Prepare For The Nastiest Bear Market Ever?
The Nasdaq Composite dropped on Friday, notching its worst week since 2020, as sharp losses in streaming giant Netflix dragged the technology-focused index deeper into correction territory.
The Nasdaq Composite declined 2.7% to 13,768.92. The index fell 7.6% since Monday, for its worst week since October 2020. The Dow Jones Industrial Average fell 450.02 points to 34,265.37. The S&P 500 slid 1.9% to 4,397.94.
Both the Dow and S&P 500 closed out their third straight week of losses and their worst weeks since 2020. The S&P 500 now sits more than 8% from its record close.
Netflix’s disappointing quarterly report is the latest setback for technology investors. Shares of the streaming giant tumbled 21.8% on Friday after the company’s fourth-quarter earnings report showed a slowdown in subscriber growth. Its competitors’ shares also declined, with Dow component Disney, which operates the Disney+ streaming service, off 6.9%.
Netflix is the first major tech stock to report earnings this season, with Apple and Tesla slated to post earnings next week. Tesla lost 5.3% on Friday. Other tech names like Amazon and Meta Platforms fell 6% and 4.2%, respectively.
Meanwhile, Peloton shares rebounded 11.7% on Friday. The maker of interactive fitness bicycles and treadmills plunged 23.9% during regular trading on Thursday after CNBC reported that the company is temporarily halting production of its fitness products.
The major losses in growth names have pushed the Nasdaq Composite further in correction territory as rising rates pressure technology stocks by making their lofty valuations look less attractive. At Friday’s close, the Nasdaq was down 14.25% from its closing record in November.
The Nasdaq is off to its worst start to the year, through the first 14 trading days, since 2008, according to FactSet.
“Given the emotional decline in the stock market of the last few days, fundamentals have been suspended as market action is entirely tied to technical support levels,” said Jim Paulsen, chief investment strategist at Leuthold Group.
“Until a level is reached in this collapse... fundamentals like bond yields, economic reports and even earnings releases will not likely have much impact. Fear now must be extinguished by some stock market stability before traders and investors again start to consider fundamental drivers,” added Paulsen.
The Nasdaq Composite’s struggle is largely due to a surge in government bond rates this week. The U.S. 10-year Treasury hit as high as 1.9% on Wednesday as investors focused on the Federal Reserve’s timeline for raising interest rates and broadly tightening monetary policy. However, bond yields retreated on Friday.
Investors will now be turning their attention to the Federal Reserve’s January two-day policy meeting, set to start on Tuesday.
“While a handful of rate hikes over the next year or two would represent a shift in Fed policy, we wouldn’t consider policy restrictive and we don’t expect the initial rate increase to derail the economic recovery,” said Scott Wren, senior global market strategist at Wells Fargo Investment Institute. However, he added that rate hikes will inject volatility into the market.
During regular trading Thursday, the Dow shed more than 300 points. At one point during the session, the 30-stock benchmark was up more than 450 points. A similar reversal played out for the other major averages.
U.S. stocks this month have often sold off into the close. The S&P 500 on average has fallen 0.16 percentage points in the final hour of trading in January, according to Bespoke Investment Group analysis through Wednesday. That average last-hour performance places January in the bottom 1% of all months and third-worst since 2000, Bespoke found.
Small caps have also been hit hard this week. The Russell 2000 secured its worst week since June 2020. The index fell 1.8% on Friday.
Bitcoin was also hit hard on Friday as investors brace for the Fed and dump riskier assets with higher rates ahead. The digital asset fell more than 10% to around $38,233 on Friday.
Anyway you slice it, it was a tough week for stocks and thus far, the start of the year is miserable:
As shown above, tech stocks (QQQ) and small cap stocks (IWM) are selling off hard and that's to be expected. As rates rise, long duration stocks get hit the hardest and generally speaking in a Risk Off environment, the riskiest stocks get hit the hardest.
Also, as rates rise, speculators which leveraged into these stocks over the last couple of years are deleveraging and that's why you're seeing wild swings in these stocks.
