Expected Correction(s)

• Stocks in the US finished mixed on Tuesday, as investors reacted to another batch of corporate quarterly results and Fed Chair Powell's comments.

• The S&P 500 and the Nasdaq lost 0.2% and 0.1% respectively, while the Dow Jones gained 63 points, supported by upbeat results from UnitedHealth.

• In earnings news, UnitedHealth surged 5.2% after beating estimates for both earnings and revenue.

• Morgan Stanley rose 2.5% on upbeat results.

• Conversely, Bank of New York Mellon lost 2% following a 5% increase in profits.

Jerome Powell made some prepared comments at a "fireside chat" with the head of the Bank of Canada.

He called the economy "quite strong." He called the labor market "very strong." And he said the recent inflation data has "clearly not given us confidence" that it's sustainably moving toward their 2% target. And with that he says it's "likely to take longer than expected to achieve that confidence."

So, Jerome Powell intentionally dialled down expectations on rate cuts.

Let's take a look at the evolution of the market expectations on the rate path since October of last year, when Powell signalled the end of the tightening cycle. The market had priced in six rate cuts by the end of 2024 (with a chance of seven) (chart below), now it's pricing in just one cut by year end.

That expectation change is effectively tightening policy.

Add to that, we've talked about the correction that's underway in stocks. Declining stocks will also contribute to the tightening of financial conditions.

The chart below shows where stocks were trading when rate cut expectations were at peak (i.e. expectations of greater than six cuts for the year). That was early January.

That's 9.4% away from the April 1st peak in S&P futures. The peak-to-trough drawdown at the moment is 4.8%.

Given the adjustment in rate expectations, and the headline risk with Israel/Iran, it's fair to expect a deeper correction for stocks. In fact, based on historical performance of the S&P 500 we should expect intra-year corrections, on average, of better than 10%. The chart below shows the number of 10% pullbacks per year since 1980 - even in the late 90s boom for stocks, there was a greater than 10% correction in four of the five years that all finished UP, big).

PS: If you aren't yet a member, join us - where I’ll be discussing the recent divergence between the MOVE and VIX indicies, and how it affects our Model Portfolio.