Why this rally is not sustainable ?

NJC
2022-08-14

Key Points: 

- US economy is strong now 

- 8.5% CPI is still too high 

- The market is stubbornly euphoric now 

- Big money shunning from stocks


Strong US economy

The US economy is definitely strong now ( the jobs number, PMI number etc )


CPI

But the most recent CPI number is 8.5% which although is lower than analyst expectations, but is still very much higher than the FED's target of below 2% inflation. This means that the FED will have to raise rates alot more in the coming FOMC meetings. 

Usually, when the FED hike interest rates, the market tends to fall because the market is a forward looking indicator and an increase in interest rates will disincentive buisnesses to hire and expand ( which is what we are seeing now ). 


Stubbornly Euphoric

But in today's scenario, the market is up because people say that the market has already priced in the 2 75 basis point hike in the most recent 2 FOMC meetings. But with rate hike, companies earnings tend to shrink & it will be reflected on its stock price when it reports earnings. And since the current 8.5% CPI number is still far from the FED's <2% goal, many more rounds of rate hike will happen & companies earnings willsuffer and it will be reflected in the stock price by then. 


Wall Street

According to Bank of America, big money has been shunning away from stocks already. The VIX index is also quite low ( considering russia war, risk of china taiwan war, FED rate hike etc ) which indicates that hedge funds / big money are buying lesser option contracts to hedge because the amount of shares they have to hedge have decreased. It is also reported that majority of the money that went out of stocks have entered into bonds which have caused bond prices to increase and yield to decrease.


Conclusion 

Big money have exited the market while newer investors with small & medium money is continuing to buy because they have been wired over the past few years to buy the dip constantly as the stock market has always been going up since the recovery in 2009. But despite the state of the current US economy, the FED will still raise rates and US the economy as a sponge to soak up the impact of rate hike which will contarct company spending due to anticipation of a reduction in future earnings and it will slowly become a self fulfilling prophecy ( companies reducing spending will affect the earnings of the entire supply chain and cause a domino effect ). If earnings misses for multiple quarter in a row, I believe that even the most optimistic of wall street suit will fold and the market will see a long due correction / crash.

However the only bull thesis I can think of is that you trust the Biden administration and that they can solve the inflation problem soon without the market having to go through several more quarters of earnings.


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