by Franklin J. Parker, CFA
Summary
- It is Fed week! Most investors expect the Fed to announce a schedule for their tapering operation. However, the big news will be the updated pace of expected rate hikes. For the most part, investors have priced in a taper to begin in November and end next August/September. The unknown is how quickly interest rates will rise after quantitative easing is finished. That will be the new source of volatility.
- Treasury secretary Janet Yellen is repeating warnings about the debt ceiling to congress. She has reminded them that, without a debt ceiling raise, a default on US Treasury debt is likely. Unfortunately, she has been unable to give congress an exact date and has instead said “sometime in October.” We have, of course, been through this before. The debt ceiling has become a game of political brinksmanship and has led to several government shutdowns and furloughed workers in the past. Investors have learned to shrug this off. The consequences of a US Treasury default, however, would be catastrophic. Lawmakers are well aware of this, of course, so I advise investors to watch it, but not yet worry much about it.
- Economic data lately has been mixed. In addition to the Fed meeting (which will dominate investor’s newsfeeds), we get data on housing, initial unemployment claims, Markit’s PMI figures, and durable goods sales. All of these are important to watch, especially as investors are struggling to find direction.
The Details
With the Fed on track to end its support of markets, and most of the ongoing Covid financial support from central governments ending, investors have been left struggling for direction. Over the past 18 months, the dominant focus has moved from economic fundamentals to the role of global central banks in offsetting the pain of the Covid-induced recession. Now, investors have begun to return their attention to these fundamentals, which are, admittedly, mixed.
To be fair, it does not appear that a recession is on the horizon. The central question is whether markets have run too far too fast on the hope of a rebound from Covid that is, perhaps, more disappointing than was otherwise expected. And the data is somewhat mixed. On the one hand, consumers continue to spend, job openings are plentiful, and corporate profits growth is quite strong. On the other hand, the unemployment rate is high, inflation is holding at stubbornly high levels, and supply constraints and transportation costs continue to plague earnings outlooks. It can be easy to see why major investment shops are increasingly calling for a market correction (or at least subpar returns).
In my view, numerous structural issues exist that are contributing to poor data, and many of those issues should be worked through over the coming six to nine months. The Fed’s retreat will feed volatility, no doubt, but I see a market downswing as a buying opportunity for investors with cash. For longer-term investors, a downswing is likely to be short-lived and relatively shallow, not worth worrying much about.
Of course, I am actively concerned with being wrong, so this view may well change as markets and data develop.
Chart of the Week
From a technical analysis perspective, the S&P 500 has clearly exited the trading channel that has dominated price action since the start of 2021 (top chart). This is likely to indicate some sideways consolidation for a time, which is very similar to what we saw in the last half of 2020 (bottom chart). The point is that this change of character, while worth acting on for short-term trading, investing cash, or even rebalancing a portfolio, is a pretty normal yearly occurrence. Stocks tend to lose 3% to 5% every month and quickly recover. They also tend to lose 8% to 10% about once a year and quickly recover.
Of course, your goals will always dictate how we behave in any market environment, including this one.
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