Sickness Spreads – September 23, 2022

Sickness Spreads – September 23, 2022
Morgan Lewis Posted on September 24, 2022

Sickness Spreads

Regrettably, a sickness, not unlike the one now brutally tormenting global financial markets, has also overwhelmed this author. Yours truly has succumbed to an ailment that requires a little chicken soup and an awful lot of bed. As a result, this week, HAI refers readers to Doug Noland’s Credit Bubble Bulletin for full coverage of what was an exceptionally eventful and consequential week for global markets. This writer will share merely a few brief thoughts.

The everything bubble has definitively transitioned into the everything rout. This was another significant week regarding increasingly widespread recognition of the new bearish reality engulfing financial markets and the global economy. On Wednesday, the U.S. Federal Reserve again raised rates aggressively with a third straight 75-basis-point jumbo fed funds hike, and signaled a possible fourth 75-bp hike in November, with yet more hikes to follow. Fed officials now project that interest rates will hit 4.4% by the end of the year and top out at 4.6% in 2023. That’s up significantly from a projected 3.8% peak at the last FOMC meeting. In the Fed’s Summary of Economic Projections, the unemployment rate is now seen rising to 4.4% next year. 

With the new economic projections, Chairman Powell essentially acknowledged that the Fed will accept a recession in trade for at least temporarily slaying the inflation dragon. Historically, the US has never avoided a recession with the increase in unemployment now being forecast by the Fed. During his Wednesday FOMC press conference, the chairman said, “We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.” That said, while the Fed is finally painting a picture that more closely resembles reality, KPMG’s Diane Swonk cut to the quick with her unsettling observation, shared by many, that “the Fed is still fanciful on its forecast.”

The ominous reality is that the Fed, with decidedly hawkish rhetoric and policy actions to match, is increasingly slowing a credit bubble economy already headed toward recession. This is effectively pressing the pin to the “super-bubble.” Signs of deeply intensifying underlying financial stress are increasingly attested by internal market indicators. The nasty recessionary terminus of our current economic cycle appears fatefully and clearly etched in stone. 

Accordingly, the previously swollen ranks of soft-landing scenario enthusiasts have dwindled to an ever-smaller cohort of diehard optimists. While the future is never certain, HAI defers to BMO’s head of fixed income, Earl Davis, who told Bloomberg this week that,“the likelihood of recession is 99.9%.” The remaining questions regard timing, severity, and specific details. At present, the probable answers to these questions aren’t inspiring.

As renowned author Nassim Taleb has accurately observed, “Basically, experience in finance with a discount rate near zero is like having studied physics except without gravity.” With global central banks having collectively jacked interest rates by a combined 700 basis points just this week, market participants are indeed getting a crash course in the new financial physics of interest rate gravity. As the reality of this emerging financial and economic landscape punches through to full recognition, markets are reacting, and prices are crashing.

Ruling over this bold new bearish financial fiefdom like a mad despot with a massive wrecking ball is King Dollar. For now, this green-backed tyrant is putting on a show, and the show may go on for a while yet. The dynamics driving the dollar’s surge, however, are neither healthy nor ultimately sustainable. While at present market action can accurately be described without exaggeration as a story of “King Dollar up; everything else down—hard,” generational opportunities are brewing in the “regime change assets” of commodities and precious metals. Legendary first ballot hall of fame investor Stanley Druckenmiller drilled home the point this week, saying, “When I look back at the bull market that we’ve had in financial assets, really starting in 1982…all the factors that created that not only have stopped, they’ve reversed.” Significant market change is unfolding, and the era of financial asset dominance is over. Once we emerge from unfolding market crisis dynamics, regime change assets take center stage. In the meantime, the game plan remains “patience and defense now, aggressive opportunism later.”

Weekly performance: The S&P 500 was down 4.65%. Gold was off 1.66%, silver lost 2.43%, platinum shed 4.69%, and palladium was down 2.00%. The HUI gold miners index was down 5.76%. The IFRA iShares US Infrastructure ETF dropped by 5.40%. Energy commodities were crushed this week. WTI crude oil was lost 7.10%, while natural gas was drubbed by 9.94%. The CRB Commodity Index was lower by 3.73%, while copper was down 5.11%. The Dow Jones US Specialty Real Estate Investment Trust Index was lower by 6.74% on the week, while the Vanguard Utilities ETF (VPU) was down 3.10%. The dollar gained 2.93% to close the week at 112.96. The yield on the 10-yr Treasury jumped 24 bps to end the week at 3.69%.

Best Regards,

Morgan Lewis
Equity Analyst & Investment Strategist

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