Unlike the Volcker Fed, today’s Fed supports persistently growing excess liquidity and low real interest rates. Durably containing inflation will be a challenge.
Nasdaq 100 index correlations with other assets have been disrupted by a surge in mega-cap technology stocks. There is an extraordinary divergence of Semiconductor sales from stock prices, and the Nasdaq 100 from the 10 year Treasury Yield. How durable is this technology stock rally and what is the optimal medium term strategy?
An investor’s only protection from repeating investment mistakes is having the discipline and patience to stick to an effective long term process, based on data, math, and history to avoid behavioral override.
Clearly weak earnings from technology stocks and discretionary retailers have led to a record poor ratio between stock advances relative to declines. Nevertheless, a handful of mega cap technology stocks have still managed to generate further rises in big cap weighted indexes. A range of longer term challenges remains, not least the rising probability of recession.
t is the cumulative effect of flawed policies that has brought us to the current predicament.
The Fed has broken out beyond its mandate, and has been rushing into unprecedented and extreme policy action in recent years. Examination of Fed’s policies show just how adrift the Fed has become.
Instability is likely to continue. Investors need to understand the dynamics of the situation to be prepared as events unfold.
After the Fed’s liquidity injections and the stock market rally of recent weeks the emerging narrative is that the banking crisis is not the concern it was. Then again, what if the credit cycle has only just started to turn down, while the Fed has begun to reduce liquidity again and intends to raise rates further? What signal is the weakest stock market breadth on record sending us?
With the regional bank ETF trading at its 52 week lows, it is clear that the banking crisis is far from over, and this is also the view of Jamie Dimon. This is a major problem for the broader economy as the chart below shows that the S&P 500 Index generally performs poorly when banks are trading poorly. In the current banking crisis there are more shoes to drop.
On Wednesday afternoon, March 22, Fed chair Powell and Treasury Secretary Yellen decided to continue business as usual. Powell raised interest rates to contain inflation, perhaps for the last time in this cycle, while Yellen announced she is not considering blanket bank deposit insurance. Is the banking crisis over? Or have they run out of options and new ideas?
The recent divergence between the real yield and the forward P/E is a red flag for US equities. The forward PE Ratio has never been this high compared to real yields for the last 7 years. With earnings growth likely to weaken further, and real interest rates continuing to rise, it’s the price of the S&P 500 that looks the most fragile in this equation.
The divergence between bond yields rising and earnings yields falling has driven the S&P 500 Equity Risk Premium to extremes beyond 2008 levels into the clearly defined 110 year “death zone”.
What kind of losses could you expect on your equity portfolio?
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