S&P Resists The Bear
May 13th, 2022
The S&P 500 leapt closer to bear market territory this week, skidding nearly -20% year-to-date from previous highs. The interest-rate sensitive and tech heavy Nasdaq experienced a bigger decline, falling a whopping -30% from last year’s highs, while the Dow posted its seventh consecutive weekly loss – its first in nearly 20 years. The trading was volatile but by week’s end dip buyers emerged, allowing the S&P 500 to hover just above bear territory, which is defined as -20% down from the peak. Negative sentiment intensified this week as inflation data on consumers and producers showed no true signs of relief. If anything, the data showed just how broad-based inflation is right now, which signifies a systemic issue rather than something that can just be easily tamped down. In international data, global trade continues to struggle with high demand at a time when China’s zero-Covid strategy is making it difficult for factories around the world to source manufacturing components. Faced with fresh evidence of inflation and seeing little immediate hope for relief, markets ground lower, fearing the Fed will be forced to be even more aggressive than they have signaled. For the week, the S&P 500 fell -2.41%. It technically remains out of bear market territory, but is now down -16.11% from all-time highs.
Global Trade Strains Amid Zero-Covid
Global supply chains continue to suffer under China’s zero-Covid lockdown policy, hindering factory floor activity. Shanghai, the world’s busiest container port is now in its seventh week of lockdown. Although hard to believe, the city of 25 million has recently moved to tighten restrictions even further. No commercial food deliveries or unapproved visits to the hospital are allowed unless it’s an emergency. The restrictions have resulted in broader production delays with factories now having difficulty sourcing basic components due to lack of inventory or transportation shortages. Despite the challenges, factories did manage to produce some goods. Exports rose 3.90% from a year earlier in April. That was significantly lower than the 14.70% yoy increase in March and it was the weakest increase in nearly two years. Meanwhile, imports were flat in April from a year earlier, slightly higher than the -0.10% decline in March. The data comes on the heels of disappointing manufacturing numbers from Germany and weakening export growth in South Korea and Taiwan. Taken together, it all points to a slowdown in world trade and global manufacturing. Central banks have been counting on supply chains loosening as part of the monetary policy calculus, but China’s decision to stay in lockdown is frustrating that as a source of potential inflation relief.
Prices Sizzle
It may only be late spring, but inflation has kept consumers sweating in April with the CPI index rising 8.30% from a year ago. It was basically unchanged from March, remaining near its 40-year high. Inflation was broad-based with the Core CPI, which excludes food and energy, rising 6.20%. Shelter costs, which comprise about one-third of the CPI, rose at their fastest pace since 1991. Airline fares continued their climb as more people took to the skies amid increased business travel and vacations. Prices there were higher by 18.60% on the month and are up 33.30% over the past year. The CPI increase came despite a -2.70% month-to-month drop in energy prices, including a -6.10% drop in gasoline. Food prices also rose, up 0.90% in April. On a 12-month basis, the cost of food has risen 9.40% while energy costs are 30.30% higher. The national average for a gallon of gasoline hit $4.1418 on Thursday, according to AAA. This means that consumers are now paying 32 cents a gallon more than they were just last month, which in aggregate translates to a $125 million more being spent on gasoline in the U.S. every day. Even with a strong jobs market, consumers are struggling to keep up with inflation, having seen their real wages fall -2.60% over the past year due to the surging cost of living.
The inflation story was worse at the producer level, where prices rose 11% yoy in April. That was a slight decrease from the record 11.50% set in March, but it serves as only a small, moral victory. Excluding food, energy and trade services, core PPI rose 0.60% in April and 6.90% from a year ago. Auto prices, particularly used vehicles, showed strong growth during the month. Prices for gas and groceries continued to move higher, rising 1.70% and 1.50%, respectively in April. The International Energy Agency had this to say about the outlook for energy prices: “The current, almost universal product shortage, low inventories and refinery capacity bottlenecks have led to inelastic short-term supply, pushing cracks for almost all products to extraordinary high levels.” As the summer driving season heats up, consumer and producers are likely to be feeling the pinch.
