• Parts of the US economy might have been flagging, but employment was holding strong and there was ample room for consumers to keep spending.
• Oh, and there was a whopping eight weeks of downtime between Federal Reserve meetings.
Of course, the dog days of summer turned out to be much more eventful than many expected. The S&P 500 Index rallied 17% from its June low; meme stocks and Bitcoin began to sizzle once again; and even downtrodden homebuilders caught an updraft. Some chalked it up to the illusion of a change in Fed messaging at Chair Jerome Powell’s July 27 press conference. Others credited the resilience of earnings. And some saw indications of a classic short squeeze.
Whatever the case, it’s clear that the summer price action can’t be trusted, as was illustrated last week as the S&P 500 posted its biggest weekly decline since July 1, with the slump exacerbated by the expiration of $2 trillion in options. If the trajectory felt uncertain in June, it’s even shakier in August, when stock prices are significantly richer but the fundamentals — and fundamental uncertainty — have changed as little as everyone expected.
Consider the monetary policy outlook. When Powell speaks in Jackson Hole on Friday, he may well push back against the notion that he will soon wind down the tightening cycle and start reducing interest rates. That idea took hold in earnest after his July press conference and was responsible for supercharging the nascent rally across asset classes. Since then, however, Fed funds futures and bond markets have mostly returned to Earth, while stocks have stubbornly held onto their gains. Fed funds futures have gone from pricing a December peak of around 3.25% to a March peak of around 3.75%, with cuts not expected to start until the latter part of 2023, which seems more reasonable, if far from the most hawkish scenario. (The Bloomberg Economics team thinks the peak will be 5%.)
Next, there’s the earnings outlook, the factor most likely to explain the divergence between stocks and Treasuries. Earnings season has been marked by widespread resilience, and it’s been tempting to believe that it has vindicated the “soft landing” thesis for the economy and companies despite widespread concerns about the impact from rising interest rates. In fact, the verdict is far from in. What investors have in hand are often figures for the period that ended in June — a quarter that saw a time-weighted average fed funds target rate of just 0.86% (based on the Fed’s upper bound). In July, the Fed got to an upper bound of 2.5%.
The impacts of monetary policy famously lag increases by several quarters. What’s more, US consumers entered 2022 with particularly strong cash balances and ample borrowing capacity that they have only begun to tap. These factors have extended the runway on US consumption considerably, but they don’t preclude an unhappy ending. US companies experienced incredible earnings-per-share gains during the pandemic, and they still haven’t paid the piper. We don’t yet know what kind of price they will pay, nor have analysts come anywhere near assuming a worst-case scenario.
Ultimately, the market narrative is far from settled. If the cooling of inflation is confirmed in reports due in September and October, that would finally give Powell the “series” of improving reports that he covets. That would give market bulls something concrete to hang their hats on. Of course, it may take even longer than that to properly assess whether Fed increases are proving too much for the US consumer. Indeed, many economists still think that a recession — if it occurs — would be a 2023 event. In any event, it’s likely that the vapid price action of the summer of 2022 will go down as a head fake and that the A-Team traders should get back to work soon, because the market is about to get real again.
More From Other Writers at Bloomberg Opinion:
• ‘The Godfather’ Insight on What’s Driving Markets: John Authers
• The Stock Market’s Rebound Has History on Its Side: Aaron Brown
• Don’t Buy the Stock Rally? The Smart Money Does: Robert Burgess
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.
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Read More: Analysis | Stock Market’s Summer Fling Wasn’t the Real Thing