Chart of the day: 10-year TIPS yield.— Edward Harrison (@edwardnh) January 21, 2022
Real yields are exploding higher in 2022 on the back of an anticipated normalization of monetary policy pic.twitter.com/ovDr0lZwlg
Of course, everyone is worried, January is usually a good month for stocks but with inflation soaring to 40 year highs and the Fed sounding more hawkish with each passing week, there are increasing concerns that this will be a terrible year for risk assets in general, and stocks specifically.
And then there is the Jeremy Grantham warning which shocked investors.
The legendary investor doubled down on his crash call, saying the selloff has only started:
Jeremy Grantham, the famed investor who for decades has been calling market bubbles, said the historic collapse in stocks he predicted a year ago is underway and even intervention by the Federal Reserve can’t prevent an eventual plunge of almost 50%.
In a note posted Thursday, Grantham, the co-founder of Boston asset manager GMO, describes U.S. stocks as being in a “super bubble,” only the fourth of the past century. And just as they did in the crash of 1929, the dot-com bust of 2000 and the financial crisis of 2008, he’s certain this bubble will burst, sending indexes back to statistical norms and possibly further.
That, he said, involves the S&P 500 dropping some 45% from Wednesday’s close -- and 48% from its Jan. 4 peak -- to a level of 2500. The Nasdaq Composite, already down 8.3% this month, may sustain an even bigger correction.
“I wasn’t quite as certain about this bubble a year ago as I had been about the tech bubble of 2000, or as I had been in Japan, or as I had been in the housing bubble of 2007,” Grantham said in a Bloomberg “Front Row” interview. “I felt highly likely, but perhaps not nearly certain. Today, I feel it is just about nearly certain.”
In Grantham’s analysis, the evidence is abundant. The first sign of trouble he points to came last February, when dozens of the most speculative stocks began falling. One proxy, Cathie Wood’s Ark Innovation ETF, has since tumbled by 52%. Next, the Russell 2000, an index of mid-cap equities that typically outperforms in a bull market, trailed the S&P 500 in 2021.
Finally, there was what Grantham calls the kind of “crazy investor behavior” indicative of a late-stage bubble: meme stocks, a buying frenzy in electric-vehicle names, the rise of nonsensical cryptocurrencies such a dogecoin and multimillion-dollar prices for non-fungible tokens, or NFTs.
“This checklist for a super bubble running through its phases is now complete and the wild rumpus can begin at any time,” Grantham, 83, writes in his note. “When pessimism returns to markets, we face the largest potential markdown of perceived wealth in U.S. history.”
It could, he said, rival the impact of the dual collapse of Japanese stocks and real estate in the late 1980s. Not only are equities in a super bubble, according to Grantham there’s also a bubble in bonds, “the broadest and most extreme” bubble ever in global real estate and an “incipient bubble” in commodity prices. Even without a full reversion back to statistical trends, he calculates that losses in the U.S. alone may reach $35 trillion.
Grantham is a dyed-in-the-wool value manager who’s been investing for 50 years and calling bubbles for almost as long. He knows his predictions are fodder for skeptics. One obvious question: How could the S&P 500 advance 26.9% in 2021 -- its seventh-best performance in 50 years -- if stocks were poised to plummet?
Rather than disprove his thesis, Grantham said the strength in blue-chip stocks at a time of weakness in speculative bets only reinforces it.
“This has been exactly how the great bubbles have broken,” he said. “In 1929, the flakes were down for the year before the market broke, they were down 30%. The year before they’d been up 85%, they had crushed the market.”
Seeing the same pattern that played out in every past super bubble is what gives him so much confidence in predicting this one will implode similarly.
Grantham pins the blame for bubbles of the past 25 years mostly on bad monetary policy. Ever since Alan Greenspan was Fed chairman, he argues, the central bank has “aided and abetted” the formation of successive bubbles by first making money too cheap and then rushing to bail out markets when corrections followed.
Now, investors may no longer be able to count on that implied put. Inflation running at the fastest clip in four decades “limits” the Fed’s ability to stimulate the economy by cutting rates or buying assets, Grantham said.