Final Thoughts
The market’s narrative continues to revolve around that of excess demand, supply constraints, inflation, interest rates, monetary policy and ultimately whether we’re headed for a recession as a result of the Fed’s policy. These issues have been around for months but the fear around these factors has risen sharply over the last several weeks. Fear, as measured by the volatility index (VIX), spiked to 34.5 on Monday at the height of the selling. To put this into context, we started the year in a calm market, with a VIX at 20 and we’ve averaged around 25 for most of the year. To put this into ever greater context, the VIX hit 82 during the COVID sell-off and 80 when Lehman collapsed during the 2008 financial crisis. We’re highly unlikely to go anywhere near those levels given the scenarios in front of us (Russian nuclear confrontation notwithstanding). What we’re beginning to see is a resistance to how far fear will go, settling around the 35-40 level on the VIX. We’ve seen this twice now, once in early March and again this week. This suggests to us that we are testing the edges of where investors are willing to let the market fall before the values become too enticing. We’re not prepared to call a bottom, because we do think we’re bound to see fear ratchet higher in some capitulation moment, but we believe we are approaching a bottom. We would guess a total decline on the S&P 500 of 20-25% and a VIX of 40-45 – if it doesn’t prove to be the bottom – is a level where one could feel good about the fundamentals supporting the market from there. First, the pessimism being reflected in the market is not being mirrored in corporate earnings or corporate guidance, on average. The tone from companies is that things are getting marginally better on the supply side, and once China ultimately does emerge from lockdowns, things should improve even faster. Second, inflation is expected to cool significantly by year end. The Fed’s base case is that we average 4.1-4.7% inflation for 2022, but be at a run rate of 2.5-3.0% inflation by December. Even assuming the Fed is wrong in their prediction (which we do) so long as price growth is showing consistent moderation, we believe the market is going to feel positive about the improvement. All this to say, that if we were to see a 20-25% decline in the S&P 500, this would be a suitable discount in our minds for the recessionary risk we face. Why? Because the median decline from peak to trough in an actual recession is -24% according to Goldman Sachs, who researched recessions going back to 1949. Add to this that we’re not assured to actually enter recession and the fact that several of the recessions included in the median were not “typical” events (i.e. banking crisis, pandemic, dot.com bust) then the S&P 500 price movement this week begins to look as if the recessionary risk is almost fully priced in.
The Week Ahead
With inflation above 8.00% for two consecutive months, consumers are beginning to feel the heat from higher prices. We’ll see by how much as April retail sales are released. The housing market has also been red-hot for much of the pandemic. We’ll see if the trend can continue with the latest existing home sales figures.
Happy Astronomers Capture First Image of Our Galaxy’s Black Hole
Yesterday, scientists shared the first image ever captured of the super massive black hole at the center of our galaxy. It has been called a feat roughly equivalent to photographing a single grain of salt in New York City using a camera in Los Angeles.
It took an international team of more than 300 scientists to capture the image with a worldwide network of radio observatories called the Event Horizon Telescope collaboration. The accomplishment has been called the dawn of a new era of black hole physics.
Black holes are among the most fascinating and mysterious objects in our universe. A black hole is a region in space where the force of gravity is so strong that nothing can escape, even light, and where the laws of physics, space and time no longer apply. Their enormous gravity pulls surrounding material into a disc, accelerating it to nearly the speed of light and heating it to extreme temperatures, resulting in torrents of radiation that can be seen from Earth.
What’s more incredible is that the discovery was consistent with the theories published by Albert Einstein in 1915. Event Horizon Telescope Project Scientist Geoffrey Bower said, “We were stunned by how well the size of the ring agreed with predictions from Einstein’s Theory of General Relativity.” Einstein had predicted the existence of black holes—unseen points in the void where gravity warps the very fabric of space—and more than a century later, scientists are able to provide photographic evidence.
Scientists used a technique called very long baseline interferometry that combines multiple dishes that are very far apart into a single effective virtual Earth-size telescope. There’s only a very limited period of time each year when telescopes around the world can all see the same things in the sky. Scientists established an elaborate, precisely timed schedule of when Sagittarius A* (pronounced “A-star”)—the name of the black hole—could be visible. The cooperative effort spanning five continents resulted in the creation of a virtual telescope with the highest resolution of any instrument ever built.
The locations were scanned in tandem for several nights. All of the observations stored in hundreds of computer hard drives—some 3.5 petabytes of data—were physically shipped (there was too much data to send electronically) to two super-computer banks, one in Massachusetts, and one in Germany, and then processed and correlated into a single data set. Scientists then searched the compiled data for common detections where all of its telescopes saw the same thing.
It’s only the second time visual evidence of such an object has been captured. In 2019, astronomers captured a black hole at the core of a giant elliptical galaxy in the constellation Virgo.
Stellar and super massive black holes are the most common types of black holes identified by scientists. Stellar black holes form when massive stars die and collapse. They are 10 to 20 times the mass of our sun. Supermassive black holes are millions or possibly billions times larger than the sun. Scientists have known that black holes exist at the center of nearly every large galaxy, including our own galaxy, the Milky Way. The black hole at the center of the Milky Way has been calculated to have a mass that is 4.15 million times the mass of the Sun.
Black holes themselves are invisible, and the invisible boundary line between a black hole and the rest of the universe is called the event horizon. Anything that crosses the event horizon, such as gas and dust, along with stars and the light they emit, vanishes from the known universe. The image released yesterday doesn’t show the black hole itself, but instead reveals the shadow that the immensely dense black hole casts against the glowing, super-hot gas swirling around it, helping scientists prove its existence. In 2020, the Nobel Prize in physics went to three researchers for providing the most convincing evidence for the existence of the Milky Way’s central black hole. The Event Horizon Telescope captured the first actual image of the massive object.
You can view the image and read more about this discovery on the Event Horizon Telescope website.