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Investors search for signs the market has hit a bottom

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKETS COMMENTARY — October 17, 2022

 

Last week, investors appeared willing to begin the search for a market bottom. That said, the S&P 500 Index finished the week lower by 1.6%, while the NASDAQ Composite dropped 3.1%. The S&P 500 is currently off more than 25% from its January peak, while the NASDAQ closed at its lowest level since July 2020, down more than 36% from its November 2021 high-water mark. However, the Dow Jones Industrials Average bucked the slide lower in stocks last week, gaining +1.2%, helped by solid Q3 earnings reports from Walgreens Boots Alliance, UnitedHealth Group and JPMorgan Chase. Yet, the Dow remains nearly 20% lower than its January high.

Consumer Staples (+1.5%), and Healthcare (+0.8%) outperformed the broader S&P 500, while Consumer Discretionary (down 4.1%), and Technology (down 3.2%) underperformed. The 2-year U.S. Treasury yield climbed to 4.50% on the week, while the 10-year US. Treasury yield hit 4.22% before settling at 4.02%. Gold finished lower by 3.5%, West Texas Intermediate (WTI) crude dropped 7.6% last week, and the U.S. dollar advanced against the Japanese yen and British pound.

Notably, stocks dropped for four of the five trading days last week. However, a big rally on Thursday, which saw the S&P 500 jump roughly +5.0% after touching a fresh intraday year-to-date low, intensified talk among traders that a bear market bottom may be forming.

Markets tend to move ahead of recessions… what does this mean for stocks?

Last Thursday, the S&P 500 posted its biggest daily swing since March 2020 and broke a six-day losing streak. Yet, stocks quickly sank following Thursday's September Consumer Price Index (CPI) release. Headline CPI last month rose +8.2% year-over-year, higher than the +8.1% expected but fractionally slower than the +8.3% pace in August. Given the still hot CPI print and a Producer Price Index that showed wholesale prices remained elevated in September, traders took the S&P 500 down past the 3,500 level for the first time since November 2020. But stocks posted a massive turnaround by the end of trading on Thursday as some traders appeared willing to start buying the bottom.

While capitulation moments in the market are often difficult to identify until a lasting rally has already occurred, market bottoms often form when investors have discounted all the bad news. Notably, further bad news tends to have less impact on driving stock prices lower as selling pressure becomes exhausted. However, from our point of view, we haven’t exactly hit a point where stocks can brush off further disappointment. Nevertheless, points that help support a bottom may be forming in the market are as follows:

  • Investors more fully understand that inflation is persistent and the Federal Reserve will do what it says. For example, based on the CME Fed Watch Tool, there is a 70% chance the Fed funds target rate will climb to 4.50% - 4.75% by the end of the year. One week ago, that chance stood at 23%; one month ago, those odds stood at roughly 11%.
  • Wild swings in the market, like last Thursday, usually occur near market bottoms.
  • The S&P 500 is currently down more than 25% from its high. The Index drops by approximately 35% on average during a typical bear market going back to 1950. It's important to remember that a lot of stock damage has already occurred.
  • According to Bespoke Investment Group, more than one-third of all trading days to end the week this year has resulted in the S&P 500 falling more than 1.0%. Only 1974 and 2008 come close. While capitulation moments in the market are challenging to identify, the fact that traders are unwilling to hold positions through the weekend is very telling, in our view. An unwillingness among traders to go into the weekend "long" is indicative of very negative sentiment today, which typically forms when traders are attempting to discount all the bad news.
  • Markets tend to move ahead of recessions. Historically, stocks tend to price in most of the pain before the National Bureau of Economic Research officially calls a recession. Given the stock market's adverse reaction to the two consecutive quarters of negative U.S. growth already seen this year, further economic weakness may not have the same magnitude of effect on stocks moving forward. Such a scenario would point to investors looking beyond the current economic environment and on to better days.

