Relief rally or sustained bounce?
In this video insight Roger discusses current market conditions with equities having rallied off the lows recently thanks to a lower oil price and a retreat in bond yields amid fears of a recession. Have we reached the bottom yet?
Transcript
Roger Montgomery:
You have probably been relieved seeing the market rally over the last few days. The S&P500 Index made a low on June 17 and has since bounced almost eight per cent, dragging markets globally up with it. I was personally feeling pleased with my recent additional investment in the Polen Capital Global Small and Mid Cap Fund. But investing is a long-game, we’re in it for years not minutes.
Nevertheless, one of the biggest objections to investing during a crisis – which history has shown to be the best time – is the possibility the market could fall further. And it could.
Equities have rallied off the lows recently thanks to a lower oil price and a retreat in bond yields amid fears of a recession. Recession concerns are dominating the narrative and even the head of the U.S. Federal Reserve, Jerome Powell has admitted the risk. Meanwhile google searches for “recession” have spiked ten-fold and are as high as during the Global Financial Crisis and the onset of the COVID pandemic.
Perhaps counterintuitively, recessions can be good news for equities particularly if prices have already fallen dramatically. That’s because, rather than focusing on the negative pressure on company earnings, investors instead look to the fall in bond yields and the consequent positive effect on present values.
But should we be getting too excited? Have we hit the bottom already? Even though I have recently invested additional capital, I am not certain we have hit the bottom. I can see reasonable arguments to suggest there could be more losses for equities. To be clear of course this would be a positive for anyone who considers themselves a net buyer of shares. The lower the price goes, the higher the subsequent return.
The U.S. Federal Funds futures curve has recently reduced its bet on additional aggressive rate hikes and is even forecasting an easing of interest rates next year. Along with the decline in the oil price and other commodities such as wheat, corn and copper, the reversal of rising bond rates suggests investor sentiment had switched recently from inflation to recession.
Unfortunately, the optimism is due to the U.S. Federal Reserve’s history of backing off rate rises whenever the equity market has fallen between 15 and 20 per cent. It’s known as the “Fed Put.”
It is true that the U.S. Federal Reserve eases aggressively when bear markets in equities precede recessions. However, it is also true that when the Fed has chickened out the circumstances were very different to today.
Since the 1990s, and certainly after the GFC, the primary problem confronting central banks and governments has been pallid organic economic growth and low inflation, and even the intermittent threat of deflation. Understandably, rate cuts make sense.
But prior to the 1990s the Fed’s response differed. In the 1970s for example persistent inflation meant Fed policy was aimed squarely at fighting inflation, with less concern for the impact on economic growth. Back then the Fed raised rates despite already large falls in the stock market and a weakening economy.
I cannot be sure of whether today’s U.S. central bank will be as callous as it was decades back however the reality is inflation has broken out and wage growth is accelerating with unions protesting and striking, risking a dangerous wage-price spiral.
So have we reached the bottom yet? Well, uncertainty about the Fed’s stance is sure to mean more volatility. Until we get a clear read on interest rates, the lows could easily be retested.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