“They will try, they will have some effect,” he added. “There is some element of the put left. It is just heavily compromised.”
Under these conditions, the traditional 60/40 portfolio of stocks offset by bonds offers so little protection it’s “absolutely useless,” Grantham said. He advises selling U.S. equities in favor of stocks trading at cheaper valuations in Japan and emerging markets, owning resources for inflation protection, holding some gold and silver, and raising cash to deploy when prices are once again attractive.
“Everything has consequences and the consequences this time may or may not include some intractable inflation” Grantham writes. “But it has already definitely included the most dangerous breadth of asset overpricing in financial history.”
So, is Jeremy Grantham right, is the stock market selloff only beginning?
That's definitely how it feels like but I caution my readers, we are entering month-end and many of those large pension funds I cover are rebalancing here, adding to their equity exposure as stocks decline.
Moreover, the Fed is meeting next week during its January two-day policy meeting and I don't expect any negative surprises.
Some people are adamant, the Fed needs to hike rates and some think it should start with a 50 basis points hike to "restore credibility" and fight soaring inflation:
While it has become conventional wisdom that the @federalreserve will raise rates 3 to 4 times this year to mitigate inflation, the market expects 25 bp increments. The unresolved elephant in the room is the loss of the Fed’s perceived credibility as an inflation fighter and— Bill Ackman (@BillAckman) January 15, 2022
needs to be, with painful economic consequences for the most vulnerable. A 50 bp initial move would have the reflexive effect of reducing inflation expectations, which would moderate the need for more aggressive and economically painful steps in the future. Just a thought.— Bill Ackman (@BillAckman) January 15, 2022
But I'm not sure how the market will perceive a 50 bps rate hike, if the Fed has the chutzpah to go through with it.
Moreover, some feel the Fed is pushing on a string here as the economy slows and inflation expectations collapse:
In his latest weekly research report, Francois Trahan of Trahan Macro Research states this:
The Fed's 180 degree change in stance last month, and the ensuing rise in bond yields, has halted the S&P 500's advance. Truth be told, the renewed vigilance of the Fed toward inflation is not the only problem facing U.S. equities in 2022. Indeed, an extended downtrend in PMIs this year also is likely going to rein in equity returns. This story is not unique to U.S. equities, however. PMIs are likely to slow around the globe in 2022 as the pandemic recovery begins to stall.
In normal times, the S&P 500 has outpaced most of the world's equity markets in the face of a synchronized global slowdown. Obviously, these are not normal times. For one, the Growth-laden S&P 500 is far more expensive than most of the world's major indices. Most importantly, perhaps, the Fed's unique focus on core inflation might just play a big role this year. After all, core inflation is a lagging indicator of the economy, and thus continues to accelerate well beyond a peak in PMIs. Meanwhile, headline inflation, the primary focus of most of the world's central banks, should slow alongside the world economy as commodity prices lose momentum. The point here is that this is one of those weird points in the cycle where the Fed's somewhat unique mandate keeps them vigilant when other central banks start to promote a less hawkish backdrop.
The one good thing going for U.S. investors is the Dollar. The USD tends to appreciate against most currencies in the face of a global slowdown. Moreover, the Dollar could find additional support in monetary policy if headline and core inflation do end up behaving differently in 2022 as we suspect. All that said, there are plenty of opportunities in the world's equity markets even when adjusting for currencies. This week, we look across the world's indices for stocks that would qualify as lower beta and lower equity duration if they were in the S&P 500. Nothing is simple about stocks this year, in the U.S. or otherwise. We try to sort out all the influences and focus on those gems investors should be aware of in the months ahead.
Nothing is ever simple in stocks but Francois is right, this year is particularly tricky with a lot of macro headwinds and risks of policy errors.
