Reality Check: Markets Wait for the Other Shoe to Drop!

Asset prices follow narratives in the short term, and unfortunately for many retail traders, the narrative has been a fast-moving, constantly changing target lately. Going from “hard landing” to “soft landing,” and now “no landing,” investors have been conditioned to hope for the best but must now expect the worst.

It’s an upside-down world we’re living in where a resilient labor market (lowest unemployment since 1969 if you believe the BLS’s data) and better-than-expected retail sales are considered bad news. Everything comes down to fear of the Fed and its policy errors.

Yesterday we witnessed a post-Presidents’ Day sale with the S&P 500, Dow Jones Industrial Average, and NASDAQ all having their worst single-day sell-offs so far this year. There was no specific negative catalyst on Monday or Tuesday; it was just the market’s collective realization that the other shoe will drop sooner or later, and probably sooner.

Another factor was investors’ nervous anticipation of the release of the minutes from the previous FOMC meeting, though the minutes releases tend to be non-events. Analysts and economists will comb through it and parse every word, but don’t expect any major revelations.

Instead of relying on analysts to tell you what’s real and what’s not, it’s much easier and more effective to look at the data and apply your common sense. Bond yields shot up yesterday because all signs point to inflation persisting, which will require the Federal Reserve to keep interest rates higher for longer.

Treasury yields are inverted, corporate earnings are being revised downward, and there’s a new announcement of a tech company laying off its workers practically every day. Bear in mind that these tech businesses led the stock market higher for a decade after the 2008-2009 financial crisis and then again after the COVID-19 crash of March 2020.

Taking a big-picture perspective and zooming out on your charts will help you see just how far stocks could fall this year. This week’s one-day 2.5% drop in the NASDAQ might have felt drastic, but it may only be a drop in the bucket compared to what’s coming.

Consider that the NASDAQ rallied from 1,300 at the financial crisis bottom to 8,000 just before the COVID-19 crash. That’s a gain of over 500%, which was much more a function of government bailouts and quantitative easing than corporate earnings.

The chart above also shows the drastic upswing in the NASDAQ after the COVID-19 crisis of early 2020. Unprecedented quantitative easing and government-funded (meaning taxpayer-funded) stimulus payments/bailouts prompted a bottom-to-top NASDAQ rally of roughly 150%.

The top occurred in November 2021, and as with all bubbles, it was easy to think that the rally would continue without interruption. Every action has its consequences, including extreme quantitative easing/rock-bottom interest rates and flooding the circulating supply of U.S. dollars with stimulus/bailout money.

I’ve been warning you about a big increase in dollar inflation for a long time, and it’s one of the reasons I recommended a position in precious metals. That helped investors preserve the value of their wealth and buffer against the tech stock crash of 2022 and will continue to serve these and other purposes in 2023.

The other shoe is still dropping now since we’re seeing historically sturdy businesses like Walmart and Home Depot publish lackluster earnings reports. We’re also seeing weakness in bank stocks and softness in technology businesses like Intel, which just slashed its dividend by over 65%.

The stock market’s voting machine handed the bulls a sizable rally in January. The weighing machine always wins out in the long run, though, and the majority of Big Tech names have already released their quarterly earnings reports, many of which were disappointing.

Plus, surprisingly sticky inflation (January’s 6.4% CPI print showed barely any improvement over December’s 6.5%) means that the coming weeks could be a bumpy ride for long-leaning investors. The next several months might be volatile as the Fed continues to focus almost exclusively on slaying the inflation monster regardless of the consequences for the stock market.

On that front, the Federal Reserve has a long way to go. St. Louis Fed President James Bullard expects the federal funds rate to peak between 5.25% and 5.5%, and he’s certainly not the only hawkish Fed official.

Some oddsmakers are even envisioning the federal funds rate reaching nearly 6% by July of this year. One can easily imagine the pressure this scenario would put on technology stocks if comparatively risk-free government bonds offer outsized yields.

There’s no way to know exactly how high bond yields will go, but some things are in your control right now. How you choose to allocate your funds and how much dry powder you have ready to purchase high-conviction assets at low prices can make the difference between weathering the storm and getting left high and dry in 2023.