The Market Is Flashing Echoes of 2007 and a Fed Cut Can't Save Us
Several sectors of the economy are screaming "recession" and the Fed might not be able to thread the needle to avoid one.
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The players may have changed, but the game always remains the same.
Compared to 15 years ago, today we have a whole new generation of traders that have been conditioned to buy any 10%-plus dip as it always goes up, so why bother questioning it? Then throw in the world of algo trading on every millisecond of moving indices up and down when the average person has not even had a chance to comprehend the news, let alone the moves.
Decades of cheap money and low rates have compelled investors to chase the one asset class they always have: equities! So much so that most seem to ignore any risks building, no matter how dire they are.
It has been a good strategy to buy equities but it has also paid to trim and sell when market extremes and risk-reward becomes skewed to the downside. If one kept holding during the crisis, it would take years to just average it out. So, timing is as important as the decision to be invested.
Today, most have thrown all of their savings into the one market that they know and trust, the S&P 500. This index is dominated by mostly large-cap tech stocks, which may have suited them well in 2023 as it caused rallies in excess of 20%. But, going forward, the leadership is changing and this index can remain flat for a long time because of the weight that these tech stocks have in the index — sector rotation!
Stock selection will be crucial going forward. Idle money can cause some jitters. There is no such thing as a no-brainer trade. Today, we have seen the fastest rate rise campaign in the history of the Fed, since a recession never happened during all of last year, most have given up on any hiccups whatsoever. The massive fiscal easing by the Joe Biden administration (despite what Kamala Harris says) has been the major cause of the largest inflation move in the U.S. over his term, more so than under Donald Trump. This just masked the underlying weakness, but it does not mean that it does not exist.
Today, if one looks at any asset other than equities, it will be screaming "recession" and that something has broken. The Fed keeps insisting that the labor market is robust and is pricing in a maximum of one 25 BPS or 50 BPS cut this year. The bond market is in major distress and the front spreads have completely un-inverted with the two-year trading at 3.65%. The market is pricing in about 200 BPS of cuts by January 2025 alone!
Everyone thinks that one Fed cut can save it all. That may have been true during the good times, but today, the Fed has waited too long as inflation was too sticky. We saw that in the data reported on Wednesday that showed core CPI went up by 0.3%, rather than 0.2%, as super core CPI is a lot stickier than the Fed would like.
They may need to cut to have the consumer that is just falling out of bed and housing and other parts of the market, but they cannot, as inflation is still their nemesis. During 2007, we saw similar things happen, as when Bear Sterns collapsed. It took another one-and-a-half years to see more victims, like AIG and Lehman.
We also had a Fed that reiterated weeks before Lehman collapsed that they do not see a recession and that risk is well balanced. It is their job to say that. Things don’t just happen in isolation. Last year, we saw Credit Suisse get taken down. Just because the Fed stepped in and launched their BTFP, it does not mean that there are not more casualties to be had.
Back in 2007, the markets fell hard in July only to rally back up aggressively and then collapse after the first Fed cut. It took a year and a half before the market rallied. But first, it was the bond market that went and then the gold market. Today, both of those asset classes are screaming that something is not right with the financial landscape. We know what happened in September onwards.
The AI trades have certainly supported markets but even they are running out of steam, as the market is in wait-and-see mode to see how their margins fare going forward. It is an election year and, whether we get Trump or Harris, it is important to consider that neither will be able to execute any of their policies without issuing more and more debt.
Today, the U.S. national debt stands at $36 trillion and we still cannot get off the drug. Inflation may have settled down, but Harris is talking about free housing deposits of $25,000, and more Medicare aid to all — where will the money for all of this come from?
The Fed has their work cut out for them. China is imploding as there is not a single bid and commodities keep falling, despite supply being held back by OPEC in oil and copper in supply outages. The demand is just not there. If they cut rates too much, the yen can rally and cause a lot more pain for the Japanese markets. But if they don’t, they risk their own economy and consumers being sent right back to the stone ages.
At the time of publication, Bengali had no positions in any securities mentioned.
