Putting our heads together is what Stray Reflections does best. This was especially apparent in the helpful insights gained from the community in our members-only Slack group building up to the Fed’s pivot.

Here’s how we debated the market ramifications. All of us are smarter than any of us. Rumi says, “Be with those who help your being.”

December 1

MB (New Jersey): As growth slows, the Fed just told us today that it is shifting focus to inflation risks.

CJ (San Francisco): I’ve wanted you to be wrong MB, but so far you appear to be right. I’m wondering how much of his statement was to appease Biden’s recent anti-inflation talk; part of the renomination understanding?

JM (Toronto): Bringing focus on inflation would be counter to their new monetary policy framework, as well as the cultural cross currents. 

I’m skeptical today marks meaningful change. I’m more in the camp of “watch what they do, not what they say.” While tapering made perfect sense, speeding up makes no sense to me at all. Nor do contemplating hikes at this point. Caveat is inflation is becoming political now.

SW (New York): Nice call on a more hawkish fed, MB. After Powell said we may taper faster we should believe that a faster taper is likely. The question is how much does a faster taper actually matter? 

The back end of the bond market continues to be anchored. I suspect a faster taper won’t matter much to risk assets.

JM (Toronto): Can you please summarize the cross-asset behavior as you see it?

MB (New Jersey): Since the arguable downshift in economy in the second quarter 1) Russell 2000 underperforming and false breakout 2) Russell underperforming TLT by 10 percent 3) S&P 500 and TLT with same returns 4) continued weak breadth in markets that has persisted for months 5) JPY cross performance in line with Russell 6) US dollar outperforming every currency where central bank has been hiking 7) cyclicals have gone nowhere 8) investment grade credit spreads wider on year now, BB spreads wider as well 9) major commodity performance in line with Russell 10) and the degree of curve flattening.

If history is any guide, what comes next is Russell 2000 loses 20-30 percent, S&P 500 loses 10-20 percent, 5/30 curve goes flat, the dollar index probably reaches 100-102 level. What has me concerned is that no one I talked to has this view.

CJ (San Francisco): We’re of the mindset that the economy doesn’t slow to pre-Covid trends, so we’re finding a good number of ideas. Sentiment, especially in small cap, has been horrid post-April and this grind sideways has felt worse than it’s looked. Outside of the potential for a market-wide multiple compression, we’re quite positive on the road ahead.

December 4

JM (Toronto): In 1999 there were at least nine drops of more than 5 percent in the S&P 500, and from its intraday peak in July to the October low it fell 13 percent. Then rallied 24 percent to the March 2000 top (9 percent above the July high).

MB (New Jersey):  Entirely different context. Economy was accelerating from the 1997/98 Asia crisis plus Fed cut rates in 1998.

CK (New York): Financial conditions now are much looser versus then; real rates deeply negative; so what if they end taper? I personally wish they would do it asap and get it over with; that’s not going to drain all the excess cash; that will require actual rate hikes and the fed won’t need to do much to get inflation in check given CPI has likely already largely peaked.

The gap between hyper growth and everything else needs to shrink cause it got to insane levels, but I don’t see a lot of risk in buying mid-caps and small caps given they are cheap in absolute terms and insanely cheap in relative terms. 

I don’t see a recession on the horizon and if (it’s a huge if and the key to it all imo) labor supply starts to improve in a material way then we can have a very strong economy without runaway inflation.

MB (New Jersey): I don’t see a recession. My view is inflation is not going to be an issue either. But that’s irrelevant. 

What’s relevant is that we are slowing, and Fed is getting hawkish. Fed is giving signals that it’s getting more concerned about inflation, likely at worst possible time.

Financial conditions are easy, but they are less easy than they were months ago. And they will be even less easy if Fed accelerates taper. The bid ask is whether taper matters. I think it matters and will have an impact in a slowdown because it directly impacts M2 growth.

If small and mid-cap indices failed to rally in the last 8 months under the most loose financial conditions in modern history, why are they going to rally if Fed tightens financial conditions? I just think it’s appropriate to play defense.  

