@theMarket: Blood in the Streets

It turns out that the president was correct in his warnings. Russia did invade Ukraine. Financial markets predictably crashed, but then rebounded. That's old news. What happens next?

 

In my last column, I wrote that the fate of the markets was in the hands of two big "ifs." One was an invasion of Ukraine by Russia. That has now occurred. That event broke the range the market was struggling to maintain on Thursday, Feb. 24. But by the end of the day Thursday the markets bounced back up big time. It was a classic investor behavior pattern of "sell the rumor, buy the news." Stocks fought to continue that bounce on Friday.

 

There is an old saying, attributed to Baron Rothschild, an 18th-century British nobleman, that "the time to buy is when there is blood in the streets." That famed member of the Rothschild banking family made a fortune buying into the panic that followed the Battle of Waterloo against Napoleon. But buying becomes a bit more difficult if the blood spilled happens to be yours.

 

I have tried to steer investors to safety over the last two months. Whether you listened or not, my target level has been 4,060 on the S&P 500 Index. This week we hit a low of 4,114. I guess you can say that was close enough for government work. As such, I would begin to add back equities into my portfolio, if you haven't already. But that does not mean that this pullback is over.

 

I do not expect a V-shaped recovery in these markets. We have yet to see a "capitulation" day where 90 percent of all stocks are sold. Rarely, if ever, is a market decline over without at least one capitulation day. In addition, geopolitical events like this Ukraine debacle usually lasts several months, not several days. If the fear index, called the VIX, remains above 20 (and it is right now above 29), we could still see 100-point swings or more in the index averages daily.

 

And as usual, Wall Street strategists, who were so bullish a month ago, are now predicting confidently that we could see the S&P 500 fall to 3,750. It is therefore not the atmosphere where stocks can soar into a new bull market. There is still a boat load of headline risk, so purchases should be done slowly and not all at once. Average in as the professionals usually do. And any adds you may decide to make should be in the more defensive sectors of the market at first.

 

Of course, the markets can go lower, or bottom a little higher than my predictions. In markets like these where geopolitical uncertainty can move markets wildly, don't expect precise measurements. Suffice it to say that most of the decline is over in my books. 

 

The face-ripping rally we experienced this week is normal in bear markets. From the lows to the highs, the S&P 500 Index swung 180 points in a single day. We could easily see the reverse happen next week.

 

In this type of a downtrend, I believe we will need to test the lows and possibly go lower one, two, or even three times before this correction is over. That should take us close to the mid-March FOMC meeting. Even then, I am not expecting the overall market to come out of the doldrums before mid-year. Why?

 

My second big "if" of last week was the Fed. I am sure that the bond market will be wondering if their present expectations for seven interest rate hikes by the Fed this year remains a possibility. Could the Fed change its monetary tightening policy because of the invasion of Ukraine and resulting U.S. sanctions? My short answer is no.

 

Soaring oil and gas prices, and dislocations in the supply chain due to this geopolitical conflict, will only add upward pressure on the inflation rate. The Fed will continue to tighten, because they must, if we don't want to see hyperinflation. But I am not in the camp that seven rate hikes are being contemplated by the Fed membership. That premise is simply noise from a crowd of neophytes who have never worked in a rising interest rate environment. If the Fed raises interest rates even three times this year, I would be surprised.

 

That said, the Fed's monetary policy change will continue to pressure stocks through the first half of the year. That should cap any real upside we see going forward over the next three to four months. Still, flatlining by the stock market is better than going down I guess.