It was a week that looked promising. The three main U.S. averages spiked higher, gaining almost 4 percent in two days on no news. The remainder of the week saw profit-taking. Blame higher interest rates and a stronger dollar. 

 

The benchmark yield on the U.S. 10-year Treasury bond has topped 4 percent this week and hit 4.3 percent on Friday. The greenback climbed higher as a result. It is about one percent below its year-to-date high on the U.S. Dollar Index (DXY) of 114.78. As interest rates and the dollar continue to climb higher, stocks can still go up, but only to a point. We have reached that point this week.

 

The impetus for these rising rates is the bond market's belief that the Federal Reserve Bank will be unrelenting in its promise to raise interest longer and higher than the equity markets had hoped. Underlying this belief is the continued strength of the economy and the persistent strength in the inflation rate. Nothing in this statement is new. So why do both the bond and stock markets continue to ignore that fact?

 

I believe there is a hidden conflict among traders and investors that explains this divergence. It has its roots in the underlying, short-term behavior of equity and fixed income traders today versus the longer-term approach of the Fed.

 

This is understandable given the nature of the markets. Bond investors historically have thought in terms of months to years. That has changed somewhat as young, inexperienced, bond vigilantes attempt to push interest rates up and down rapidly. Many argue that the volatility in the bond market outstrips that of the stock market.

 

That is more difficult to accomplish given the depth of assets in the bond markets. In short, it takes a lot more money to move bonds around than it does stocks. However, applying leverage can amplify price movements.

 

In comparison, the Federal Reserve Bank thinks in terms of years. Inflation is high, and in their view, it will take anywhere from a year to three, or more, before they can manage to bring inflation down to their stated target of 2 percent. No matter how many ways they express those sentiments to market participants, investors, fail to believe them. Why?

 

Equity and bond players, I believe, have become increasingly short-term in their trading behavior. Generally, 70  percent of them (day and algo traders) are immersed in trading where the time horizon is in minutes, if not seconds. Long-term to them is, at best, a couple of weeks. Why is that significant?

 

The markets have been in a downtrend since December of last year. The decline has tried the patience of these new financial jockeys. They simply do not have the temperament to accept the longer-term perseverance that is required in these troubling economic times. They might be able to accept that the Fed will continue to raise Fed funds to some terminal rate of 4.5 percent or so, but then what?

 

The mistaken assumption is that the Fed will immediately start reducing interest rates again. What if interest rates simply remain at these higher levels for much longer? Most traders can't conceive of that happening. What if interest rates remain elevated for a year, maybe more? If so, we may face declining markets at worse, or sideways markets at best for longer than many might expect. 

 

For someone who began his financial career in 1979, I know how dreadful a sideways market can be. At the time, I think the S&P 500 Index gained a total of 26 points from 1979 to 1982.

 

From a technical point of view, we are still in a downtrend, and to see markets do what I want, we need to get above 3,800 on the S&P 500 Index by 20 points or so. I believe we will see that happen over the next week. However, we could easily see a hundred points or more down before that happens. 

 

How high could we go if I am right? A guess on the upside would be as high as 4,100-4,200, over a few weeks.

 

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 bill@schmicksretiredinvestor.com.

Oversold, stretched to the downside, too bearish, call it what you will, stocks bounced from another bottom this week. How long can this rally last?

 

It was the first time the Dow Jones Industrial Average fell at least 500 points and then rose 800 points in one trading day. The S&P 500 and NASDAQ gained 2.6 percent and 2.2 percent respectively. The huge turnaround was even more impressive when you consider that this week's inflation numbers, the Producer Price Index (PPI), and the Consumer Price Index (CPI) both came in hotter than expected.

 

The Bureau of Labor Statistics revealed that in September the CPI rose 8.2 percent over the prior year and 0.4 percent over the prior month. Core CPI rose 0.6 percent, month over month. Investors were hoping that inflation was at least flat-lining, but that does not seem to be the case. September's PPI came in hotter than expected, indicating a 0.4 percent jump in headline PPI. These numbers bolster the Fed's case that equity investors should prepare and accept that interest rates will be higher interest for longer.

