Good evening:
“Avoid big losses. That’s the way to really make money over the years.”– Julian Robertson
Robertson, the Wall Street investor who with a handful of others pushed short selling into the mainstream, helped to create the modern hedge fund industry. He died on Tuesday at his home in Manhattan. We begin this week’s note with his quote on avoiding loss, a particularly helpful reminder amid these choppy waters. One day markets are ripping into the close, the next they’re diving lower on the Fed’s hawkishness. The elite stay the course amid the turbulence.
Here’s Chair Jay Powell on Friday from Jackson Hole, affirming that the Fed will “use our tools forcefully” to attack inflation that’s still running near its highest level in more than 40 years:
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance,” Powell said. “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.”
“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
The speech was unusually brief, clocking in at just about eight minutes. What does it mean for markets? Our research heads convened again this week to discuss, and we’ve shared the highlights from their conversation further down in this note.
One thing worth considering, meanwhile, is the strong inverse correlation between the U.S. Dollar and the S&P 500, a trend that has held steady throughout the past five years. This year’s first eight months is no different. With just a little bit of Dollar weakness in July, look how well stocks and crypto performed. When the strength returned to USD last week, markets dipped, hardly a coincidence. We continue to see that this correlation needs to be a focal point, especially amid all the headlines around the Fed and inflation. Said Mark Newton, our Head of Technical Strategy: “The Dollar theme has been with us for some time. It’s difficult to fight the dollar.”
Furthermore, across Wall Street, bearish sentiment persists. For instance, Ray Dalio’s hedge fund, Bridgewater Associates, warned that stocks and bonds could fall up to 25% as the Federal Reserve’s tightening cycle isn’t being priced in. Inflation is still running near a 40-year high, and many bears are pointing to lowering earnings guidance as a headwind in the near term.
Speaking of lower guidance, Brian Rauscher, Head of Global Portfolio Strategy and Asset Allocation, says this week was a microcosm of what he’s been discussing for the past several weeks. We had earnings misses from cyclical retailers like Nordstrom, and weak data from home builders and auto parts. Bottom line, in Rauscher’s view: Earnings and valuations remain too elevated.
“The Fed needs to get inflation down,” Rauscher said, reiterating his view as counter to that of Tom Lee, our Head of Research. “In my view, the Fed’s hawkishness will ultimately be problematic in markets. Where I do agree with Tom: Headline inflation has peaked. But the Fed will linger. The economy will slow, it won’t be a disaster, but we need an adjustment on profits and valuation, then we can move forward.”
On the other hand, Newton, Head of Technical Strategy, says we could experience more volatility between now and October. “I don’t think it will be a straight shot in either direction,” he said. “It’s going to be choppy.” His downside target is around 3850-3900 in the next six weeks, with anything below 4000 being a chance to buy dips. He’s encouraged by the positive movement in Tech since the June lows, and he noted that Energy continues its relative strength. Energy, a sector we reiterated in June as a great long-term buy, has seen strong gains in recent weeks without much help from oil prices, which is an encouraging sign.
As for crypto, Sean Farrell, our Head of Crypto, noted that not only is the strength of the Dollar inversely correlated with the S&P 500, but the Dollar is also running counter to that of Bitcoin. “That’s an interesting thing to monitor,” he said. “If the Dollar degrades, that’s good for BTC. It makes me more confident in Ethereum for the latter part of this year,” because Ethereum is expected to be buoyed by the merge in September.
“We got a big wipe out leverage last week. But we are constructive on Ethereum into year-end,” Farrell added, which falls in line with Newton’s view that it’s right to be long BTC and Eth.
Another thing to monitor is cycles, a favorite of Newton, who relied on them in part to predict the turbulent first half of the year and the subsequent bounce. Since World War II, there have now been 21 midterm years, including this year. There’s never been a negative market return from the midterm election in the fall to the following June. Six times, the return has been greater than 20%. It’s no secret that the toughest year of a presidential cycle is year two, the midterm year. The best quarters of a cycle? Q4 of a midterm year through Q2 of the next year. This cycle evidence is an additional tailwind backing Tom Lee’s view that a second-half rally is intact through year-end.
“The drivers for accelerating inflation have essentially evaporated,” Lee said. “There’s a misconception that just because the Fed is raising rates, markets must fall. It really depends on how much is priced into markets already. That’s something we’ve been focusing on. If you look at the rates market, it has already priced in the Fed being aggressive into year-end and staying tight into 2023.”
Thanks for reading. We’ll see you next week.
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