We finally saw some green on our screens last week after seven consecutive weeks of declines. The question is, were these the green shoots of new growth or just another head fake from this grinding bear market? The negative sentiment in the market has been substantial as seemingly everywhere we look we see financial pain – with increasing prices on food and fuel, new and used cars, airlines and travel, and continued supply bottlenecks due to war and shipping disruptions. When sentiment gets overwhelmingly negative it eventually becomes exhausting and the selling can quickly dry up. At this point buyers step back in. During a bear market you can see this cycle take place many times before the ultimate bottom. But trying to predict which specific rally is the true beginning of the next bull market and which one is just a head fake is a fool’s errand. As long-term investors we are buyers on the way up and the way down and try to capture the most value along the way. That means rotating from overvalued sectors to undervalued ones rather than outright selling and moving to cash for prolonged periods of time jumping in and out of trades. Too many investors will make the devastating mistake of getting overconfident and trying to become traders during bull markets as everything is going up only to see their trades wiped out during a bear market and then feel the urge to sell not just losing trades but quality holdings as well, for “peace of mind”.
The rally we saw last week was most likely a result of more than just a break from relentless selling. The big metric all traders are focused on is inflation. And last week the Fed’s preferred inflation metric, the Core Personal Consumption Expenditure (PCE), showed signs of easing inflationary pressure. The figure came in at 4.9%, down from 5.2% the previous month. The markets reacted positively to the news since it raises the possibility that the Fed may be able to moderate its rate hikes if inflation continues to come down.
Consider this example on how raising interest rates by the Fed works its way through the economy and decreases spending power and ultimately demand for goods.
Today the median home price is 6.7x higher than median household income. Homes have never been more unaffordable - the Fed is aware and wants to moderate home price inflation. Raising interest rates will accomplish this. Furthermore, the Fed understands this action will moderate inflation more broadly as well. In Jan 2021 the cost of a 30-year mortgage was 2.65%. At that time the average home price was $401,700. Today a 30-year mortgage is 5.25% and the average home price is $570,000. That is a 95% increase in monthly payment from $1,294 to $2,519.
The cost of living in a home (for new buyers) essentially doubled in that time frame. All those extra dollars that would have flown through into the economy to be spent on gadgets, and clothes, and travel and whatever else will now be sucked up by banks rather than chasing goods and services.