The narrative around Wall Street changed significantly last week when Chairman Powell confirmed what his colleagues have been saying for many weeks. In other words, Mr. Powell took the “pivot” off the table (or at least they took it off the table for any time soon). An upcoming “pivot” was something the consensus on Wall Street had been looking for over the past 4-6 weeks….and it’s something the stock market had been pricing-in as well. Therefore, Powell’s short speech on Friday blew a big hole in that argument.
However, we’d also note that by using words like “pain,” the Chairman also took a soft landing off the table as well. Of course, the Fed won’t acknowledge this…and they’ll continue to talk about the possibility of a soft landing, but the odds that we’ll get one are very, very low…and they know it.
In fact, they’ve known it for a long time. You cannot thoroughly reverse a situation where massive levels of liquidity are being pumped into the system…at a time when the stock market that has become extremely expensive (which is what we were facing in late 2021)…without it causing something more than run-of-the-mill bear market and a mild downturn in growth.
Let’s step back for a minute…..In order to save the financial system from the global economic shutdown in 2020, the Fed pumped enormous levels of liquidity (steroids) into the system. They’ve always known that could not keep providing those steroids without making the situation worse over the longer-term. They have ALSO always known that taking away those steroids at some point in the future would cause some meaningful pain. However, they’ve always known that it was going to HAVE to be done…so that the solution for the last problem did not give us a bigger problem at some point in the future.
Put another way, the Fed pumped all of that liquidity into the system…in order to save the system. However, they’ve always known that we’d have to go through some pretty serious pain to get back to a situation where the system is running in a normal and healthy fashion (without major levels of artificial stimulus).
In other words, they purposely caused the markets to become addicted to liquidity…because they had to save the system. However, they’ve always known that they would have to go through the painful process of forcing the system to become “clean” again…and they’ve always known this would be a painful process…….Last week, the Fed spelled it out in a more forceful manner…because it had become too obvious that most pundits on Wall Street did not understand what would have to take place. (Those pundits have thought that they could have their cake and eat it too.)
Okay, let’s look at the situation we’re facing in the marketplace right now. The stock market got hit very hard on Friday…as the major averages all fell over 3%...with the NDX Nasdaq 100 falling more than 4%! The volume was the highest of the week, but it still was not overly high (less than 3.7bn shares). That said, for a Friday in August, it was still somewhat robust. However, the breadth was horrendous. For the S&P 500, it was 99 to 1 negative! For the NDX 100, it was 50 to 1 negative and 22 to 1 negative for the Russell 2000. (For the DJIA, all 30 stocks declined on the day.)…..It was also a 90% day in terms of volume (where more than 90% of the volume came on declining shares). Therefore, no matter how you slice it, Friday was an ugly day on Wall Street.
When you look at these very negative “internals” from Friday…and you combine them with the (now) significant MACD crosses on the major indices, key groups and key stocks we highlighted again in our weekend piece…it seems quite clear that an important change in the short-term trend of the stock market has taken place……This does not mean that the market is going to fall out of bed this week. Yes, the futures are trading considerably lower in pre-market trading. So, it does look like today will be another tough one. However, that does not mean that we cannot or will not see some sharp bounces along the way. Let’s face it, there are still a lot of people who think that we can return to the kind of marketplace that existed in 2021 without outsized liquidity injections. Thus, we’ll see more bear market rallies along the way.
Again, the Fed had no choice back in 2020. In order to save the system, the Fed forced it (the system) to become addicted to liquidity (steroids). Yes, we CAN blame them for not forcing the system to start the process to becoming “clean” sooner, but they did the right thing back in 2020……The problem is, either way, this process of becoming “clean” was ALWAYS going to be a painful one. The fact that the system was allowed to stay addicted longer…will make it an even more painful process. However, it still NEEDS to take place. This process will allow the financial system to work in a more normal/healthy manner in the future. However, to think we can get through it with only a normal bear market and a mild slowdown in growth is wishful thinking in our opinion.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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