December 7

JM (Toronto): If the Fed speeds taper, given how well telegraphed it’s becoming, I don’t expect it to hurt sentiment or stocks. We have “corrected” into the decision from a bottom-up level. 

The median stock is down 21 percent, while the Russell 3000 is up 20 percent for the year. You’ve basically had a 4Q18 type correction. It’s just not obvious at the index level.

December 13

JM (Toronto): I’ve been reviewing chart patterns from March 2020 lows, and they look incomplete. I like using Elliot Wave and I see us ending wave 4 corrections or correcting patterns within wave 5 that has much higher to go. 

Russell 2000 had a false breakout. But for that to be valid, it usually turns to a quick reversal and breakdown. We haven’t seen that. Still holding above 2021 trendline and within flat range. 

Small-cap tech (PSCT) broke out of flat YTD range like the Russell 2000; the breakout is still valid. Equally weighted tech index (RYT) is near all-time highs (AAPL and MSFT are not in the top 10 holdings). 

Advisory Services Sentiment bull-bear spread is lowest since March 2020. Breadth has been weakening (stocks above their 200dma), but I find that more useful to time bottoms than tops (arguably, didn’t work in 2018). 

That said, last week S&P 500 triggered a very strong 5-Day Thrust (percent of stocks up) which marks rally initiations (including after the 2018 bottom).

CAC and DAX are ending wave 4 correction from March 2020 rally. Nikkei in sideways consolidation all of 2021. KOSPI had a breakdown but fighting now to move back above key level. USDKRW, I think, is topping. 

EM ex China (EMXC) is correcting sideways while China A-shares are improving and back above 200dma. EMFX has corrected 61.8 percent Fib level of the rally from March 2020. Copper is correcting sideways for last 6 months.

It’s encouraging to see other assets respect key risk levels: 10-year yield held above 1.33 and AUDUSD is back above 0.71. Want to see VIX stay below 28 now. 

Fundamentally, the case is a lot simpler: the most bullish factor may simply be falling inflation in 2022 (it will seem so obvious in hindsight), reversal of the concerns around supply chain issues and rising wages, productivity will be a positive surprise, and all that will combine to produce continued earnings beats. 

December 15

JM (Toronto):  Am I wrong in thinking the focus now tilts back to employment from inflation?

PG (London): Seems unlikely. Powell highlighted that “inflation is one of the main threats to getting to maximum employment.” 

JM (Toronto): But he also said that “we would not in any way want to foreclose the idea that the labor market can get even better” once the Fed judges the US has reached maximum employment. 

SW (New York): Powell commented “the risk of persistent inflation has increased, but it’s NOT high.” That means no accelerated policy action. Takes tail risk off the table in my mind.

JM (Toronto): I just don’t think monetary policy is where risks are situated this cycle. It wasn’t in the last cycle either. Fed is always going to be reactionary. If you’re watching for warning signs for a major top (as I am), I suspect the Fed won’t be the catalyst. 

MB (New Jersey):  I disagree. Eventually it’s always about growth and the Fed. The two are interconnected. It was in 2018 and 2020 as the two most recent examples. Covid was the trigger in 2020, but markets were already ringing alarm bells. I’m not going to ignore what I see as alarm bells this time.

JM (Toronto): We saw the signs in 2018 and 2020. Bearish in Jan of both years. But I guess the way I approach it Fed decisions don’t matter a whole lot. It’s always a confluence of forces. 

I think we’re off to the races now. The final chase.

CK (New York): I agree. However, covid cases are about to go nuts so I think you buy Covid winners who are reasonably valued that just went down on Fed overhang.

December 16

PG (London): Failed breakout not a great sign, horrible breadth was a tell.

RL (Cleveland): A lot of tech, growth players look like crap.

VB (Hong Kong): China internet is in a nuclear winter.  

JM (Toronto): Rumi says, “Patience is not sitting and waiting, it is foreseeing. It is looking at the thorn and seeing the rose, looking at the night and seeing the day.” 

It is looking at horrible breadth and seeing new highs.