@theMarket: Stocks Drop as Fed Delivers Same Dire Message

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.