Stock Market This Week: Five Themes to Watch

If there ever was a reminder for investors to focus on the fundamentals, the events that recently transpired in the equities market – particularly for the Friday session – provided a necessary reminder that near-term positive momentum can fade rather quickly. Until the underlying vulnerabilities of the economy are addressed, stocks are potentially liable for continued volatility.

Indeed, discouraging economic data provided the catalyst for Friday’s severe selloff, with the benchmark S&P 500 shedding nearly 3% on the session. On a year-to-date basis, the index is down almost 19%, worryingly close to the 20%-down metric that represents the unofficial standard for a bear-market correction. Over the trailing month, the S&P is down roughly 1%, thus erasing the recent work of the bulls.

Particularly troubling is that at its current level of 3,901 points, the index may have further to fall. Eventually, the bulls may lose their nerve since core metrics such as inflation are moving in the wrong direction for equities. Additionally, brewing geopolitical tensions across the world suggest that investors may become more defensive in their posture.

Given the shifting dynamics, here are some of the key themes to consider in the week ahead.

Painful Inflation Figure

As alluded to above, one of the biggest negative catalysts for the softening of the equities sector was inflation. According to the latest disclosure of the consumer price index (CPI), the inflation rate increased to 8.6% on a year-over-year basis in May, which is up from 8.3% in April. The consensus forecast among economists was 8%.

Naturally, this unexpectedly pessimistic reading sent shockwaves to the stock market because of its implications on real corporate revenue and earnings growth. On one hand, inflation tends to raise the price of in-demand goods and assets, which is why gold has long been a safe haven. However, escalating costs hurt the consumer economy, causing collective belt-tightening.

Since consumer spending contributes approximately 70% to the U.S. GDP, any loss in this arena will be pronounced. And that means companies will be looking to reduce overhead costs, which invariably translates to layoffs – a circumstance we’re already witnessing. Of course, reduced employment levels cuts into consumer spending, sending stocks into a spiral until the economic growth engine stabilizes.

Fed in a Quandary

While it’s convenient to blame inflation on present societal and political factors, the reality is that the expansion of the money supply played a major role in rising prices. After all, the money to support the nearly $5 trillion stimulus package that both Democrats and Republicans agreed on had to come from somewhere.

By logical deduction, the Federal Reserve simply needs to continue raising borrowing costs and reducing the size of its balance sheet to address the situation. That way, fewer units of currency are chasing after limited goods. Though this might be the answer in the classroom, in practice, it’s not so simple.

Beyond the argument that raising benchmark interest rates may cause a recession, the economy fundamentally might not be in a position to absorb an aggressively hawkish monetary policy. Because if the economy were truly healthy, you would expect the velocity of money stock – or the circulation rate of each unit of currency – to rise. Instead, money velocity has dipped to historic lows.

Therefore, excessive tampering might not cause a recession but rather a depression.

Water Wars

At the moment, the world’s attention is focused on Russia’s invasion of Ukraine, arguably for good reason. The modern global order is founded on the respect of rules and sovereignty. Should military might instead be the primary instrument for international relations, then any effort for diplomacy is rendered moot.

Interestingly, while the U.S. and western powers support Ukraine through shipments of weaponry and financial packages, they refuse to put boots on the ground to avoid a wider conflagration. However, steps taken to avoid a direct confrontation between the U.S. and Russia may be naïve as eastern Europe is not the only hotspot in the world.

As Haaretz reported, tensions are brewing in the Middle East, particularly between Iraq and Iran over water rights tied to the Tigris river. Due to the ravages of climate change, some scientists expect the Tigris and Euphrates to dry up by the year 2040. Understandably, this dire forecast has many nations competing for precious water resources.

The problem is Russia-backed Iran also has rivalries with Turkey, a NATO member, over water access issues. Therefore, a clash between the west and Russia almost seems inevitable, suggesting that it’s better for democratic coalitions to deal with Moscow decisively while it’s in a weakened state.

Struggling Cryptos

Though much talk is disseminated about the eventual disassociation between global equity markets and the cryptocurrency sector, so far, bearishness in the former has eventually translated to negativity in the latter. Last week was no different with the total market capitalization of all cryptos slipping below the critical $1.2 trillion mark.

Indeed, during the early hours of the Sunday session, cryptos plunged badly, with the price action boding poorly for many individual coins and tokens. At this rate, unless a robustly positive spark enters the frame, the market cap for digital assets could be at risking of falling below $1 trillion. That would almost certainly spell a bear market cycle for virtual currencies.

Although the segment passionately attracts free thinkers, the greater issue is that the retail investor community might not want to tie their wealth into a speculative, non-productive asset class. In that case, cash may present a more attractive alternative.

Earnings in Focus

While the heart of earnings season is behind us, there are still a few important financial disclosures that investors should pay attention to. First up on Monday is Oracle (ORCL). Specializing in business software applications, Oracle is instrumental in helping products move around the world. However, with recession fears mounting, Oracle’s enterprise-level clients might switch over to cheaper alternatives.

On Tuesday, RF Industries (RFIL) will release its earnings report. Not a household name, RF Industries is nevertheless critical to our digitalized economy as it manufactures interconnect products for the data communications and telecom industries, among others. Thus, RF’s disclosure could provide insights into the impact of the current global supply chain picture.

Finally, Kroger (KR) reports on Thursday. A grocery store giant, Kroger’s earnings report may provide a rubber-meets-the-road assessment of consumer economic health. For instance, if people are conspicuously skimping on groceries to mitigate inflation, the economy could be a lot worse than previously advertised.