June is offering no respite for the markets as the S&P 500 is now down 23% YTD, its worst start since 1932. That’s been coupled with an 11% loss in the aggregate bond market as the Fed just jacked interest rates by another 0.75%, the largest increase since 1994. This tough policy stance is now being implemented globally as other central banks like the ECB, the Bank of England and the Swiss National Bank are in tightening mode. Liquidity is being drained from the system and assets are declining accordingly with the riskiest falling the most as noted by crypto. The question for us here at Warcap is whether the decline has been enough to justify investment in various areas.
To answer we need to consider macro policy. The challenge for central banks is that they can’t directly influence various commodities like oil as the Fed holds no barrels on its balance sheet and adjusting interest rates has no effect on supply. Instead, central bank policy can only directly influence demand as higher rates force consumers to make decisions about their spending and how they allocate their resources. Tighter policy gradually causes “demand destruction” as is now evident in many areas like retail sales, home construction and leading commodities like lumber. In short, prices are coming down and there are signs inflation is curbing. But for markets to bottom the Fed must shift its stance and that will only happen when there is a clear sign inflation is under control.
The two largest factors inside CPI are energy and food prices. Over the last two weeks we have seen weaking in the oil markets, which is something we are watching closely. However, the food price index has remained stubbornly high. Once both show consistent signs of easing, we will get more constructive on the markets as the tightening policy will be coming to an end. That said, there are select investments that have stabilized and are attractive at these valuations. We will continue to hold those investments and may increase exposure over time. As always, I appreciate the continued trust and confidence.
Joe Warren
CEO & Founder