U.S. businesses in a position of strength; consumer sentiment continues to decline 

Unlike the mantra from the crypto world, we believe fortune favors the patient. Yes, stocks could fall further from here. If growth conditions continue to weaken and inflation pressures persist, investors should expect stock prices to feel more near-term pain. But U.S. consumers and businesses are in a position of strength and should be able to weather a shallow recession. And fundamental conditions heading into a downturn are on more stable footing compared to previous downdrafts in the economy. As rates move higher, inflation moderates with time, and demand cools, stock prices should eventually discount all these adverse effects and eventually move higher. Though it's a fool's errand to try and time market bottoms, we are likely closer to the bottom than we were a few months ago. Bottom line: Patience, discipline, and a solid investment strategy is what is needed to manage through what could be several more quarters of volatility and uncertainty.

That said, the preliminary look at the October Michigan Consumer Sentiment Survey, which showed one-year and five-year inflation expectations rising after several months of decline, helped to bust the bottom is in narrative on Friday. In fact, one-year ahead inflation expectations within the survey rose for the first time since March. Importantly, until last week's update, the report's inflation component has pushed back on the idea that inflation is becoming entrenched among consumers. Surveys like this and one conducted by the New York Federal Reserve had pointed to the notion that consumers believe higher price pressures will moderate with time.

But given lingering inflation pressures today, the critical question to ask is: How long will consumers think inflation can move lower in the future if they don't see much evidence of prices moving lower over the near term? The early read from October Michigan Sentiment, as well as a recent uptick in inflation expectations across the New York Fed consumer survey, suggests cracks may be forming in this important market dynamic. We believe a critical point of context between hot inflation today and expectations for lower price growth in the future is that, at some point, price growth needs to moderate lower and likely in a more consistent pattern. Fed officials, who will do everything in their power to avoid inflation expectations becoming entrenched in consumer behaviors/attitudes, closely monitor inflation sentiment data like this. Unfortunately, to combat higher price pressures becoming entrenched in consumer attitudes, the Fed will likely keep pushing rates higher.

Confidence in the UK’s Prime Minister appears shaky; third quarter earnings continue this week

Lastly, September retail sales showed little change at the aggregate level but were more mixed by grouping, showing more cautionary spending in larger ticket goods. Overseas, UK Prime Minister Liz Truss backtracked her plans to lower corporate tax rates and replaced her Chancellor of Exchequer. Mrs. Truss will have to fight for her political survival now as an increasing number of Conservatives look to oust the prime minister as confidence in her leadership has quickly faltered.

This week brings a busy third quarter earnings calendar with 66 S&P 500 companies (including 8 Dow 30 components) scheduled to report their results. However, the economic calendar is relatively light. September housing data, the New York Fed's Empire Survey, The Philadelphia Fed manufacturing survey, and Fed Beige Book are all on tap. And over in Asia, China's 20th National Congress, which meets every five years, kicked off Sunday. China President Xi Jinping is expected to secure a third term while the body of officials sets key priorities for the next five years.

Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.

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An index is a statistical composite that is not managed. It is not possible to invest directly in an index.

The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.  It is not possible to invest directly in an index.

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The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas.

University of Michigan Consumer Sentiment Survey is a rotating panel survey based on a nationally representative sample that gives each household in the coterminous U.S. an equal probability of being selected. Interviews are conducted throughout the month by telephone. The minimum monthly change required for significance at the 95% level in the Sentiment Index is 4.8 points; for Current and Expectations Index the minimum is 6.0 points.

The CME FedWatch Tool analyzes the probability of FOMC rate moves for upcoming meetings. Using 30-Day Fed Fund futures pricing data, which have long been relied upon to express the market’s views on the likelihood of changes in U.S. monetary policy, the tool visualizes both current and historical probabilities of various FOMC rate change outcomes for a given meeting date. The tool also shows the Fed’s “Dot Plot,” which reflects FOMC members’ expectations for the Fed target rate over time.

The Survey of Consumer Expectations is a monthly survey of U.S. households by the New York Federal Reserve Bank. The people are asked about how much they expect to spend, how high they expect inflation to be, their employment situation, and whether they are searching for a job.

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