The S&P 500 experienced its second Lévy flight event of 2022, as investors suddenly shifted their forward-looking attention away from the near-term quarter of 2022-Q2 to instead focus on more distant future quarters.
Precisely which quarter that is has yet to be determined, but here's how it looks on the latest update to the dividend futures-based model's alternative futures spaghetti forecast chart, where the magnitude of the shift spans the redzone forecast, going from its lowest limit to its highest at this point of time.
(Click on image to enlarge)
The redzone forecast range identifies where the model would place the level of the S&P 500 after adjusting for the echo effect of the past volatility of historic stock prices, which provide the base reference points from which its projections of the potential futures for the index are made. It is also based on the assumption that investors would fix their focus on the upcoming future quarter of 2022-Q2 through the period it is shown. Stock prices moving outside that range would simply confirm that assumption from six weeks ago no longer holds.
Whenever investors reset how far they are looking into the future, we recognize that stock prices are undergoing a Lévy flight event. These events can be a significant contributor to the outsized changes that occur periodically in stock prices. Since investors have different expectations for the pace of dividend growth that will be realized at different points of time in the future, those differences create the different trajectories shown in the alternative futures chart with each shown trajectory associated with the expectations that apply at specific points of time in the future. How much stock prices change in in a Lévy flight event depends upon how different the expectations for dividends are at the point of time they had been focusing upon and the point of time to which they turn their attention.
2022's second Lévy flight event was triggered by the Federal Reserve's release of its latest "dot plot" communicating the Fed's minions' new expectations for how they will set the Federal Funds Rate over the next year. ZeroHedge describes how that new information impacts how far forward investors are looking in time (the following excerpt omits ZH's charts):
After some early volatility, when stocks moved with every fake news headline either out of the FT, Ukraine or Russia, traders put World War III on the backburner to read the FOMC statement and listen to Powell. Initially there were no surprises when the Fed announce a 25bps rate hike, just as expected, a move which is woefully behind the curve as the last time CPI was 7.9%, the Fed funds was 13%...
... but the Fed also boosted its dots so high it effectively confirmed what the market had been saying all along: the Fed now expects 6 more rate hikes in 2022, or one rate hike at every meeting!
Hilariously, seven hikes is precisely what the market had been saying all along. However, once the Fed confirmed that the market was right, guess what happened? Rate hike odds tumbled.
Why? Because with even the Fed now forecasting a big slowdown to growth coupled with a surge in inflation...
... the most likely outcome now is stagflation. This immediately manifested itself in a plunge in 30Y yields...
... as the entire yield curve pancaked...
... culminating with the 5s10s inverting, a clear sign that a recession - the same recession which the Fed hopes to induce to crush commodity demand - is now coming.
And while the 2s10s curve still has about 20bps before it too inverts and begins the countdown to the next recession...
... one look at the 3Y1Y - 1Y1Y OIS fwd shows that markets are now pricing in almost two rate cuts in the next 3 years...
... confirming that the Fed, which was trapped long before today's rate hike, will be forced to ease and/or resume QE in the not too distant future even as inflation continues to rage. Translation: policy error.
That's why we say we don't yet know to which future quarter they've shifted their attention. The anticipated timing of when the Fed might be forced to reverse its rate hike plans will be a recurring point of interest.
Dividend futures were stable throughout the week, where they have not yet begun changing with the anticipation of recessionary conditions. Since they would be expected to erode as such conditions develop, the higher trajectories associated with more distant future quarters in the alternative futures chart are unlikely to be sustained in the event of an earnings recession or full-fledged economic recession.
Regardless, another metric for investors to follow will be dividend cut annoucements, which also have the potential to re-shift how far investors are looking into the future when they are made in addition to directly changing the expectations for dividend growth. We could be in for a period of heightened volatility in stock prices as all these dynamics play out.
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