This is a big problem for the investment community. During a stock market sell-off, bonds are usually the safe haven in the storm. However, during this selloff, all sectors of the S&P 500 are down with the exception of the energy sector. Normally, one would not assume that energy is the safest place to park one's money. In foreign exchange, the yen has collapsed as a haven, the dollar is king and now threatens parity with the euro. Runaway inflation, growth fears, and a Fed that wants to raise interest rates and curb inflation regardless of the damage to the global economy means that the dollar liquidity we have become accustomed to is no longer there. The question now is when will this sell-off end.

Does technical analysis matter at all anymore? Over the last 20+ years, with a little luck and the support of central banks, we could predict where markets would fall in a given sell-off. Let's take a look at the financial crisis or the global pandemic: 

When these major events pulled the rug out from under stock market bulls around the world, markets tended to sell off quickly before being calmed down by a support from major central banks led by the Federal Reserve. But the last two months have been epochal. First, stocks and bonds have fallen side-by-side for the first time in decades, and U.S. and global markets are in the midst of the longest sell-off in years. The S&P 500 is down 19%, just above bear market (downtrend) levels. Major technology companies have fared even worse: The Nasdaq is down more than 25% so far in 2022. Bonds have also suffered. The yield on 10-year Treasury bonds, while down slightly, is still at 2.78%, down from 1.75% six weeks ago.

We have already mentioned that technical analysis no longer seems to have any significance at the moment, and that it is important to look at fundamental analysis instead. We believe that the financial markets will not calm down until there is an inflation buffer. Either inflation has to come down, or the market has to be confident that equity market sectors can withstand high inflation. Even positive earnings data has not helped the markets. To date, 95% of the companies in the S&P 500 have reported their first quarter earnings. Of that 95%, 75% of the companies have reported earnings that were above their EPS estimate. However, the companies that have reported earnings above their EPS estimate have, on average, experienced a negative price reaction. If this trend continues, it would be the largest average negative price reaction to positive EPS surprises since Q2 2011. For the 25% of companies that reported negative EPS surprises, the negative price reaction was much stronger than average.

The reason for this Q1 earnings season reaction is twofold. First, companies are beating their EPS estimates by a narrower margin than in recent quarters. In Q1 2022, companies beat EPS estimates by an average of 4.7%, below the 5-year average of 8.9%. In addition, companies and analysts have become more pessimistic in their forecasts for the rest of the year. 70% of the 88 S&P 500 companies that have issued forecasts have issued negative forecasts. Analysts have also lowered their Q2 2022 EPS estimates by an average of 1%. This is only the second time in 8 quarters that analysts have lowered their overall EPS estimates. So the market sell-off may be driven by future earnings expectations rather than what happened in Q1.

This gloomy backdrop suggests that further selling is possible. However, the sell-off could be halted if second quarter earnings beat estimates and prove analysts wrong. We will have to wait until early July to get that information. For now, we are waiting for some key fundamental reports to provide guidance on the future direction of the markets. Unfortunately for the bulls among us, the path of least resistance is still the way down, and we don't think this week's economic data will change market sentiment. This means that the sell-off in equities could continue, albeit at a slower pace than the last three to four weeks. The key this week will be whether bond yields respond to the wave of negative economic data we expect in the coming days. If the yield on 10-year U.S. bonds continues to fall on economic fears, can stocks find their bottom? This question is why we will be watching bond markets closely this week.

1. Federal Reserve Minutes: 

The Federal Reserve raised rates at its early May meeting, and according to the CME's FedWatch tool, the market is pricing in a greater than 90% probability of two rate hikes of 50 basis points each at the June and July meetings, which would take the Fed Funds rate to 1.75% to 2% by mid-summer. While we believe these minutes will put to rest the prospect of a 75 basis point rate hike at a single meeting, we do not believe they will change expectations for rate hikes over the next two months. Instead, the market will look for reasons why the Fed is taking a softer path in reducing its balance sheet. The Fed will reduce it by $47.5 billion starting in June and increase it to $95 billion starting in September? Why not reduce a larger amount in June? Could the Fed be taking things slowly because it is concerned about the outlook for economic growth? If so, this could reassure markets because it would suggest that the Fed could use the balance sheet reduction to reassure markets in the coming months.

2nd US GDP Q1: 

This is the second reading of first quarter GDP, which we would not normally look at so closely, but this report is worth watching. The first reading showed a 1.4% drop in GDP, and the market expects that figure to be revised down slightly to -1.3%. The GDP price index is expected to remain unchanged at 8%. The reason we are watching this reading is that the market still expects US growth to remain in positive territory this year, mainly due to a robust consumer. So, if there are any negative surprises in foreign trade or inventories, it could be more difficult for U.S. growth to pick up later in the year and make up for the weakness in the first quarter. Any sign that the U.S. economy is even weaker than the initial GDP result could weigh on stock prices and send the dollar higher.

3rd Flash PMIs for May: 

The preliminary S&P Global PMI estimates for May for Europe, the United Kingdom and the United States will be released on Tuesday. Although manufacturing and services PMI readings are expected to weaken in all regions, they are all expected to remain solidly above the 50 mark. That doesn't make sense: growth is weakening rapidly around the world, and first-quarter corporate results point to a weaker second quarter. Thus, PMI data become meaningless when it comes to predicting how global growth will develop. Will rising inflation finally weigh on these indices this month? If so, markets could get nervous, as this would be another piece of the bear market puzzle that would paint a bleak picture for the economic outlook.