Financial Market Breakdown – Week of May 9, 2022

Quick Highlights

Futures are sharply lower following new COVID lockdowns in China.
COVID cases in Shanghai are rising again, prompting new restrictions on movement and work. Meanwhile, Beijing continues to suffer from limited lockdowns and this is compounding worries about global economic growth.
Geopolitically, Victory Day in Russia offered no notable news and there remains no end in sight to the war in Ukraine.

What’s Happening in the Financial Market?

It was another rollercoaster ride in the markets last week as stocks rallied big in the wake of the FOMC meeting only to give all those gains back into the weekend as hawkish policy concerns continued to linger. The S&P 500 dipped 0.21% on the week and is down 13.49% YTD.

Market volatility increased last week as stocks gyrated wildly from Wednesday to Friday, but those moves weren’t driven by fundamentals (the outlook didn’t change much) and, instead, it’s technical and emotions (fear/greed) that are driving the markets on an intraday basis and we should all prepare for more elevated volatility ahead. So, while the intra-week volatility was extreme, the S&P 500 finished more or less flat on the week, and that makes sense as the macro outlook remains the same: stocks are facing three major headwinds from the hawkish Fed hiking rates, continued COVID lockdowns in China, and the ongoing Russia–Ukraine war.

To start the year, we knew that central bank tightening would make for a challenging market. But that has been compounded by two surprise events: the Russia–Ukraine war (no one expected that in January) and Chinese lockdowns (it’s quasi-shocking the Chinese are still adopting these policies and crushing their economy).

Again, this all matters because of economic growth. Markets are down because of growth worries and it’s the three factors mentioned above that are driving markets lower (including this morning). Collective worries about economic growth are causing tech to (still) act as an anchor on the market, which happened again last week. But we have to remember that these threats to economic growth don’t exist in a vacuum. Yes, there are real threats to economic growth. Yes, economic growth is absolutely going to slow. And yes, the chances we get a recession are rising quickly.

But the S&P 500 is down 13% YTD. That’s not a small amount! The multiple on 2023 earnings, (even if we take a conservative number of $240/share), is now 17.17x, a reasonable number that doesn’t imply that much more downside before valuations become attractive. And despite last week’s volatility, the news, on balance, was slightly positive. The Fed isn’t quite as hawkish as we thought (and that makes it more likely they “back off” dramatic hikes as the economy slows). China isn’t abandoning “Zero COVID” but they are trying to offset it with stimulus, and the COVID wave is showing some signs of peaking.

Bottom Line

It’s very easy to be “max negative” right now, and there are certainly reasons for that. Until we have real improvement/resolution on Fed hawkishness, Chinese growth concerns, and European growth concerns (which is a product of the Russia–Ukraine war) then this decline won’t be “over.” And if things get materially worse, no one should be shocked by another 5%-10% downside in the S&P 500.

But the consistent comparisons we’re hearing to ’99-’03 and ’08-’09 ring hollow. This isn’t 1999. We aren’t coming off a huge tech bubble that engulfed huge new portions of the investing public. And this isn’t 2008, where the bursting of a massively speculative bubble crippled banks, lending, and consumer spending. This isn’t a bubble popping on its own. It’s an economy that’s running “too hot” and the Fed and global central banks are engineering a slowdown. But, their goal is to not implode the global economy—they won’t sit idly by if that starts to happen, regardless of inflation. It’s important to keep that in mind amidst all this negativity.

Yes, economic slowdowns and recessions hurt. But not every recession is a crisis. We’re not oblivious to the challenges facing the economy and the market but we are fact-driven, and the facts are that the stock market is down the most in years (looking past the pandemic) as investors price in these risks, valuations are reasonable, and sentiment is extremely negative.

We doubt we’ve seen the absolute bottom, but medium-term risk/reward to us appears generally balanced, which is why we are continuing to hold positions and “hide” in defensive sectors, value, and commodities/inflation hedges (PDBC). That strategy has handily outperformed YTD and we think it can continue to do so going forward.

Near-Term General U.S. Stock Market Outlook

Near-Term (1 month) Stock Market Outlook: Neutral

Volatility exploded late last week following a less-hawkish-than-feared FOMC decision combined with mixed economic data. But stocks ended nearly unchanged as early-week gains were offset by late-week losses.

By The Numbers

WEEK ENDING 5/6/2022 (CUMULATIVE TOTAL RETURNS)