Whiff of Panic: 10% Correction Is Coming Next
Markets opened the month on a down note with a spike in volatility and the Fed won't be able to execute a soft landing.
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The month of August opened with an ominous note in trading on Thursday as the Nasdaq sunk by 2.3%, even with Meta Platforms META reporting better-than-expected Q2 results after the bell on Wednesday. The S&P 500 was also off nearly 1.4% and the Dow lost almost 500 points on the day. And, unlike in much of July, there was no sector rotation as we commenced August as the Russell 2000 plunged just over 3%. Elsewhere, the yield on the 10-Year Treasury fell by six basis points to under the 4% threshold and the VIX spiked by 13%.
There seems to be whiff of panic in certain quarters as Paul Krugman, Elizabeth Warren and former Federal Reserve member William Dudley have all called for the central bank to start cutting rates immediately in recent days. Now, these calls could be interpreted as trying to elevate the chances for the current party to retain the White House come November. However, I think concerns over whether Chairman Powell is waiting too long to cut rates and achieve a "soft landing" are legitimate.
My regular readers know my view has always been that a soft landing was very unlikely. First, as with almost every governmental agency over my lifetime, the Federal Reserve has consistently failed with its primary mission. Its last successfully-engineered soft landing was in 1995. This was in an era where the Cold War was over, the federal budget was nearly balanced and the Boomer generation was in their prime earning years. It was also in the early stages of the internet revolutions. None of those conditions exist today.
In addition, COVID-19 and its response caused huge distortions in the economy. Money supply increased by 40% in two years. Combined with massive congressional largess, this set off the biggest burst of inflation since the days of Paul Volcker. These actions have distorted economic readings. For instance, the yield curve has now been inverted for a longer duration than any time since 1929. Spoiler alert: Things did not end well when the yield curve normalized then, and we are simply not going to normalize without some significant economic pain now.
Higher interest rates have already damaged many parts of the economy. Corporate bankruptcies are at their highest levels since 2010, and credit card delinquency rates have registered their highest reading since the Fed started monitoring this metric in 2012. In addition, the delinquency rate against commercial mortgage-backed securities (CMBS) on office properties came in at over 8% in July, for the first time since 2013.
Throughout 2024 we have heard consistent commentary about weak consumer demand from well-known names like Nike NKE, McDonalds MCD, Starbucks SBUX and Home Depot HD. So far in the second quarter, we have seen sales at The Hershey Company HSY fell nearly 17% on a year-over-year basis and the CEO at Wayfair W just noted that the falloff in demand for home goods is like nothing the company has experienced since the Great Financial Crisis.
A cut or two of 25 basis points by the Federal Reserve over the next few months will do little to lessen these pressures and dynamics. And the market has some ways to go to properly price in these increasing economic headwinds. My view is that we will see at least a 10% correction from peak to trough over the next few months, very similar to what occurred around the same time last year. Therefore, I will only be deploying my "dry powder" incrementally as still lower entry points seem likely.
At the time of publication, Jensen had no positions in any securities mentioned.
