For the week ending Sept. 23, 2022 AD, markets were sending out clear signals about a slowing global economy. The word "data" means 'givens' or even could be translated as 'gifts'. We look at data as a gift of providence, which helps us to understand the design of the world, including the economy. And while that design is clear when principles are followed and things go well, it's represented just as starkly when those principles are violated and things go badly.
A good theme verse for this week would be "When the righteous are in authority, the people rejoice: but when the wicked beareth rule, the people mourn." (Proverbs 29:2) Plunging asset prices are simply the financial form of the people mourning and are often associated with misrule.
Let's look at the details:
Big Picture: Last week was almost entirely about the Fed meeting. There were a few other data releases: new housing starts (fairly strong); existing home sales (pretty weak); new unemployment claims (pretty strong), but the star of the show was the Fed. It did what markets have been saying it will do all quarter: it hiked rates 0.75. So if markets already knew that this would happen, why would they react so strongly when it did? Because while markets weren't surprised by the hike; they were surprised by all of the fine print which the Fed put out along with it.
Please remember these two very important truths:
- First, markets are about the future, which means they are about uncertainty. Investors buy based on what they expect to happen later. Therefore, they only care about the past to the degree that the past helps shed light on the future.
- Second, the way things work now, the most important thing about the future from the standpoint of investors is what the Fed will do. The Fed is now the single largest buyer (and seller) of investments in the markets.
So each new piece of economic data, announcement from the Fed, or obscure appendix to an announcement from the Fed, is dissected and sifted through in the hopes of lifting the fog of uncertainty about what the central bank will do later.
Last week, the Fed stopped talking about a painless outcome to their inflation-fighting plans. Also, members of the Fed changed their predictions about their future activities, indicating they would raise rates to a higher peak. That's the so-called "dot-plot" in which Fed members predict their own behavior. So, if individual Fed members predict that the whole committee is going to sell enough bonds to drive the interest rate to about 4%, that's suggestive that they will do so. In other words, markets bet that the Fed committee members are pretty good at predicting what the Fed committee will do.
And that's exactly how markets reacted: The futures markets said the Fed will hike more, and longer. Current interest rates rose. Inflation hedges such as gold, crypto, foreign currencies, and inflation protected bonds fell. That implies that inflation will be lower than recent time, and lower than expected (but not lower than historical averages). Growth-sensitive asset classes such as commodities, real estate and equities outperformed recession hedges such as bonds. That implies that growth will be lower due to the Fed tightening. U.S. equities overperformed global equities, which suggests that the global slowdown is expected to be worse than the slowdown in the States.
These comparative returns between asset classes such as stocks, bonds, currencies, and commodities continue to fit the story of lower U.S. growth, lower global growth, and slightly lower inflation expectations. We'll see below whether the comparative returns of different sectors within asset classes also told the same story as the comparative returns between asset classes. Spoiler: they do.
This coming week the big item is likely to be the Commerce Department report on spending, which tells us not just how much consumers are buying, but how much they're paying for what they're buying, i.e., the measure of inflation of consumer groups. Of course, there will also be weekly unemployment claims. Any one of those items has the potential to either intensify or reverse the narrative, and market dynamics along with it. For example, if markets are right and inflation is dropping, or there is a spike in unemployment claims, that might cause markets to hope that perhaps the Fed will pivot away from its inflation-fighting, unemployment-raising mandate to its conflicting unemployment-fighting, inflation-raising mandate.
Real Estate Last Week: REITS performed quite poorly, as one would expect given the prevailing themes of the week. REITS do well with inflation (real estate is an inflation hedge); growth (because in seasons of higher growth renters can afford to pay more); and low interest rates (because it is a debt-dependent sector). Last week was the opposite of all of that, a perfect storm to sink the real estate asset class. And a large spike in mortgage rates didn't help. REITs performance is typically between that of equity markets and bond markets; however, last week it fell short of both, likely because of the three factors mentioned above.
US Stock Markets Last Week: Equity markets were sharply down for the week.
Growth stocks tend to underperform value stocks during times of falling economic growth expectations, because growth presumably helps earnings actually deliver on growth companies' high expectations. Last week that's exactly what happened, and in all size buckets. Large cap growth fell more than large cap value. Ditto for mid cap growth and value, and for small cap growth and value. This pattern reflects both a deteriorating growth outlook and a rising interest rate expectation The latter is because growth stocks are dependent on a longer time horizon, which means that the interest rate which is used to discount future earnings has more years in which to have a larger impact.
Sectors told the same story. Cyclicals (which are designed to benefit from growth) fell short of defensive funds (which are designed to be recession hedges). Consumer discretionary funds (which rely on growing prosperity leading consumers to buy more optional items) fell short of consumer staples (which are made up of things people keep buying even when times are tough) and utilities (another essential).
Nasdaq's tech QQQ index underperformed the S&P index slightly. Materials were arguably the worst sector, another anti-growth trade and one which tracks with the global sell-off in commodities, especially energy.
International Markets Last Week: International equity markets were down for the week, more so generally than most domestic equity markets. This was due at least in part to the headwind of a rising dollar. In other words, the international underperformance was stronger than it would have been because of the underperformance of the currencies in which foreign markets are denominated.
EM underperformed DM, but the main story is regional rather than level of development; the worst hit were developed Europe and emerging Europe. This suggests that the Ukrainian crisis and the fluid situation there with Russia losing territory, and in response raising rhetoric, was the major driver of regional return differences.
Bonds Last Week: Bond markets were down last week, consistent with the macro outlook discussed above: the Fed hiking rates is bad for bonds because the way the Fed hikes rates is by literally selling enough bonds to make the price go down, and bond math means the lower the price, the higher the yield.
But the real story is found by comparing different types of bonds, at individual sectors. The story was consistent with decelerating growth (just as the stock sector dynamics we described above were), with high yield bonds, and investment-grade corporate bonds significantly underperforming treasuries.
On the inflation side, TIPS underperformed non-inflation-protected treasuries, and the yield spread between them narrowed, which is an indicator of a lowering of inflation expectations. Remember: when the price goes down, the yield goes up. So if the price of TIPS go down more than the price of regular treasuries, then the yield of TIPS go up more than the yield of regular treasuries, which narrows the gap between them. This market signal concurs with the anti-inflationary message of a rising dollar and falling gold and falling crypto currencies.
Jerry Bowyer is financial economist, president of Bowyer Research, and author of “The Maker Versus the Takers: What Jesus Really Said About Social Justice and Economics.”