Stocks bounced again this week. Recession fears raised hopes that the Federal Reserve Bank might a relent a bit on their tightening program. That could be a false hope but was enough to provide a relief rally.
There is a higher probability that we could continue to rally in fits and starts. Exactly what does and does not gain will likely have more to do with what has lost the most in the last month. Energy comes to mind since we have seen more than a 25 percent decline in energy stocks triggered by a sharp decline in oil and gas. Commodity stocks have also swooned with some stocks experiencing double digit declines in the last month or so.
The expectations that global demand would decline in a recession was the motivating factor behind these hefty falls. These plummeting prices sparked hope among investors that inflation could level off, or even come down faster than expected — in which case, the Fed might ease its foot off the tightening pedal.
Readers might scratch their heads at all this, since none of these "could be" scenarios have much data to back them up. Last week, however, I did mention that the Atlanta Fed was expecting 2022 second quarter GDP to come in at minus-2.1 percent, following the first quarter's decline of 1.6 percent. Technically, two down quarters in a row counts as a recession, but the National Bureau of Economic Research (NBER) will be the final arbiter of what is and what is not a recession.
Large cap technology shares as well as the most beaten-up sector stocks saw gains this week. Did that make sense?
Not really. In a recession, large cap, well capitalized companies (think FANG stocks, for example) should be able to withstand the negative impact of a slowing economy on earnings and sales far better than weaker companies. And yet, these companies, many with no earnings at all, rallied just as much. But who said bear market rallies have any basis in facts anyway?
Later in the week, China's Ministry of Finance was said to be "considering" a $220 billion program to fund additional infrastructure in order to boost their economy. The official target for GDP growth for this year is 5.5 percent. This goal is in jeopardy due to the economic hit caused by COVID-19 lockdowns and a housing slump this year. Infrastructure spending is the "go-to" policy the Chinese government has historically used to goose the economy.
That rumored announcement was enough to send oil, gas, and all sorts of commodities soaring higher, sparking a rebound in these depressed areas. The thought is that commodities and energy would be key inputs in building infrastructure. It doesn't appear that traders care about the obvious contradictions in chasing commodity, high growth tech and the weakest stocks in the universe all at the same time.
Remember too that in this atmosphere of recessionary fears, coupled with higher inflation, and tight monetary policy expectations, bad news can be good news for the stock market, and vice versa. As I see it, negative data that shows a weaker economy, slowing employment growth, and/or lower commodity prices is "good" for the markets because it means the Fed might not tighten further. A stronger labor market, increasing GDP, and higher commodity prices would constitute bad news for the markets, at least for now.
Friday's non-farm payrolls data is a case in point. The U.S. economy added 372,000 jobs in June, which was slightly above expectations, while the unemployment rate remained unchanged at 3.6 percent. Stocks dropped immediately, since stronger job growth equates to a Fed that has no reason to relent on its aggressive tightening mode in monetary policy.
Given this background, I see this bounce as just another bear market bounce. My target on this one could see the S&P 500 Index reach 4,000. If traders get enthusiastic, we could see the 4,100 level. The only question is how long it will take to achieve my target.
Next week, the second quarter earnings season begins. Given all the issues plaguing U.S. corporations — falling consumer demand, a rising dollar, inflation, and supply chain issues — analysts are expecting weaker earnings and even weaker guidance. This could mark an end to any rally, so traders should be making hay while the sun shines.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at email@example.com.
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