dollars.”

As a result, while I’ve long warned that unanchored inflation would elicit a hawkish response from the Fed and uplift the USD Index, the man at the top remains focused on the task at hand.

Please see below:

Quote From Reuters

Likewise, Fed Governor Christopher Waller said on Jun. 18:

“This week, the FOMC took another significant step toward achieving our inflation objective by raising the Federal Funds rate target by 75 basis points. In my view, and I speak only for myself, if the data comes in as I expect I will support a similar-sized move at our July meeting.”

Please see below:

Quote From Bloomberg

Thus, while I’ve been warning for months that the Fed isn’t bluffing, investors are suffering the consequences of their short-sighted expectations. For context, I wrote on Dec. 23, 2021:

Continuing the theme, Atlanta Fed President Raphael Bostic said on Jun. 17: “We’re attacking inflation and we’re going to do all that we can to get it back down to a more normal level, which for us has got to be 2%. We’ll do whatever it takes to make that happen.”

As a result, the more investors bid up stock and commodity prices, the more “muscular” the Fed’s policies become.

Please see below:

Headline From Reuters

Thus, while Fed officials continue to press down on the hawkish accelerator, the plight of many financial assets highlights the ferocity of central bankers’ war against inflation. Moreover, with all bouts of unanchored inflation ending in recessions over the last ~70 years, more fireworks should erupt in the months ahead.

Short Squeeze 2.0

It’s important to remember that financial assets don’t move in a straight line. Therefore, while the fundamental outlook continues to deteriorate, the algorithms may spot bullish short-term trends that let the scalpers profit in the interim. For example, I noted on Jun. 15 that one-sided positioning could (and eventually did) spark a relief rally. I wrote:

Prime Book: U.S. Equities

To that point, last week’s selloff has too many market participants on one side of the boat. As a result, don’t confuse a short squeeze with bullish price action.

Please see below:

Prime Book: Global Equities

To explain, the blue bars above track the short-selling and short-covering activity of Goldman Sachs (NYSE:GS)’ hedge fund clients. If you analyze the red line at the bottom, you can see that the z-score of hedge funds’ weekly short sales was the highest since April 2008.

In a nutshell: hedge funds shorted more stocks as the S&P 500 declined, leaving them highly exposed to a short squeeze. As a result, if the markets rally, consider the price action within the context of the above data.

Likewise, oversold conditions are also present.

To explain, the green line above tracks the percentage of S&P 500 stocks above their 50-day moving average. If you analyze the right side of the chart, you can see that only 2% of S&P 500 constituents hold the key level, and the reading is abnormally low.

For context, it’s a contrarian indicator, meaning that too much pessimism often elicits a short-term reversion. Moreover, with the dot-com bubble, the global financial crisis (GFC), the 2011 growth scare, the COVID-19 crash, and the 2018 sell-off the only periods with lower readings, it may take a shock-and-awe event to move the metric lower in the short term.

Also noteworthy, Bloomberg’s SMART Money Flow Index diverged from the Dow Jones Industrial Average late last week. For context, the indicator gauges the behavior of ‘smart’ investors that trade during the final hour of the day.

Please see below:

SMART Money Flow Index

To explain, the green line above tracks the DJI, while the red line above tracks Bloomberg’s SMART Money Flow Index. If you analyze the right side of the chart, you can see that the smart money expects some selling reprieve.

Finally, Bank of America’s Bull & Bear Indicator is at its lowest possible level. Again, this uses contrarian methodology, emphasizing how bearish over-positioning can spark sentiment shifts.

Bull/Bear Indicator

Bottom Line

There have been several fits and starts along the VanEck Junior Gold Miners ETF’s (NYSE:GDXJ) path to lower prices, and the medium-term fundamentals remain profoundly bearish. However, rallies can increase investors’ anxiety if they’re unsure of why the optimism has manifested. As a result, while the contrarian bullish stock data may uplift the PMs in the short term, a potential sentiment reversion doesn’t impact their medium-term outlooks.

Moreover, with the Fed hawked up and the developments bullish for the US dollar and U.S. real yields, the S&P 500 and the PMs should confront lower lows in the months ahead.

In conclusion, the PMs declined on Jun. 17, as volatility has asset prices gyrating sharply by the day. However, the frantic buying/selling activity is bearish and highlights the fragility of the financial markets. Therefore, more bouts of panic should erupt in the coming months, even if the selling pressure subsides in the near term.

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