History Doesn’t Repeat, But it Often Rhymes

By:

Chief Strategist at Interactive Brokers

Let’s recap the end of a month. From the 15th through the 31st, the S&P 500 (SPX) rallied about 10% after failing to take out the lows set a few weeks earlier. The catalyst was enthusiasm after an FOMC meeting that was not as bad as feared. All seemed great.

You were thinking July, of course. Except I was talking about March of this year. We saw a sharp advance in response to March 16th’s FOMC meeting. There were plenty who thought that the year’s then-low, set on February 24th, would hold. Might it be reasonable to think that March’s experience – just four months ago – could be a precedent to what we’ve been experiencing over the past few weeks?

To recap the wild month of July, we entered the month about 3% above the low set on June 16th, the date after an FOMC meeting. On July 14th we hit our low for the month, only about 1.7% below where SPX started. That did seem like an oversold moment of selling exhaustion. Since then, investors have taken encouragement from a positive response to second quarter earnings and most recently by seemingly dovish comments from Federal Reserve Chair Powell.

Let’s examine these elements separately, even though they became intertwined during last week’s 4.25% surge. Ahead of earnings season we noted that “it will be important to see if investors are in a relatively forgiving mood”. Clearly they were, it started with a modest dip on light JPMorgan Chase (JPM) earnings and a double-digit percentage bump in Citigroup (C) when they beat. That has carried through since then, culminating with Friday’s 10.5% bounce in Amazon (AMZN) after a modest operating beat. Contrast that with last quarter’s -14% shellacking. (Btw, they also rallied 13.5% after January’s report. A little earnings volatility, anyone?) 

Psychology, not actual numbers are at play here. According to FactSet and Standard & Poor’s, Q2 earnings for SPX components are up 6%, which is the lowest since the Covid-impacted Q4 2020. As of July 29th, Bloomberg’s Gina Martin Adams reported that stock price declines to earnings misses were averaging less than 1%, which was the lowest in over a decade.  Although the concept of the “whisper number” has mercifully faded into oblivion, the key to earnings seasons – and this one in particular – was not the absolute size of the beat or miss relative to consensus estimates, but investors’ state of mind.   

That positive mindset clearly followed through to the post-FOMC press conference.  Wednesday’s statement was unequivocal when it said that the FOMC “anticipates that ongoing increases in the target range will be appropriate.” Yet traders preferred to focus on this portion of Chair Powell’s press conference: “So, I guess I’d start by saying we’ve been saying we would move expeditiously to get to the range of neutral. And I think we’ve done that now. We’re at 2.25 to 2.5 and that’s right in the range of what we think is neutral.”  

It will be fascinating to see if other Fed Governors agree with the Chair that a Fed Funds rate of 2.25-2.5% is indeed neutral when inflation is running well above that level.  Economic luminaries like former Treasury Secretary Robert Summers and the well-respected Mohammed El-Erian certainly disagree. If other voting members disagree with the Chair, that would be unwelcome news indeed.  

Either way, the markets chose to ignore the rest of the answer to the “neutral” question anyway.  A few sentences later, Powell continued:

“I think the Committee broadly feels that we need to get policy to at least to a moderately restrictive level. And maybe the best datapoint for that would be what we wrote down in our SEP at the June meeting, so I think the median for the end of this year, the median would have been between 3 and a quarter and 3 and a half. And then people wrote down 50 basis points higher than that for 2023. So that’s– even though that’s now six weeks old, I guess, that’s the most recent reading. Of course, we’ll update that reading at the September meeting in eight weeks. So that’s how we’re thinking about it.”

It sounds like rates are headed higher nonetheless, not to mention “So, there’s probably some additional tightening, significant additional tightening in the pipeline.” Last week we quoted Paul Simon in saying that “a man hears what he wants to hear and disregards the rest.” It’s human nature to prefer information that reaffirms our biases.  The market has been reacting positively to good news, so it is not unreasonable to see traders gravitating toward a narrative that fits the recent era of good feelings.

And of course, we’re also reacting positively to bad news too. It seems logical that investors will have to pick a side. Is bad news what we want, or is good news? I’d assert that it’s far healthier to focus on the latter. The former is ultimately a case of “careful what you wish for.” Now that we have priced in a fair amount of good news, or at least modestly positive news and selective analysis, the next few weeks will be crucial to telling us if late July’s bounce was the start of something new, or merely a March-like bear market rally.

Disclosure: Interactive Brokers

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