(Please enjoy this updated version of my weekly commentary originally published October 13th, 2022 in the POWR Stocks Under $10 newsletter).
Over the last week, the S&P 500 (SPY) is down by 2%, although it was down by nearly 7% at today’s lows. The major catalyst for market weakness was a potential financial crisis in the UK.
It’s something I can’t stop thinking about, specifically, whether it’s an anomaly or a preview of what could happen in the rest of the world.
To recap: the UK is dealing with similar issues to the US and Europe in terms of inflation and a slowing economy. The Bank of England was aggressively hiking rates in the same way to curb these pressures.
But, incoming Prime Minister Liz Truss ran on a very populist platform of subsidies to households and tax cuts. In essence, throwing more money into the economy while the central bank is withdrawing liquidity to fight inflation.
The crux of the issue is energy. One hand of the government is attempting to reduce demand to lower prices, while the other is handing out money to households which inevitably increases demand.
Not surprisingly, financial markets had a fit with bond vigilantes punishing gilts as the prognosis of the British economy worsened and the pound plunged in value. It got so bad that it raised concerns about a solvency and liquidity crisis for pension funds, many of which own gilts of large size and have bylaws about what to do in event of losses.
It risked sparking a financial fire that spread with the pain in gilts exacerbated by pension funds becoming forced sellers. The Bank of England stepped in with a 2-week QE program to stem the slide. Of course, this also undermines the fight against inflation.
But, it’s also obviously necessary as the risks to financial stability overrode the risks of inflation.
The positive news is that the short-term crisis could be over with the BoE intervention and PM Truss backing off on her plans for fiscal largesse.
But, it’s easy to imagine this happening: A populist politician decides that providing relief to short-term pain is the best avenue to getting elected.
Such a proposal could come from the right or left wing given that it’s been tried many times in South America by leftist politicians and was just attempted by Truss, a conservative.
Such measures in the midst of an inflationary spiral risk wrecking the credibility of currencies and governments. The long-term cost is not worth the short-term boost in spirits.
Inflation Report
The Bureau of Labor Statistics reported that inflation increased by 0.4% in September which was above consensus expectations of a 0.3% increase. Annual inflation rose by 8.2% compared to last year which was lower than the peak of 9% inflation in June.
However, the report continued a larger trend of core CPI continuing to strengthen while many were hoping that the Fed’s rate hikes would start to have some impact on suppressing inflationary pressures.
Core CPI came in at 0.6% which was an acceleration from 0.5% last month and above consensus expectations of a 0.4% increase. On an annual basis, core CPI came in at 6.6% which is the most since August 1982.
The stock market plunged on the news with the S&P 500 (SPY) opening 2% lower.
This was despite futures being up prior to the inflation report due to reports of a possible change in policy by incoming UK Prime Minister Liz Truss and better than expected earnings reports which increased optimism that Q3 could see continued earnings growth.
However, the market did surprise bears as it finished up nearly 3%.
Market participants attributed the strength to the UK change in policy removing some tail risk from markets, and many seeing the current report marking a ‘peak’ in core CPI due to recent developments in the labor market and real-time data from the real estate market which should portent a softening in rents.
The bond market also rallied as the 10Y hit a high of 4.1% before closing at 3.95%. One interesting note about the market action is that the leaders were higher-quality companies including those in the defense and utilities sector.
In terms of inflation components, food prices were up 11.2% from last year. This was more than enough to offset the impact of a 4.9% decline in gas prices. Rents were also up 0.7% and 6.6% from a year ago.
Overall, average hourly earnings on an inflation basis were down 0.1% and are off 3% from last year.
The CPI report led to the chances of a 75 basis point hike at the November meeting increasing to 98%. Odds of a 75 basis point hike at the December meeting also climbed higher.
Final Thoughts
This was a very strong move from a technical perspective with the market once again above the mid-June lows, a key inflection point.
That being said, the fundamentals continue to deteriorate for the stock market. This rally was about some tail risks coming out of the market and a very oversold market.
It was also a classic ‘buy the rumor, sell the news’ type situation as many were positioned for a beat in inflation.
So, this move higher could certainly turn into a bear market rally, but I don’t think it’s prudent to expect anything more meaningful.
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All the Best!
Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Stocks Under $10 Newsletter
SPY shares closed at $357.63 on Friday, down $-8.34 (-2.28%). Year-to-date, SPY has declined -23.83%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
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