Dragons Must Never Be Underestimated

The savage winds, rain and storm surge of Hurricane Ian have finally left Florida, but the hurricane is not done doing damage.

I have friends in the Carolinas who are bracing for impact this weekend, and though these friends are some of the toughest ex-military operatives on the planet, Mother Nature is a dragon never to be underestimated. In times like these, when our fellow Americans are hurting from a natural disaster, it’s nice to have the financial means to help out a bit.

If you can do this, then I encourage taking this action. Here are a few ways you can do just that.

Of course, financially, this year has seen a pernicious storm, and this week markets showed us again that bear market headwinds also are a dragon never to be underestimated.

Stocks in the S&P 500 are on pace for a weekly loss of about 1.5%, and that is despite the big rebound day on Wednesday that lifted the broad measure of the domestic market nearly 2%. For the month, the S&P 500 is set to close down nearly 10%, and for the quarter we are on pace for a decline of nearly 5%.

So, why have stocks been so unloved of late?

To answer this question properly, I am going to borrow some of the commentary I sent out this morning in my Eagle Eye Opener, which if you don’t subscribe to yet, why not?

Here is what my “secret market insider” and I wrote about the headwinds facing this market as we enter the fourth quarter.

The S&P 500 fell to fresh year-to-date (YTD) lows on Thursday. The honest answer to “why” is simply because the headwinds facing stocks are becoming overwhelming.

Stocks were already facing significant headwinds from 1) A more-hawkish-than-expected Fed and 2) Sticky inflation, two headwinds that have been with us throughout most of 2022, but that got incrementally worse over the past month. However, even with that deterioration, there were some hints of positive movement in both. Plus, the S&P 500 was “hanging on” in the high 3,000 range (between 3,700-3,900).

But while the S&P 500 was fighting through both those headwinds, it was not ready for the surprise United Kingdom monetary and fiscal shambles that has been unleashed on the global markets by the Truss government and the ensuing Bank of England reaction. That event, which is totally self-inflicted, has had both a concrete negative impact on markets and an abstract one. The direct impact on markets has been the spike in bond yields, which is leading to lower equity prices via multiple declines (as yields rise, multiples drop, it’s simple math).

The abstract impact is to further shake the market’s confidence in the institutions that are supposed to ensure orderly markets and stable economies. It is not an exaggeration to say this entire mess is one continuous policy error.

Too much global stimulus contributed to spiking inflation. Too stringent lockdowns in China and other countries (i.e., EU) contributed to supply chain collapses. Too much unemployment compensation contributed to a tight labor market. Too easy monetary policy contributed to even more inflation.

Now, dramatic rate hikes and fiscal tightening may cause a recession. And, the United Kingdom, a country that is steeped in economic history, has a government that is enacting massive stimulus in the midst of massive inflation — and while the central bank is aggressively hiking interest rates! The central bank, in turn, now must add to bond holdings while simultaneously reducing bond holdings, and in about six weeks unleash a massive interest rate increase to offset the fiscal stimulus from the Truss government. Simply put, the market already had a confidence problem in the people in charge, and this is making things worse.

Finally, as if all this wasn’t enough, Russian President Vladimir Putin upped the stakes in the Russia/Ukraine war. He will soon officially annex parts of Ukraine (that his army can barely hold), which is the geopolitical equivalent of drawing a line around something and declaring it “mine!” The United States and its allies will, obviously, not put up with this and we should all expect over the next several weeks to see the biggest escalation in nuclear threats between the United States and Russia since the Cuban missile crisis, as Putin has said any attack on his Ukrainian land grab could be defended with nuclear weapons.

Put simply, it’s all too much for stocks at the moment, and that’s why markets are hitting fresh lows. And they will likely continue to hit fresh lows as long as global governments and critical economic institutions continue to enact plans that erode confidence and threaten the world order.

Positively, there is a way out for stocks, and it’s not particularly unrealistic.

Inflation recedes (which it will do), the Fed signals a pause (which it will do), a Russia/Ukraine ceasefire occurs (which will happen at some point, even if it’s a Korean War-type solution where the war never actually ends and there’s a demilitarized zone).

Then, China realizes that an economic collapse is worse than COVID-19 and the United Kingdom accepts the reality that one can’t solve a problem partially caused by too much money via throwing more money at it.

These things can happen, and they can happen fast. When they do, stocks will stage a massive, legitimate, well-rounded rebound — so be prepared to ride that dragon higher.