Normal Pullback or Deeper Correction?
August has always been a special time of year for me.
However, this year August holds great sadness. Despite enjoying a wonderful weekend getaway with my family for my birthday, our hearts break for the tragedy that struck Hawaii.
For the last 5 or so years in August, my family and I have spent a couple of weeks in Hawaii. We come back to the mainland feeling refreshed after some intentional family bonding time.
And although we did not make the trip this year, Maui in particular, holds a special place in our hearts.
We love the atmosphere, the island vibe, and the people. I loved it so much that I proposed to my wife there.
So it comes with a heavy heart to hear about the devastation endured on the island. Our hearts go out to the people of Maui.
We know it will take years to rebuild but knowing the communities of Hawaii, they will come back stronger than before.
This tragic scenario has reminded me of all of the life volatility we have experienced over the past few years.
Perhaps not as catastrophic, but heavy nonetheless such as a war, pandemic, fire, drought, layoffs, crippling inflation, health issues, or a market crash. We have all collectively experienced some type of hardship in the recent past.
And from a market perspective, all of these events have played a role, one way or another, in our investing lives. At the current time, it may seem that we are walking a tightrope of uncertainty.
Does the market make it to the other side relatively unscathed - i.e. soft/no recession? Or are we facing a delayed economic hardship from a culmination of past monetary and fiscal policy - i.e. hard landing/severe recession/continued market crash?
The above reminds me of a quote from Sir John Templeton, "Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
And according to the American Association of Individual Investors (AAII), there has been quite a bit of optimism over the recent months.
Current AAII Reading
AAII is seen as a contrarian indicator. Meaning, when bullish sentiment is high and bearish sentiment is low it can be seen as bearish and the opposite would be more bullish. At least in the short term.
Currently, the indicator has come down slightly due to the recent market pullback; however, last week, the AAII previously stated "... At 10 consecutive weeks, this is the longest that pessimism has been below its historical average...".
Giving us a short-term bearish outlook for the stock market.
Yet, the recent AAII change to a more bearish sentiment gives us an indication that the current market weakness may be coming to an end in the coming weeks.
Of course, I spoke about the potential for a market pullback this quarter in last month's update (read here) but size and scope were, and still are, anyone's guess.
Personally, I am still optimistic about the direction of the capital markets in the medium to long term. Nevertheless, prices did move higher without the inkling of a pullback for the last several months.
That's not normal.
Right now, it is difficult to deny that there is a plethora of stronger-than-expected data keeping the Fed's interest rate higher for the longer hawkish position in play.
However, the change to a more bearish sentiment gives us an indication that the current market weakness may be coming to an end in the coming weeks.
With the Fed's perceived strong arm on monetary policy and the recent US debt and banking institution downgrades (possibly more on the way), a continued decline in leading economic indicators, and the Chinese economy blowing up, investors are suspicious that the current path will produce any positive outcome.
I am eager to hear more about the Fed's position at the Jackson Hole economic symposium this week. This may shed light on how aggressive they are actually willing to be to fight inflation.
In addition, the continued decline of the leading economic indicators are of concern as well.
Leading Economic Indicators (LEI)
I know I have talked about the LEI in the past; however, what is most interesting is that the indicator has declined yet again in July making this the 16th month in a row of decline. See the chart below.
The positive here is that GDP has shown a slight uptick. Yet, the decline in the LEI has been quite accurate in recession calls in the past.
I know we have all heard the saying - “it is always darkest before dawn”, which may be the case with this indicator, but it still raises the question of will the Fed take it far?
This is precisely why I personally am interested in the Jackson Hole symposium.
Too hawkish and lower we go, but with any inclination in the Fed backing off then we may see green shoots in the near future.
Conclusion
We have seemed to re-enter a time period of strong news being not so strong for the capital markets. Mainly because strong news means the Fed may still see a path to raise rates.
The market has anticipated this as treasury yields have rallied while bond prices and stock prices have fallen.
I have trimmed some oversized positions in recent weeks in anticipation of this, yet, we still remain significantly invested.
I suspect the Fed will not be as hawkish as the markets have priced in as of this writing.
Even though this pullback was a bit overdue, as they always are, I maintain that I am fairly optimistic in terms of capital market direction in the mid to long term.
In the short term, we may have continued volatility for the coming few weeks.
Of course, this is based on all of the ever-changing information that we know at this time.
For now, we are patient, sticking to the process, and looking forward to what the future will bring.
Enjoy the rest of your summer and time with your families as these long sun-filled days will soon come to a close.
“After a stock market decline, people may perceive more risk than before when, in fact, the decline may have taken some of the risk out of the market.” - Robert Shiller
Thank you for reading,
James Anadon
