Vertigo: Market Succumbs to Myriad Pressures

With the path of least resistance for stocks seemingly lower for now, the key to watch will be a stabilization in interest rate volatility and clarity on the path of monetary policy.

As many readers know, I (Liz Ann) started in this business 37 years ago and worked for the late, great Marty Zweig for 13 years. He operated his hedge fund/money management/newsletter business with 17 "trading rules." Number one on the list: "The trend is your friend; don't fight the tape." Number six: "Don't fight the Fed." One of my favorites has always been his 17th: "Beware 'new era' thinking; i.e., it's different this time because … "

Those truisms have been in and out of play this year, with the strong equity market rally off last October's lows sometimes begging the question of whether the market was fighting the Fed. The (up)trend had certainly befriended many equity investors. What's interesting is that on Marty's list of trading rules, number six specifically read: "Don't fight the Fed (less valid than #1).

Long and variable lags

Most investors know that the effects of monetary policy (on the economy) operate with "long and variable lags." We've read a lot this year about a "new era" of irrelevance around the inversion in the yield curve and/or the plunge in leading economic indicators. We do not think the economy (or the market) has passed the expiration date on those lags. Some consideration—or version—of that is likely a contributor to the recent pullback in stocks.

As July came to a close, the S&P 500 was less than 5% from its early-2022 record high. What changed?

  • Treasury yields surged to their highest levels since the period before the Global Financial Crisis;
  • Increased focus on the federal budget deficit, high debt levels and the elevating cost of servicing the debt;
  • U.S. economic growth has surprised on the upside, while inflation remains sticky (bringing Federal Reserve rate hikes potentially back into the picture);
  • Concerns about the ripple effect of China's weak economic growth;
  • S&P 500 earnings did not surprise into positive growth territory and forward estimates have been trending lower;
  • Investor sentiment had become a bit frothy alongside elevated valuations.