 

However, the disappointment and subsequent sell-off that one would have expected didn't quite happen in the way day traders expected. The PPI announcement on Wednesday caused a bit of a downturn, but nothing major. Before the CPI was reported at 8:30 a.m. on Thursday, Oct. 13, the S&P 500 Index was up over 1 percent. An hour and a half later, the disappointing data had driven the market down to a new yearly low of 3,491.

 

At their lows, the NASDAQ was down 3 percent, the Dow nearly 2 percent and the S&P 500 dropped more than 2 percent. By the end of the day, however, we closed at 3,669, which was an intraday swing of 175 points off the day's low! Financial commentators were at a loss to explain the massive move up on after hitting yet another yearly low this week.

 

The explanation is simple for those who understand the options markets. Options are contracts that give the bearer the right — but not the obligation — to either buy a call or sell a put an amount of some underlying asset (in this case, stocks) at a predetermined price at or before the contract expires.

 

There were a ton of put options in place that professional investors and market makers had purchased over the last few weeks. Puts make money when the markets go down. The purpose was to hedge (protect) their stock portfolios in the event of further bad news, which is a common practice in the financial markets. They were bracing for the worst to happen and got what they wished for.

 

The CPI inflation data triggered massive selling. Billions of dollars of put options were suddenly "in the money" and traders began to take profits. What happens when you sell all these puts? The selling pressure in the markets subsides, and the markets, like a beach ball underwater, pop to the surface. Of course, Friday, we retraced more than half the prior day's gains on both the S&P 500 and the NASDAQ Indexes. That is what happened this week.

 

Technical target levels around the 3,500 level on the S&P 500 Index had been reached. It was a downside target that I, and many others, have been predicting for weeks. Markets reversed from there. Were there massive amounts of fundamental buying? No, it was simply another exercise in short covering on a grand scale. That, in a nutshell, has been behind every one of these bear market rallies this year.

 

I am expecting several more days of up-and-down consolidation before traders try to move the markets higher. I will keep my fingers crossed that this relief rally continues.

 

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 bill@schmicksretiredinvestor.com.

This week, investors are once again thinking that the Federal Reserve Bank will soon be pivoting away from its hawkish interest rate hikes. It is the same old song of misplaced optimism that has fueled the last few bear market rallies. Enjoy this one while it lasts.

 

Last week, I advised investors that the S&P 500 Index decline to the 3,550 level and then reverse higher. "I will use that behavior to purchase stocks. If we continue higher, buy some more," I said.

 

I was off by a mere 20 points (the S&P 500 hit 3,570 last Friday). On Monday, stocks soared with all the indexes climbing almost 6% in an epic "V" shaped bounce. As I said in my last column, "Bear market rallies, of which we have had several this year, can be powerful. The October-into-November time period could be an ideal time where we could see another such relief rally. 

 

Driving markets higher is another spin on Fed easing. This time traders are betting that the U.S. jobs market is starting to weaken, pointing to the number of job openings in August, which declined by more than one million, according to the Job Openings and Labor Turnover survey (JOLTS) data. Friday’s jobs data dampened some of that euphoria.

 

Non-farm payrolls data for September 2022 came in at a 263,000 increase, which was a bit higher than the 255,000 jobs expected, while the unemployment rate dropped to 3.5 percent versus 3.7 percent expected. Average hourly earnings were up 0.3 percent, in line with forecasts. Although the results were statistically insignificant, it gave traders an excuse to take profits from the week’s healthy gains.

 

Another key barometer, the Institute for Supply Management's (ISM) manufacturing survey fell to a 28-month low in September as high interest rates and inflation dented growth. To the markets, bad economic news is good news for stocks.

 

The thinking is that the race to raise rates by central banks worldwide (the U.S. included) has been overdone. The decline in growth of global economies is happening far faster than anyone expected and if that's true, a pivot by the Fed will come sooner than expected.

 

The bulls are already pointing to the U.K.'s rate shock, which forced the British central bank to support the markets and trouble at Credit Suisse, a major European bank, that is worrying European regulators. Over in Australia, their central bank hiked interest rates less than expected.

