Most METARs are old enough to have experienced the economy and markets of 1973 and 2001, and also the determination of Federal Reserve Chairman Paul Volcker to raise interest rates until inflation was wrung out of the economy in 1980. Conditions today have a flavor of those times. This is a caution that the current market drop in both stocks and bonds will not end soon. The history shows that a rally could be a bear trap.
https://www.investopedia.com/terms/b/beartrap.asp
https://www.wsj.com/articles/conditions-are-ripe-for-a-deep-…
**Conditions Are Ripe for a Deep Bear Market**
**The risk is a series of bear-market rallies that don’t last, hurting dip buyers and further damaging investor confidence**
**By James Mackintosh, The Wall Street Journal, May 22, 2022**
**...**
**This time central bankers are scared not by falling markets or the economic outlook, but by inflation. Sure, if something major breaks in the financial system, they will refocus on finance, and a recession may prompt them to rethink rate rises. But for now, inflation means that falling stock prices are seen merely as a side effect of tighter monetary policy, not a reason to invoke the “Fed put” and rescue investors....**
**My concern is that this time could be more like 1973-1974. Just as then, the primary concern of the country is inflation, thanks to a war-related oil-price shock. ... Most important, in 1974 the Fed kept raising rates even as a recession took hold because it was running to catch up with inflation. The result was a horrible bear market interspersed with soul-destroying temporary rallies, two of 10%, two of 8% and two of 7%, each snuffed out. It took 20 months before the low was reached — not coincidentally, when the Fed finally began to get serious about cutting rates....** [end quote]
In 1974, the Fed began to get serious about cutting rates. The stock market rebounded…but so did inflation. The late 1970s were plagued by uncontrollable inflation until Paul Volcker decided to ignore the stock market and decisively get ahead of inflation. This caused the deep 1980-1981 recession with high unemployment along with super-high mortgage rates (which I remember very well).
Financial writers are already looking for a bottom. But they are ignoring history. Conditions like today’s are stubborn and take time to resolve. (This short attention span reminds me of newscasters who talk about how long the Russian invasion of Ukraine has gone on, ignoring the history of European wars that lasted years and even decades. “Mommy, are we there yet?”)
https://www.wsj.com/articles/stock-market-bottom-remains-elu…
The conditions that led to today’s asset market bubble were unique and extraordinary. The Covid-19 shutdown caused both the Federal Reserve and Congress to shower an unprecedented amount of monetary and fiscal stimulus which led to bubbles in the stock, bond and housing markets. This stimulus prevented a deep recession and financial market crash, so it was the right thing to do. But it led to high inflation, both in consumer prices and asset prices. Energy price inflation was overlaid on this.
The huge amount of cash sent to households was meant to stimulate consumer spending. But instead of targeting it only at households which really needed the money, Congress indiscriminately sent “Economic Impact Payments” (EIPs) to almost every household, whether they needed it or not.
M1 is the measure of readily-spendable money. Money tends to burn a hole in people’s pockets. Everyone was stuck at home due to Covid. Spending shifted from services to goods…but supply chains were backed up.
https://fred.stlouisfed.org/series/M1SL
Many who didn’t spend the money on goods invested it in the stock market, driving a bubble reminiscent of 2001. Like 2001, much of the money was invested in the stocks of “growth” companies with high debt and little, if any, current profit. Like 2001, this bubble is now bursting. History shows that a bubble, once burst, will not re-inflate. That money is lost, at least for many years to come (until the next bubble inflates). Congress won’t send out any more EIPs so that was a one-off which won’t happen again.
https://www.multpl.com/shiller-pe
Ordinary workers are suffering as prices soar. Food, gas, home prices, rents are becoming unaffordable. The Fed is using their only tool, interest rates, to try to reduce inflation which was caused by fiscal (not monetary) stimulus and supply chain constrictions caused by pandemic and war. This will take a long time and will probably cause a recession.
It has been 97 stock market trading days since the last high. Very close to triggering the “mungofitch 99 day rule.” It’s pretty safe to say that the market will not make a new high in the next 2 trading days.
The Control Panel is uniformly grim. The Fear & Greed Index is in Extreme Fear. The trade is risk-off. Even though the safe investments (Treasuries and the USD) are dropping, stocks and junk bonds are dropping even faster. When all assets drop at the same time, it shows that money is draining out of the markets. It’s the opposite of when the Fed was pumping and money flooded into the markets, raising all assets together.
The Treasury yield curve has dropped a touch, which could be noise or a sign that investors are moving money from stocks into safe Treasuries – a reasonable move.
The METAR for next week is gloomy. If the markets stay calm, the forecast is for rain. If the markets lose their cool, there could be a thunderstorm (an accelerated drop in the markets). I don’t think there will be a hurricane (a financial crisis) since the underlying conditions are stable though negative in direction.
Wendy
https://stockcharts.com/freecharts/candleglance.html?VTI,$SP…
https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…
https://stockcharts.com/freecharts/candleglance.html?$SPX,$U…