We saw a very volatile market in the past two weeks. This precisely demonstrates the power of narratives versus fundamental analysis. Here is the classic example.
The US government released inflation data that showed consumer prices had surged 8.2% in September on a year-over-year basis. This is pretty bad news because the fight against inflation is nowhere near over. The clear implication of this is that the Fed will continue tightening, most-likely with another 0.75% rate hike on November 2. Rate hikes are not good for stocks. It makes borrowing more expensive for companies and slows down the economy. Stocks, as anticipated fell from a closing level of 29,210 on October 12, the Dow Jones Industrial Average index plunged to 28,709 by 9:40 am on October 13, a 501-point dive, down 1.7% in a matter of minutes. Then the narrative took over and stocks soared. By the close on October 13, the Dow was at 30,038, a 1,329-point gain or 4.6% surge from the lows of the day. But what had changed?
Nothing, but the old saying, “bad news is good news.” took over and the market psychology changed to the Fed tightening expected would kill inflation faster than expected and set the stage for interest rate cuts early next year. Those expected rate cuts would be good for stocks, so it makes sense to buy stocks now! This narrative is nonsense for several reasons. The first is that the Fed has made it clear they have no intention of cutting rates anytime soon. Inflation may come down, but the Fed’s target rate is 2% and the current 8.2% is still a long way away. The second problem is that if the Fed actually did cut rates early next year, it would not be a sign of success but a sign of dismal failure. It would mean that the economy was in a severe recession, which would be awful for stocks. The turnaround in the market was a highly condensed version of the Fed pivot narrative that caused stocks to rally in late July until mid-August. Markets seemed to come to their senses when a sharp decline occurred in response to the rally. There will be no Fed pivot but rather another bear market trap.
Sven Franssen