 

All of this has created a "buy loop" where bad economic data was signaling to the bulls that the terminal Fed funds rate (4.25 percent-4.50 percent) is as high as interest rates will go. That led to a declining dollar, stable-to-lower bond yields, and rising equities, as bears covered their shorts. I suspect this story could carry the markets higher into mid-November. However, don't expect markets to move straight up. Each economic data point (like the jobs report) will provide an excuse for traders to move markets up or down, but overall, the trend will be your friend. Dips should be opportunities to buy.

 

I favor beneficiaries of a declining dollar and lower bond yields to outperform in this kind of environment, focusing on precious metals, especially silver. Technology, communications services, consumer discretionary, financials, utilities and the Kathy Wood stocks will fill out my list.

 

Last week, silver soared 8 percent before profit taking set in. Oil was not far behind. However, make no mistake, this is simply another bear market rally. The Fed will continue to warn markets that their buy loop is a work of fiction. As one Fed head put it, "don't mistake market volatility for market instability." Markets will continue to ignore them.

 

At some point, sadly, investors are going to realize that bad economic news and slower growth truly are going to be bad news for the stock market. Then, the buy loop will become the doom loop, but that will require a few weeks to sink in.

 

In the meantime, I expect stocks to give back about half of last week's gains. I am looking at the S&P 500 Index falling back to around 3,650-3,675 (give or take), before again bouncing higher mid-week.

 

Stocks have made new yearly lows this week as fears of declining corporate earnings, higher interest rates, and a climbing dollar sent investors running for the hills. As we enter October, another relief rally may be in the offing.

 

This week, the countertrend bounce I predicted in the early part of the week happened on Wednesday. It was triggered by events in the United Kingdom. A sell-off in the Gilts (bond) market over there had reached such epic proportions this week that the Bank of England stepped into calm markets. The UK bond market rallied a record 5.6 percent and the global markets rallied with it. The U.S markets bounced as well with the S&P 500 Index gaining more than 2 percent, while the NASDAQ leaped by more than 3 percent. However, it did not last long. Traders tore those gains apart on Thursday. The indexes retraced those gains and then some.

 

There are plenty of excuses for further downside. A key metric the Fed is watching, U.S. jobless claims, hit a five-month low this week. Investors have been hoping to see a softening of the labor market (and therefore consumer demand), but so far, not so good.

 

The Personal Consumption Expenditures price index (PCE), a key inflation variable that the Fed follows to gauge the impact of their actions to fight inflation, came in slightly hotter than expected the following day. The month over month gain was 0.6 percent versus 0.5 percent expected. The PCE data was negative, but not negative enough to drive markets much lower.

 

As readers know, I have been predicting a re-test of the year’s lows (and possibly lower) for this past week. Both forecasts have come to fruition.  However, the new lows have been relatively minor -- 3,610 on the S&P 500 Index (intraday) versus the June 2022 low of 3,666. Could we see something lower, like 3,550 or below? That’s a definite maybe.

 

I am already looking ahead, because that's what you read this column for, right? My thinking is once we form another temporary bottom for the year, we should see a rally. If we actually decline further into that 3,500 to 3,550 level on good volume, and then reverse higher, I will use that behavior to purchase stocks. If we continue higher, buy some more.

 

Bear market rallies, of which we have had several this year, can be powerful. The October-into-November time period could be an ideal time where we could see another such relief rally. Why?

 

The run-up into mid-term elections could be the excuse, since politicians on both sides use the elections to promise the world to voters. The economy, according to numerous polls, will be one of the leading election issues as inflation continues to hurt the consumer's pocketbook. In addition, recession risks, higher mortgage rates, and plenty of other unknowns are on the voters' minds.  

 

Politicians usually promise remedies for all these problems and then some if elected, without providing much in the way of how it could be done. Nonetheless, these promises can provide some hope, however misguided, that there are solutions just around the corner.

 

I also suspect that the U.S. dollar may be topping, and if it is (at least for a month or two) that could also help support equity markets and provide some relief in stemming the continued climb in interest rates. That doesn't mean the dollar will have a major break down, but it could usher in a period of consolidation.

