Message Received

Message Received

Markets went from riding high to feeling low, last week. What happened? You can look at a variety of things, but I think the basic problem was that central banks stole the jam out of the market’s donut, saying no pivot is coming anytime soon.

Obviously, the FOMC’s message was poorly received. My personal opinion is that, in addition to a hawkish statement and presser by Powell, he also said that if the market were to loosen financial conditions, the Fed would have to tighten all the harder.

The market has been searching for signs of a pivot for months, and the FOMC finally told them that isn’t going to happen anytime soon. The committee was unified in supporting a 50bps hike. They centered on the idea of needing “substantially more progress” to loosen, and that the “labor market remains extremely tight.” It seems the FOMC really wanted the market to get the message that there is no pivot coming anytime soon, and I think that message was received.

I think that effectively caps the upside. The market can attempt to head up, but it’s only going to encourage the Fed to stay tighter for longer.

Additionally, European central banks echoed the FOMC. In particular, the ECB talked of the need to stay tighter for longer, along with starting a QT program of their own. That hit markets fairly hard, particularly the bond market.

We also had a spate of negative economic news both domestically and internationally, and after central banks took the punchbowl away, it seems bad news is bad news again. Industrial production, manufacturing, Fed surveys, retail sales, and inventories were all negative. China also had universally terrible economic news.

Lastly, while commentators have celebrated a purported end to China’s zero-COVID policy, their market hasn’t particularly celebrated, down 3.5% last week, using the FXI. The key there, in my mind, is that SHIBOR, the Chinese interest rate, has been moving up. SHIBOR moving up effectively tightens access to credit, which should contain China’s upside.

All this combined for a bad, if not horrible week, with the S&P 500 down 2.55%. The bigger question is what is happening now? In a vacuum, nothing much has happened. We bottomed out in October at a little under 3500, rose up to about 4100, and the latest disappointment rapidly took us down to around the 3835 level that represents where the large put spread collar from JPMorgan was struck.

3835 seems like a natural resting point but is it realistic to think we can stick there for almost two weeks? That’s possible, but the recent news from the economy and central banks may mean downside potential may be significantly higher than upside.

We have an absolute minimum of a month, and likely more, before we can possibly see enough data to convince the Fed to actually pivot. The market seems to recognize this, which is at least part of why bad news no longer seems to be good news. It’s hard to see how any single economic release will be the magic lever, here.

I don’t consider myself to be in the business of calling out short-term market moves, but to my mind, there are a few danger signals, here. Plenty of people were aggressively chasing a Santa rally, and last week, their hopes were dashed. Now, they’re arguably stuck. Second, we have the usual mix of tax-loss and RMD selling going on, which tends to hit harder on down years, particularly when bonds also did poorly. Lastly, large institutions tend to square up positions into year-end, cleaning up balance sheets to look good to regulators.

I’m certainly not going to try to call out what happens into the end of the year, but I do think downside risks are elevated after last week, and the market seems to have relatively little hedging in place. I’ve been patiently waiting for a high-odds time to shift positioning more aggressively, but all last week did was solidify that, at least for now, conservative positioning makes the most sense.