For his part, Martin Roberge of Canaccord Genuity shared this in his weekly wrap-up:
It was another difficult week for stocks, with the NASDAQ and Russell 2000 entering correction territory. For now, both the S&P 500 and S&P/TSX are holding above their 200-dma but a test/breach of this line should not be ruled out if cyclicals give back some of their strong YTD gains. A week ago, the prospect of more rate hikes and quantitative tightening hampered stocks. This week, higher oil prices and the realization that wage inflation seems to be becoming a widespread issue took its toll on stocks, as the earnings outlook suddenly appears more clouded. One thing is for sure, contrary to prior corrections which seemed to end when the Fed intervened, this time around a more hostile inflation backdrop is tying the Fed’s hands. This means that markets will need to find their own equilibrium. Elsewhere, commodities continue to shine, with the DCB ETF climbing to a 52-week high. The rally is not only oil-related, as copper, gold and agricultural prices moved higher this week. Last, US-10year bond yields retraced their pre-pandemic level ~1.9% and then rallied strongly. This dynamic reinforces our view that 2% could be a ceiling in H1 and any overshoot is likely an H2 story.
Our focus this week is on the price of gold around first Fed hikes. Gold equities enjoyed an enormous bounce Wednesday (~7%) but many investors are questioning whether this is not one of those numerous false starts seen over the past several months. After all, the perception is that gold should perform poorly when the Fed hikes rates and bond yields are climbing, as this raises the opportunity cost of holding gold, which is a non-interest-bearing asset class. As our Chart of the Week shows, gold does perform erratically about six months before first Fed hikes. However, once the initial rate increase is delivered, gold takes off. In other words, gold appears to be a typical “sell the rumour, buy the news” event upon first Fed hikes. Therefore, if our chart is any guide, with March being the lift-off date, one should expect the price of gold eventually to push above the $1,850 level which breaks the downtrend that began in August 2020. Timing remains uncertain but given the close proximity of the all-time peak of ~$2,072/oz, pre-emptive purchases of dips in gold and gold equities seem like a good reward-to-risk opportunity here, especially if the US$ keeps depreciating along the way.
Is it gold's time to shine? I remain a dollar bull so it's hard for me to get too excited about gold or commodities here.
Still, gold weekly chart is looking interesting so I'm paying attention for a breakout which has yet to materialize:
And remember, gold isn't just a hedge against inflation, it's also a hedge against deflation, so having a small amount in your portfolio isn't a bad idea here.
Lastly, let me share some weekly charts with you that I track closely:
The S&P 500 ETF (SPY) remains above its 50-week exponential moving average but the Nasdaq ETF (QQQ) broke below it.
If long bond yields don't break above 2% on the 10-year or marginally do and then stabilize and decline, this will support rotation back into beaten down growth names.
That’s a big If and keep in mind, hyper-growth "Ark" type stocks continue to get clobbered and they most definitely have entered a bear market:
Once you go below that 200-week exponential moving average, sell any pop in these stocks, they're done!
Not surprisingly, at least one ETF is trying to take advantage of Cahie Wood's slump here:
‘Anti-ARKK’ ETF Amasses $234 Million as Cathie Wood Struggles https://t.co/pCUT4qBzJS— Leo Kolivakis (@PensionPulse) January 21, 2022
Alright, let me wrap it up and leave you with some more interesting tweets:
-23% off sale Amazon $AMZN, enters a bear market. Stay at home, the "new economy" plays are on sale every day. Remember the loud 2020-2021 - the narrative from the Street analysts, "covid has permanently changed consumer behavior."— Lawrence McDonald (@Convertbond) January 21, 2022
Musing of the Day: A lot of folks have mistaken winning the Liquidity Lottery for being the next Stan Druckenmiller. Avoid BYOBBS (Believe Your Own BS Syndrome). Making $ consistently in the markets is hard work and is likely to get a lot harder.— Michael Kao (@UrbanKaoboy) January 21, 2022
Love that last one, everyone is a financial genius in a roaring liquidity driven bull market!
Below, Jeremy Grantham, the co-founder of Boston's GMO and longtime value manager, details his call for a crash in the S&P 500 and explains why central bank efforts to prevent a major selloff are unlikely to succeed. He spoke exclusively to Bloomberg's Erik Schatzker on Bloomberg's "Front Row."
And Tony Dwyer, Canaccord Genuity, joins 'Closing Bell' to discuss his take
on markets and where he would be investing during the downturn.