The guest commentary below was written by Joseph Y. Calhoun, III of Alhambra Investments on 8/28/22. This piece does not necessarily reflect the opinions of Hedgeye.

Market Insights | The Dog That Didn’t Bark - chasingdog  1

Gregory (Scotland Yard detective): “Is there any other point to which you would wish to draw my attention?”

Sherlock Holmes: “To the curious incident of the dog in the night-time.”

Gregory: “The dog did nothing in the night-time.”

Sherlock Holmes: “That was the curious incident.”

- From Silver Blaze by Arthur Conan Doyle, 1892

It is hard to determine sometimes what causes markets to move as they do. Take last Friday’s stock market selloff. The widely cited “reason” for the selloff was Jerome Powell’s speech at the Fed’s Jackson Hole Symposium.

Frankly, I don’t think Powell said anything new, his message remarkably similar to his last post-FOMC press conference. But two passages drew attention as being sufficiently different to upset the market. First was this bit, where the keyword was supposedly “pain”:

Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

Again, I don’t find any of that surprising. Anyone who thought the Fed was going to kill inflation without some impact on the real economy is not living in the real world. Now, we could have a long discussion here about how growth doesn’t cause inflation but that probably isn’t the most efficient use of our time.

Suffice it to say that higher interest rates – and more importantly the reaction to those higher rates – will have an impact on growth and the labor market. The right question isn’t whether there will be some pain, but rather how much?

The second part that drew attention was this reference to the timeline:

That brings me to the third lesson, which is that we must keep at it until the job is done.

It was these two lines, according to most of the market commentators out there, that pushed the S&P 500 down 3.4% on Friday. As you might guess by now, I disagree. Vehemently.

There was something significant in this speech but it had nothing to do with Powell’s vow of higher rates for longer (I guess “lower for longer” has been retired). The most significant paragraph was this one:

We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent. At our most recent meeting in July, the FOMC raised the target range for the federal funds rate to 2.25 to 2.5 percent, which is in the Summary of Economic Projection’s (SEP) range of estimates of where the federal funds rate is projected to settle in the longer run. In current circumstances, with inflation running far above 2 percent and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause.

Remember after the last post-FOMC press conference when Mohamed El-Erian and a bunch of other Fed watchers said Powell must have misspoken when he referred to the current level of rates as “neutral”? I don’t remember if it was El-Erian but someone even characterized Powell’s neutral statement as embarrassing.

Well, if you didn’t hear him the first time, he just told you, in that paragraph above, that he didn’t misspeak, that the current policy rate is indeed what he believes to be neutral. So, when he says that the policy rate needs to rise above neutral all he’s saying is that it needs to rise from here. Based on listening to every Fed talking head all week at Jackson Hole, the consensus seems to be that rates need to rise to 3.5 – 3.75%.

That is exactly what the market is expecting by the way. We can see that through a variety of futures markets including SOFR (secured overnight financing rate; the replacement for LIBOR), Eurodollars, and Fed funds themselves.

A model developed by the Atlanta Fed that uses Eurodollar futures options and SOFR swap spreads has Fed Funds peaking in March of 2023 at 3.76%. And that didn’t change before, during, or after Powell’s speech. SOFR and Eurodollar futures were basically unchanged on Friday.

By the way, another indication that the market was already expecting the “higher for longer” narrative is that the peak and subsequent inversion of SOFR and Eurodollar futures has been moving further out the calendar recently. 6 weeks ago both expected rates to peak between January and March of 2023. After the last FOMC meeting, the date of peak rates has been moving out and is now expected between March and June of 2023.

And the difference between March and June is down to just about 5 basis points so if it keeps moving it will soon be moved out to between June and September. To simplify that, even if we assume that recession starts coincident with rates peaking, it is now a Q2 2023 event. That, in my opinion, is why stocks have been rising lately – the market no longer believes recession is imminent.

In fact, no matter where you look in the rates complex, Powell’s speech was a giant nothing. And so the question in my mind is, if the speech didn’t impact the bond and money markets did it really drive the DJIA down 1000 points? Well, there were other things going on Friday so let’s look somewhere else for an explanation.

The stock selloff in the morning may have been about Powell’s speech but there were two major new stories Friday that may have had a bigger impact. The first was this story by Politico that posted in the early afternoon:

Apple faces growing likelihood of DOJ antitrust suit

An antitrust lawsuit against Apple would be a dramatic escalation in the administration’s battle against the tech giants.

Politico, Friday August 26, 2022, 1:11 PM

The second news story was this one that came out around 3PM:

3M Can’t Use Bankruptcy to Halt Lawsuits Over Combat Earplugs, Judge Rules

  • 3M Ruling Disrupts Company Strategy for Ending Soldiers Suits
  • Unless Ruling is Overturned, 3M Faces 230,000 Jury Trials

Bloomberg, August 26, 2022, 3:00 PM

Both of those articles were unexpected and could have a large impact on corporate America. In the case of Apple, those of us old enough to remember can’t help but think back to the government’s pursuit of Microsoft in similar fashion at the turn of the century. The current administration is not exactly business-friendly but in this case, the backlash against big tech is bipartisan. The outcome could be a big deal for Apple’s bottom line and more importantly, could be a distraction for years to come.

The 3M news was also a bit of a shock. I think most people thought – after the ruling in the similar Johnson & Johnson baby powder case – that 3M’s liability would be confined to the subsidiary.

So, now we have two judges in two different districts basically coming to polar opposite conclusions. It isn’t coincidence that J&J’s stock went straight down with 3M in the afternoon.

I think the potential impact on the markets from these cases is much greater than anything Jerome Powell said or might say or do. I can’t say for sure that it is why stocks sold off so hard Friday afternoon but it is a much more satisfying answer than Powell’s speech.

Don’t assume that the reasons for a market event are really what you see in the headlines. It is impossible on most days to figure out what caused investors to buy or sell. And more often than not, like the Sherlock Holmes story about the dog that didn’t bark, the answer to the mystery of why the market moved today is not the most obvious one.

Sometimes the thing no one talked about is more important than the thing they talked about all day.


Joe Calhoun is the President of Alhambra Investments, an SEC-registered Investment Advisory firm doing business since 2006. Joe developed Alhambra's unique all-weather, multiple asset class portfolios. This piece does not necessarily reflect the opinions of Hedgeye.