Dow Drops 1,000 Points On Powell's Hawkish Talk

(Friday Market Close) Federal Reserve Chairman Jerome Powell opened the day at the Fed’s Jackson Hole Economic Symposium with a speech that reiterated the Fed’s commitment to attacking inflation even if it causes the economy to slow and unemployment to rise. He expressed the concern that inflation would become stuck in consumers’ minds and cause it to be entrenched.

The comments shored up the fed funds future odds of a 75-basis-point hike in September to above 60%.

Stocks started selling off during the speech but bounced back soon after, and for a minute, it looked like the week-long buildup to the speech was a nonevent. The Michigan Consumer Sentiment report revealed that falling gas prices throughout July helped boost consumers’ outlooks on inflation. What appeared to be good news when compared to Mr. Powell’s comments resulted in stocks plunging.

In fact, before Mr. Powell even spoke, the Fed’s favored inflation report, the PCE price index, was released and showed that July’s core inflation numbers were good—coming in lower than expected at 0.1% month over month (MOM) instead of the projected 0.3%. Year-over-year (YOY) core inflation was 4.6%, which was below the expected 4.7%. Headline inflation was 6.3% for the previous 12 months, but inflation actually fell 0.01%- from June to July.

However, judging from Powell’s comments, slowing inflation or disinflation, in one month isn’t going to be enough to let up on rate hikes.

The bond market’s reaction was much calmer than stocks. The 2-year Treasury yield and the 10-year Treasury yield (TNX) both rose one basis point.

However, fear seemed to get the better of stock investors, and the Cboe Market Volatility Index (VIX) spiked back above 25 and above its June lows.

Stocks continued to fall throughout the day with the Dow Jones Industrial Average ($DJI) plunging more than 1,000 points to close 3.03% lower on the day. The Nasdaq (COMP) recorded the biggest loss, just shy of 4% on the day. The S&P 500 (SPX) tumbled 3.37%.

The sell-off was broad with technology and consumer discretionary leading every sector into the red. Additionally, the small-cap Russell 2000 (RUT) plummeted 3.3% and the NYSE decliners outpaced advancers nearly 9-to-1. 

CHART OF THE DAY: INTEREST IN TECH. The Technology Select Sector Index ($IXT—candlesticks) and 10-year Treasury yield (TNX—pink) were uptrending at the same time from September 2020 to February 2021 when the 10-year yield hit 1.5% (pink horizontal line). Since that time, the two securities have moved in basically opposite directions. Rising yields caused investors to rethink the way they look at technology stocks, which led to changes in stock valuations. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Finding Value

According to Yardeni Research, the valuations of most sectors have improved during 2022 when evaluated by their 12-month forward price-to-earnings (P/E) ratios. Some exceptions include defensive sectors that include consumer staples, utilities, and health care. These sectors have forward P/E ratios similar to their 2021 numbers.

The blended forward P/E ratio for the S&P 500 is 18.2. Here are the forward P/E ratios by sector as of August 23:

• Communication services: 16.5
• Consumer discretionary: 27.3
• Consumer staples: 21.5
• Energy: 8.36
• Financials: 12.8
• Health care: 16.4
• Industrials: 18.1
• Materials: 14.3
• Technology: 23.2
• Utilities: 16.5

If yields continue to rise, valuation will likely get increasingly better for most sectors but only because stock prices are falling. If the economy gets worse and business slows, the earnings side of each sector could be jeopardy, which would likely drive stocks lower still, but valuations probably won’t improve.

Notable Calendar Items

Aug. 29: Dallas Federal Reserve Manufacturing Index

Aug 30: CB Consumer Confidence, JOLTs Job Openings, and earnings from Crowdstrike CRWD, Hewlett Packard HPE, Chewy CHWY, Best Buy BBY, and Big Lots BIG

Aug 31: Earnings from Polestar Automotive PSNY, Trip.com TCOM, Cooper COO, and Five Below FIVE

Sep 1: ADP Nonfarm Employment, ISM Manufacturing PMI, and earnings from Broadcom AVGO, Lululemon LULU, Hormel Foods HRL, Campbell Soup CPB, and Toro TTC

Sep 2: Employment Situation Report and earnings from DocuSign DOCU

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