Bottoms need a catalyst and there isn’t one in the cards for a very long time
Publishing date:
May 30, 2022 • 13 hours ago • 4 minute read • 7 Comments
The average bear market rally in the worst bear market in modern history averaged 11 per cent. Feel lucky, punk? Photo by Getty Images It’s because bottoms always and everywhere need a catalyst and that means the United States Federal Reserve rides the cavalry in at the lows. That’s just not in the cards for a very long time.
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We have said before that to get to the two-per-cent inflation target, the Fed will have to generate the macro conditions for a negative reading on the core consumer price index (CPI) trend (which has never happened before) and an unemployment rate back above six per cent. There is no getting around this with a demand-led recession unless the Fed changes its inflation target.
To achieve the degree of slack the Fed needs to achieve its current inflation goal, it will need to see financial market conditions tighten enough that we get to a 3,100 low on the S&P 500 and a 700-plus basis point spread in the high-yield bond market. What we saw last week is exactly not what the Fed wants at the current time, which is a risk-on rally that took financial conditions to their most stimulative (or “least tight”) level since April 21. Nicht gut for Jay Powell.
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This is a bear market rally to rent; not to own. All that’s happened is that one-quarter of the meltdown to the nearby lows from the early year high has been retraced. Nothing has even broken any trendline; unless you are a day trader, it’s really nothing to get too excited about. We are just filling in oversold gaps here.
One other thing. We had at least six rallies just like this one in the 2000-2002 bear market. Interim rallies of five per cent or more: four of the six were 10-plus per cent. The average bear market rally was 16 per cent. And yet the peak-to-trough plunge in the S&P 500 was still 49 per cent. And the bleeding only stopped after repeated rate cuts by the Ben Bernanke Fed at the time.
We had eight huge technical rallies in the horrible 2007-09 bear market, too, of five per cent or more, and half of these were also 10-plus per cent and lulled in so many unsuspecting “buy the dippers.” Poor souls.
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The average bear market rally in the worst bear market in modern history averaged 11 per cent. Feel lucky, punk? Once the market was down 52 per cent and the Fed repeatedly cut rates and embarked on Q2, the bottom was in. Wait for the catalyst unless you are a Paul Tudor Jones equivalent and know how to trade the market (and how to hedge).
In both periods, the lows were turned in at the tail end of, or after, the recession. This one is staring us in the face right now. Consumer spending is hanging in, but a shift in the spending mix highlights a new trend towards frugality. Capex plans in real terms are hooking down. The U.S. housing market has rolled over again. And retailers are stuck now with a ton of unplanned inventory.
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Article content Be that as it may, the market narrative is still one of a “soft landing.” As it was in 2001 and most of 2008. When we see businesses respond to the worst productivity performance since 1947 via layoffs and cutbacks to hours worked because they over-hired in the same way they over-stockpiled, the recession call will move from being on the outer fringes of the forecasting community to mainstream consensus thought. This is the way it always happens, and the “brave” folks saying recession odds are 30 per cent or 40 per cent will tell you after the fact that they got it right — even though it never really was their base-case view. An illusion, a diversion, a case of mind over matter.
Oh, one more thing. The view espoused on bubblevision that if we get a recession, not to worry, because it will be of the “mild” variety. As if that’s the only thing that matters — how severe the economic downturn is. We are told how pristine corporate and household balance sheets are, and how this guarantees a mild recession. All comparisons are with the Global Financial Crisis of 2007-09. We had a severe recession in the mid-1970s and early-1980s, and balance sheets weren’t the reason.
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Article content In any event, as I digress, there is no correlation between the extent of the recession and the severity of the bear market. Examples: as stated above, all we had on our hands in the 2001 recession was a 0.3 per cent dip in real gross domestic product (GDP) from peak to trough and yet the S&P 500 plunged nearly 50 per cent. The 1990-91 recession was five times as bad, with real GDP down 1.4 per cent, and the market was down only 20 per cent.
Why? Because you must factor in the starting point for the P/E multiple, and in 1990 it was 17x (for the cyclically adjusted price-to-earnings (CAPE) ratio compared with 44x in 2000 (and 27x in 2007). Where was the peak heading into this recessionary bear market? Try 38x, not far off where we were heading into the 2001-02 painful multi-year bear phase.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on Rosenberg’s website.
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