• JJ plays the starring role on Capitol Hill – what did he reveal.

  • Investors now have to price in a possible 100 bps July move.

  • Oil – under pressure as global recession fears build.

  • Treasury yields retreat – on a bet that the FED will blink.

  • Try the Summer Risotto.

“An economic downturn is certainly a possibility, we are not trying to provoke and do not think we will need to provoke a recession, BUT we do think it’s absolutely essential to curtail inflation” – Wednesday June 22, 2022 – JJ Powell
Need I say more? They do not NEED to provoke a recession, BUT it is essential and btw - it is already here!

JJ takes to Capitol Hill and tells the Senate that “steep rate hikes could tip the US economy into a recession…”  he went onto say that navigating a ‘soft landing’ would be very challenging!   BINGO!!!  He followed that up with this.

 “The other risk is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy, we cannot fail on that task. We have to get back to 2% inflation……ongoing rate increases will be appropriate to cool the hottest price pressures in 40 years.  Inflation has obviously surprised to the upside over the past year and further surprises could be in store.  We therefore need to be nimble in responding to incoming data and the evolving outlook.”

Ding, Ding, Ding…..….he has now opened the door to include a full 100 bps rate hike in July….it is now out there ‘officially’ in the global public square, it had to be….Now - The investors have to consider the real possibility of a 100 bps hike as soon as July and as a result will (and should) price it in……and if it happens (just like June’s 75 bps hike) then the markets will be prepared and if it doesn’t happen investors will have to then decide if that is (was) a good decision – based on all the data points available. Stocks will adjust to the pace at which the FED will now raise rates…. not if they will raise them, but the pace at which they raise them and that could mean further downside ahead as this gets priced in.

Recall – in yesterday’s note I made it clear – this is a math problem – and so when you go from certainty like 1+1 =2, to uncertainty like 5 x X =?  (that is the problem!)  you have to solve for X and the answer is not 2!  And all that means is that multiples in stocks and the broader market will come down – which it already has and is currently at 17.6 X’s 2022 earnings and is 16.4 X’s 2023 earnings – this is down from 24.6 X’s 2021 earnings…. Capisce. 

So, here is the math in simple terms….in 2021 we ended the year at 4,766. – S&P earnings were $193/sh and investors were willing to pay 24.6 X’s those earnings…. (24.6 x $193 = 4,766 on the S&P) but interest rates were 0 and there was little to no alternative to stocks if you were searching for yield.  Treasuries (riskless) were offering NOTHING – yields were ~ 1.25%, savings accounts were earning 0 and inflation was ~1.5% annually……but now inflation is running at 8.6% (and going higher) so the FED has started to raise Fed Fund rates – taking them from 0 to 1.75% (currently) and going up…..The rise in Fed Funds causes Treasuries prices to come down sending yields up – currently at ~ 3.3% and headed higher (they are still riskless but now are starting to pay you something…) and inflation is eating away at consumer dollars and spending habits – So now, there is a mindset change.  There is now some competition for investor dollars and that puts pressure on stocks and bonds. 

Investors are no longer willing to pay 24.6 x’s earnings because they now have to assess what higher rates will do to the economy, to consumer spending, to demand for goods and services.  The question is – Can we weather the storm without disruption to economic growth?  The answer is not so simple as 1+1.  Everyone has a different opinion (and at the moment no one is wrong – because it depends on what numbers you put in the equation….and that depends on your analysis – which is why we have GS suggesting that 3100 is the downside target for the market right now, while MGS has 3400 as the downside.  And that is just for the drawdown – those are not their year-end projections. Those projections will be driven by what they think S&P earnings will be for the year…. thus, the range in year end targets. 

Analysts now have to ‘guess’ (using the data) what they think total year end earnings will be in order to produce a target….and that depends on your outlook for economy in a rising rate environment….do you see how this works?  Someone that has the S&P at say 4800 by year end….is assuming earnings of $272/sh (4800/17.6) while anyone that has S&P 4000 as a year-end target is assuming earnings of $227/sh. (4000/17.6)   Currently – consensus estimates for 2022 is for 10% earnings growth over 2021 and that would get us to $213/sh  ($193 x 1.1% = $213) – right where the market closed last night…..(See how efficient the market is? )  17.6 x $213 = 3748!

But this is THE moving target…. because if the FED forces us into a recession, then earnings estimates will have to come down as demand for products wanes and earnings come under pressure…  2nd qtr. earnings are due out in 3 weeks…. current estimates suggest that we should see a 4.8% y/y growth rate in 2nd qtr.  (While it assumes a 10.6% growth rate in the 3rd qtr. and 10.5% in the 4th qtr.). So, depending on what they come in at will affect the year end outlook.  If they come in stronger than the estimates – say at 5.5% then targets will be raised and stocks will rise, and if they disappoint and come in less than – say at 3.8% y/y then targets will be forced lower and then investors will have to ‘re-price’ stocks – lower!    

And so, for yesterday – investors chose march in line….as they need to digest his comments and wait for today’s appearance on the Hill to see if he reveals anything new.  By 4 pm the Dow lost 47 pts, the S&P gave back 5 pts, the Nasdaq lost 16, the Russell lost 3 pts, while the Transports lost 146 pts.  The weakness in the transports is suggesting a slowing economy….and there is another data point! 
So, the confusion continues….and multiples will continue to get compressed as rates rise – it is not complicated……. All you have to do is produce the correct number! 

The sectors were mixed - Energy – XLE was the biggest loser falling 4% – but remember it is the biggest winner this year – up 32%!   Real Estate, Utilities and Healthcare ended the day 1+% higher, everything else was off small…. less than 0.5%.    

