You no doubt are aware of the market turbulence these past six months. To put it mildly, it is unpleasant and can be scary. The markets have declined in twelve of the last thirteen weeks and not without cause. The economy ran too hot for too long creating runaway inflation. The Federal Reserve now recognizes the extent of the problem but is very late to the game. While going through my notes for the week I am hard pressed to find much that isn't negative. Having said that, bear markets and recessions are a normal part of the economic cycle, even though it's been a while since we’ve gone through one. 2008-09 may come to mind, but that is a rather extreme case of a financial crisis that isn’t expected to happen again anytime soon. Rather, it looks like we could be headed for a more normal style of recession which could help reset both the economy and the stock market. That wouldn’t necessarily be a bad thing.
Let’s start with the latest interest rate hike. The FOMC voted on Wednesday to hike interest rates by 75 basis points, which is the biggest hike since 1994. It is also likely the Federal Reserve will raise rates another 75 basis points at its next meeting in July. Many may already understand this, but by raising the interest rate, borrowing money becomes more expensive for consumers and businesses. As financial conditions tighten, spending (i.e. demand) is expected to decline, which in turn should push down inflation. The move this week shows a recognition that things have gotten away from the Fed while also trying to recover lost credibility with monetary policy. The Fed projects the bank’s key interest rate will hit 3.00% in 2022. Looking even further out, the Fed expects rates to top out between 3.50% - 4.25% in 2023.
Inflation is the main catalyst for the markets these days. Last Friday’s report sent investors into a panic and this week showed just how unsettled investors have become. The S&P 500 has fallen to a 15-month low and is officially in bear market territory. The S&P 500 is down approx. 23% while the Nasdaq is down by almost 32%. Naturally, one might wonder how long a typical bear market lasts? Using historical data, UBS suggests that the average bear market since World War II continues for 16 months. Given the S&P 500 reached its all-time high on Jan 4 of this year, the current bear market has lasted six months so far. Therefore, the benchmark case would put the endpoint sometime in April of next year. However, bear markets do vary with the shortest lasting just one month (the start of the pandemic in 2020) and the longest lasting 31 months (the aftermath of the dot-com bubble). Also worth noting, on average the typical bear market includes a decline of 35.1%, according to the data spotlighted by UBS.
Doesn’t it feel like sometimes things line up in exactly the wrong way? Abbott Labs announced on Wednesday it has halted production of baby formula (again) at its manufacturing plant in Michigan after flooding at the plant following heavy rains. This latest setback comes only a week after the manufacturing facility resumed operations following a months-long shutdown due to contamination. And if you happen to live in or around California, gas prices are poised to shoot higher as refineries start maintenance. Gas prices of $6.45 in California, already far above the national average, could go higher as Chevron is set to carry out major maintenance work at its Richmond refinery, which is expected to last for about a month. The planned maintenance comes as both Phillips 66 and PBF Energy already are undergoing work at diesel and jet fuel-making facilities. I couldn’t make this stuff up.
In closing, I mentioned last week that bees are now be considered fish, in California, as relates to the endangered species act. This week, it turns out elephants aren’t people after all. New York’s top court ruled that an elephant cannot be considered a person. The case involved a female Asian elephant, named Happy, who has resided at the Bronx Zoo for over forty years. An animal rights group claimed that Happy is being illegally detained and deserves to be transferred to an animal sanctuary. The court ruled that habeas corpus, a fundamental right protecting persons against unlawful detainment, does not apply to animals. Perhaps if Happy lived in California she could open a yoga studio and start a line of athletic sportswear. Alas, she lives in New York. Now you know.Bruce J. Mason, MBA