 

If I am correct, a declining dollar would have more impact on certain stores of value that are leveraged to a weaker greenback. Gold, silver, mines and metals, crypto and energy, in my opinion, would outperform most other assets. Overall, equities would gain, but not at the pace of the sectors I have identified.

 

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 bill@schmicksretiredinvestor.com.

It was another "read my lips" moment for equity investors. Federal Reserve Chairman Jerome Powell out hawked the hawkish as he reiterated the Fed's tightening stance on monetary policy after the Federal Open Market Committee meeting on Sept. 21.

 

That should come as no surprise for those reading this column every week. A 75-basis-point hike, which was expected, was followed by a promise to continue raising interest rates higher, and longer than investors expected.

 

The eventual terminal rate where investors hope the tightening will be done, has now ratcheted higher to 4.6 percent. Expectations are now set for another 75-basis point increase in October, and 50-basis point hike by the end of the year. These actions have now forced most investors into a more defensive camp. The markets' actions reflect that.

 

And it is not only the U.S. central bank that is raising interest rates. It is almost as if bankers are outdoing themselves in their single-minded intent on seeing who can raise rates faster and further. After the Fed's actions on Wednesday, a half-dozen countries from Norway to Indonesia followed suit with hikes that were of similar size within hours.

 

Remember, too, that normally, as interest rates rise, so does a country's currency. The dollar is already at 20-year highs, which is crippling many countries ability to pay interest and principal on their U.S. dollar-denominated debt. Foreign governments need to at least keep exchange rates at their present levels. They do so by matching the Fed's rate hikes with those of their own.

 

One might wonder how all these frenzied rate hikes will impact the global economy. Not well, I suspect. The conversation here in the U.S. is now flipping from a focus on inflation to how much damage the Fed's action will inflict on the economy. It is no longer "if" we get a recession, but how deep and long will it be? The debate between the bulls and the bears centers on judging how badly the Fed will err on the side of tightening.

 

Naturally, equity investors are also concerned about how all of the above issues will impact corporate earnings. Over the last few months, I warned investors that at some point we will begin to hear corporate managements lower their outlooks for future sales and earnings. That is already happening.

 

Companies across the country are announcing layoffs, but the fall out is still uneven across many sectors. 

 

Energy companies, for example, are still looking for workers, while many high-tech companies are reducing staff. I expect as recession begins to take hold, we will see more sectors succumb to this lethal dose of inflation, rising interest rates, and slowing economic growth.

 

As quarterly corporate guidance and results continue to decline, so does the "E" in the Price/Earnings Ratio (P/E).  I have explained in the past that the P/E ratio for the overall market is a key metric when valuing the stock market. The average P/E of the markets is now hovering around 16, but there are many companies that are trading anywhere from 20 to 23 times earnings or more. Others are trading much, much lower.

 

Several of the high P/E stocks happen to be favored by investors, like the FANG stocks. The bears are betting that markets won't see a bottom until those high-valuation stocks catch-up to the rest of the market on the downside. That makes sense to me.

 

So where do we stand after this week's latest Fed disappointment? As of Friday morning, we are just a few points above my first target, which is the year's low (3,666) on the S&P 500 Index. We are at historical levels of pessimism, according to the sentiment readings of the American Association of Individual Investors (AAII). Only 17 percent of investors are bullish, while 61 percent are bearish.  Presently, there is an inverse relationship between the U.S. dollar (up) and the S&P 500 Index (down). Both are at extreme levels right now.

 

Given the dire mood of most investors (except those readers who have followed my advice, and are either short, or in cash). As a contrarian investor, I expect we will get a countertrend bounce in the early part of next week before turning down again at quarter's end.

 

It remains to be seen whether we bottom at the lows or break lower. I'm leaning toward the 3,500 level on the S& P 500 Index. In either case, I am looking for another bear market relief rally starting in October through November 2022, but it may be led by precious metals and not equities. To me that simply gives investors another chance to reduce their stock exposure.

 

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 bill@schmicksretiredinvestor.com.