The wisest answer would be “I don’t know”. Since I’m not wise, I am comfortable putting my 2 sense in. Cents, that is.
On the daily, it looks like we now have a lower high and a lower low. This is negative technically. Much of the market advance over the last couple of decades has been during declining interest rates. Higher interest rates increase debt servicing requirements over time for consumers, businesses, and governments, potentially straining budgets and thus purchasing capacity. Higher yields makes fixed income assets more competitive for investment dollars versus equities. Further, higher interest rates may affect the viability of many capital intensive alternative energy projects, suggesting relatively high energy price input into inflation may last longer than some have anticipated, perhaps including the Fed. Rather than borrowing, some publicly traded companies have decided to issue more stock, only to see their valuations punished in several cases. Current geopolitical trajectories suggest trade restrictions may increase, potentially disrupting financial, goods, and services flows.
We may be in a new paradigm. Home prices are now similar to higher in many markets just before interest rates started to rise. However, with current rates, the direct or opportunity cost of a home for potential new purchasers is roughly double. A healthy real estate market is a major pillar of economic growth. A logical question to consider is the potential effect of a Fed policy change towards the accommodative. After all, we are in the third year of a Presidential election cycle and we are in a very political environment. Given the historical cycle, 2023 should be strong. Further, the holidays are just around the corner. “401k jitters causing seasonal shopping reluctance” is not a headline I’m expecting this year. However, it is my perception if the Fed soon adopts an easier monetary policy, risk taking quickly goes through the roof, causing system stability concerns. We are in a high gamma of risk taking situation due to perceived market expectations, risk complacency, and increasingly homogenized trading models. There still seems to be plenty of liquidity. In other words, the Fed has a vanishingly small needle to thread for effective inflation management with a soft landing and the odds of them hitting this is small in my opinion. Translated, there is potential for an explosive market rally even as our economy becomes increasingly unstable.
In conclusion, I believe the market will see a short covering rally after a budget agreement is reached. Significant fresh buying and the durability of the rally will likely depend upon Fed encouragement. Personally, I’ll maintain a short term horizon, using VIX as a guide, for the foreseeable future.