Treasury yields ended the day lower….yielding 3.10% and that is telling you that bond investors/traders think the FED will blink, they will not have the guts to continue down this path of higher rates……To which I say – not happening….they are backed into a corner – JJ told you that yesterday…..but the bond market is telling you that he is talking out of his …….!  Both Fed Presidents Barkin and Dudley told us yesterday that they expect the FED to be more aggressive on rate hikes….and that falls in line with Bullard, Daly, Mester, Bostic and Vice Chair Brainard – recall Kansas City’s Esther George was the only dissenting voice in the June vote! 

Oil – continues to come under pressure as recession fears mount due to an aggressive FED that is sure now to put us into a recession…. JJ all but said so yesterday. - Falling from last week’s high of $120/barrel to this morning’s $103.50/barrel.  And remember – rising rates that put us into a recession is expected to ‘destroy demand’ for oil and a range of other goods and services – thus the concern.  

Oil is now below its 50 dma trendline and is about to kiss its 100 dma trendline at $99.50/barrel…. Depending on what we hear today from JJ and what investors assume is going to happen will determine the next move for oil as well as every other asset class out there.

US futures are essentially flat this morning…. Dow futures down 5, S&P’s up 7, Nasdaq down 3 and the Russell up 6.  Eco data today includes both Services and Manufacturing PMI’s (Purchasing Managers Index’s) – they are expected to be 53.3 and 56, respectively. We will also get the Kansas City Fed Survey of 13 – down from 23 last month…. (Suggesting slowing activity).  Initial Jobless Claims and Cont Claims are also due out.

Mortgage apps yesterday were in fact UP by 4% which was a bit of a surprise considering the cost of money keeps going up…but this is the last hooray before mortgage rates have a 7 handle. 

European markets are all lower… falling between 0.5% and 1.1% as flash estimates for German and French PMIs came in weaker than expected…. recall inflation is running at 8.1% across the Eurozone, 7.9% in Germany, 5.2% in France, 7.3% in Italy, 8.3% in Spain and 9.1% in the UK.  JJ’s comments and Christine Lagarde’s (ECB President) comments and the recent eco data out of Europe all stoking fears of a global recession…. German 10 yr. bunds (a key metric) falling 21 bps to yield about 1.4%. 

In the end – it is all about how the FED and the administration will navigate this. It is about how the ECB, and the BoE (Bank of England) will navigate this.  It is about how central banks from the major developed nations will handle this.  The risk of a global recession (or ‘crash landing’) is rising every day – as concerns are rising that the central banks will go too far and push the economy into a deeper recession than many have been expecting.  So, strap in and hold on…. more to come.
The S&P closed at 3759.  Leaving 3800 as resistance while 3600 remains the target on the downside.  Expect to hear lots of chatter about JJ testimony today. 

Again, listen to his tone, listen to the questions asked by our esteemed elected leaders – they will reveal a lot about what they understand and do not’ understand.

Summer risotto 

This is all about the fresh summer veggies that make this dish so great.  A range of green/yellow veggies add depth and great flavor - give it a try, won't you?

For risotto you need some basics......Arborio rice, some white wine, chicken stock, fresh grated parmegiana cheese, Vidalia onion, butter, and a splash of olive oil.  In addition - you need some of your favorite green veggies.... peas, asparagus tips, leeks, baby zucchini both yellow and green (yellow complements the green -sliced lengthwise and sautéed quickly) and artichoke hearts.... you can even add cut, blanched broccolini.

Begin by sautéing the Vidalia onion, and the chopped leeks in a bit of butter and splash of olive oil.... now add in the rice and stir until coated.  Next add about 1/2 cup of white wine and allow it to absorb.  Next as usual - add one ladle of hot chicken stock and stir...until almost absorbed.... repeat and repeat again...until the chicken stock is absorbed, and the rice is firm but not hard.

When ready - add the peas, asparagus, artichokes, zucchini, chopped broccolini (if you used it) stir to mix so that the veggies heat up.... add in a 'squeeze' of lemon juice (not too much) and the fresh grated cheese.... Serve as a starter or as a side dish.... either way - it is a celebration of summer.

General Disclosures

Information and commentary provided by ButcherJoseph Asset Management, LLC (“BJAM”), are opinions and should not be construed as facts. The market commentary is for informational purposes only and should not be deemed as a solicitation to invest or increase investments in BJAM products or the products of BJAM affiliates. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. There can be no guarantee that any of the described objectives can be achieved. BJAM does not undertake to advise you of any change in its opinions or the information contained in this report. Past performance is not a guarantee of future results. Information provided from third parties was obtained from sources believed to be reliable, but no reservation or warranty is made as to its accuracy or completeness.

Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will be profitable. The price of any investment may rise or fall due to changes in the broad markets or changes in a company’s financial condition and may do so unpredictably. BJAM does not make any representation that any strategy will or is likely to achieve returns similar to those shown in any performance results that may be illustrated in this presentation. There is no assurance that a portfolio will achieve its investment objective.

Definitions and Indices

The S&P 500 Index is a stock market index based on the market capitalization of 500 leading companies publicly traded in the U.S. stock market, as determined by Standard & Poor’s.

UNLESS OTHERWISE NOTED, INDEX RETURNS REFLECT THE REINVESTMENT OF INCOME DIVIDENDS AND CAPITAL GAINS, IF ANY, BUT DO NOT REFLECT FEES, BROKERAGE COMMISSIONS OR OTHER EXPENSES OF INVESTING. INVESTORS CAN NOT MAKE DIRECT INVESTMENTS INTO ANY INDEX.

BJAM is an investment advisor registered in North Carolina and Arizona. Such registration does not imply a certain level of skill or training. BJAM’s advisory fee and risks are fully detailed in Part 2 of its Form ADV, available upon request.

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