There once was a time when the dip
Was what people bought ere the rip
As equity prices
Would brush off all crises
And FAANGs showed incredible zip
 
But this year there is a new theme
That’s more like a nightmare than dream
The end of each session
Sees selling aggression
As bearishness moves to mainstream
 
There has been an evolution in the market narrative recently that is growing in strength.  After a very long period where BTFD (buy the f***ing dip) was the mantra of algorithms and day traders alike, backed up with don’t fight the Fed, it seems that market price action has turned around to sell every rally you see.  While there is not yet an acronym in place (and I’m sure there will be one soon, perhaps AS for Abandon Ship), what has become abundantly clear is that the sentiment that inflated the broad asset bubble in which we have been living is starting to change.
 
Arguably, the Fed is the cause of this change, which is to be expected as it was their monetary policies that inflated the everything bubble in the first place.  Consider that since the GFC, the Fed has increased the size of its balance sheet by $8 trillion, and the US economy has expanded by another $7.3 trillion (already a problem that the balance sheet grew faster than the economy), while the S&P500 has grown by $28.2 trillion, nearly twice as fast again.  It is certainly difficult to continue to justify the valuation premiums attributed to the equity market if there are any concerns about future growth rates.  And there are plenty of concerns about future growth rates, especially if the Fed is true to its word and actually tightens monetary policy.   
 
The upshot is that investors have been paying an increasing premium for the same dollar of earnings during the past 14 years and we appear to be reaching the breaking point.  The key thing to remember about markets is that their behavior in a rally and in a decline tend to be very different.  Rallies are made of steady, albeit sometimes sharp, moves higher with much buying at the end of each session to insure that asset allocators have their proper proportions in various sectors.  Declines are characterized by mayhem, where sellers often seek to sell anything that is liquid and as quickly as possible.  So, in the vernacular, stocks ride the escalator up and fall down the elevator shaft.  And quite frankly, having witnessed some of the biggest market declines in history (Oct 1987 anyone?) price action recently has started to take on those negative characteristics. 
 
Just think, too, this is happening before the Fed has actually even begun to tighten.  In fact, this week, their balance sheet rose to a new record high!  How will things perform when they actually raise rates, let alone start to allow the balance sheet to shrink.  For those of you who disagree with my thesis that any Fed tightening will be small and short-lived, this market reaction function is exactly how I have arrived at my conclusions.
 
Earlier this week I explained that I believe we are at peak Fed hawkishness, where market expectations have moved to the first (of four) rate(s) hike in March (some calling for 50bps) while balance sheet reduction (QT) will start this summer and proceed to the tune of $40-$60 billion per month thereafter.  Arguably, QT will be much more damaging to the equity markets than a 50-basis point rise in Fed funds, but neither will help.  Many analysts believe that next week’s FOMC meeting will result in a clear timetable for the Fed’s future actions, but I disagree.  Between the recent equity decline and the softening data, the Fed will not want to lock itself into a tightening schedule.  As I wrote earlier, look for Wednesday’s meeting to appear dovish compared to current expectations.  However, that is unlikely to help change risk attitudes that much.
 
Risk is off and has further to go.  Yesterday’s US price action was abysmal as equity markets were higher all day until the last hour and then turned around and fell between 1.5%-2.0% to close with sharp losses.  Asia generally followed that line of reasoning with both the Nikkei (-0.9%) and Shanghai (-0.9%) falling although the Hang Seng was unchanged on the day.  In fact, the Hang Seng was the only bright spot around.  Europe is much softer (DAX -1.6%, CAC -1.4%, FTSE 100 -0.9%) with the only data being weaker than expected Retail Sales in the UK (-3.7%, exp -0.6%).  It can be no surprise that US futures are also under pressure, with the NASDAQ (-0.7%) leading the way at this hour, but all in the red.
 
Remember when the bond bears were certain that the 10-year was getting set to trade through 2.0%?  Yeah, me too. Except, that is not what is going on as this morning, the 10-year Treasury has seen yields decline by another 1.6bps, taking it more than 10bps from its recent high yield.  European bonds are rallying as well with Bunds (-3.0bps), OATs (-2.2bps) and Gilts (-2.4bps) all behaving as havens this morning, and even the PIGS’ bonds performing well.  It is abundantly clear that heading into the weekend, the marginal investor does not want to own risky assets.
 
Today’s risk-off theme is alive and well in commodities too with oil (-1.9%) leading the way lower but weakness in precious metals (Au -0.3%, Ag -0.4%) and industrials (Cu -1.8%, Al -0.8%).  The only outlier is NatGas (+2.8%) which based on the 13-degree temperature at my house this morning seems driven by the weather and not risk.
 
Finally, looking at the dollar this morning it is difficult to discern a strong theme.  In the G10, gainers and losers are split 5:5 with the commodity currencies (AUD -0.4%, NZD -0.4%) leading the way lower while the financials (CHF (+0.4%, SEK +0.35%) are rising.  Given commodity price weakness, this should not be that surprising.  As to the financial side, with Treasury yields declining, those suddenly seem more attractive.
 
However, that same thesis does not appear to be valid for the EMG bloc where the leading gainers (ZAR +0.5%, CLP +0.4%, MXN +0.3%) are all commodity focused while the laggards, aside from TRY which has its own meshugas (look it up), are all commodity importers (TWD -0.25%, THB -0.25%, HUF -0.2%).  In other words, it is difficult to tell a coherent story about the FX markets right now although the one thing that is very clear is that volatility across virtually all currencies has been moving higher.  Old correlations seem to be breaking down, which is leading to the increased volatility we are observing.
 
On the data front, only Leading Indicators (exp +0.8%) are due this morning at 10:00.  Yesterday’s US data was kind of awful with Initial and Continuing Claims both printing far higher than forecast (although attributed to omicron’s impacts) while Existing Home Sales also fell far more than expected which was attributed to a lack of inventory.  However, I would contend that the US growth trajectory is definitely pointing lower as evidenced by the Atlanta Fed’s GDPNow Forecast which is currently at 5.14%, down from 9.7% just one month ago. 
 
As we all await next week’s FOMC meeting, the dollar’s cues are likely to continue to come from the equity markets, and given how poor they currently look, if nothing else, I expect the haven currencies to continue to perform reasonably well.
 
Good luck, good weekend and stay safe
Adf