Market conditions are changing faster than they ever have in history. All of our Risk-LINE signals flipped red last week. This is the strongest volatility consensus we've seen in our signals since the Fed announced it was ready to commence its quantitative tightening program at the end of last year. Utilities, along with other defensive sectors are significantly outperforming the S&P 500. Lumber prices are plummeting. The recent drop in large-cap stocks has pushed the S&P 500 below its 200-day moving average.
In the past when we’ve seen multiple signals flip red, it’s an indication of increased volatility and a caution flag that stocks could be positioned to pull back. When we see all of our signals flip red as we are right now, that tends to be an outright warning.
One of the biggest red flags for me is producer price inflation. It's currently around 11%, and you can bet that businesses will attempt everything they can to pass those expenses on to consumers. This could result in an additional short-term inflationary pulse, exacerbating the longer-term deflationary crash. I don't believe now is the time to take unnecessary risks.
Under the surface there is the chance the earnings headlines turn more positive in the coming weeks, especially if earnings season is better than expected (the next three weeks will be the peak for earnings season).
But while we continue to think there’s the chance for a rally back towards 4,600, we also continue to expect that resistance to hold because the bottom line is that the market is still facing unprecedented Fed tightening
We remain in a cautious poster because I think the real drama for this market hasn't even started yet.
Which is the reason for this morning's write-up.
One of the most important lessons I've learned from studying markets is that real-life experiences, both positive and negative, may help us identify risks and possibilities in the economy and market.
This weekend, when I was attempting to explain to some friends why I was concerned about the US economy and markets, not right now or in the coming weeks, but in the coming months and quarters, I was reminded of that. I was trying to emphasize that, while everyone knows the Fed is raising rates and tightening monetary policy, we haven't yet felt the effects of these moves—and we shouldn't be lulled into a sense of security.
To better explain this situation, I went back to a difficult time when my friend's mother was diagnosed with cancer years ago. Surprisingly, the event served as a clear comparison for why I am concerned about the economy in the next months.
Before I begin that comparison, I am in no way equating the tragedy of cancer with economic matters. People are more important than money, and I've seen the devastation and misery that cancer can bring to a family.
His mother was diagnosed with breast cancer in the mid-2010s. Her diagnosis came as a shock because she was fit and active. Nothing appeared to be wrong as far as anyone could tell. But there was obviously something wrong.
Specifically, when the cancer was discovered, we all emotionally prepared ourselves for what was to follow. It was as if we were expecting things to go wrong at that moment. But it wasn't all horrible at first. His mother was unconcerned. She had to attend multiple follow-up appointments, which disrupted her schedule, and obviously there was stress about the future, but life generally carried on as normal while her doctors devised a treatment plan.
We were all nervous as we went through that process, but life was essentially normal—just talking about what was to come and dealing with the physicians, etc. My friend would occasionally remark that it wasn't so bad, and that he was making the best of it.
Then started the chemo.
Chemotherapy is a necessary evil in the battle against cancer, but what devastation it can cause! We entered into the chemo stage of the treatment naïve in many ways. Yes, we'd heard it was horrible, but his mother was a New Yorker, and she was a tough cookie!
It was a nightmare for her and her family, and while the chemo eventually worked and his mother was cancer-free, those months were a nightmare for everyone.
When it comes to the economy, it's been infected with a form of cancer known as inflation. It will erode savings, make the poor even poorer, lower corporate earnings, increase unemployment, and slow consumer spending if left unchecked. Inflation, if left unchecked, will bring an economic expansion to a screaming halt.
Inflation, like cancer, is mostly ignored at first. But it has been diagnosed by the Fed and monetary officials, and the Fed has been formulating its treatment plan for the past several months. While the Fed has been formulating its treatment plan, there’s anxiety about what will be done: Rate hikes, QT, etc. However, life is continuing generally as normal, and it’s not that bad right now.
However, the financial chemo hasn't started.
Just like real chemo was a necessary evil to my friend's mother of cancer, “financial chemo” (rate hikes and QT) is a necessary evil to rid the economy of inflation. But the economy hasn't begun treatment yet, and just as his family was surprised by how difficult those chemo treatments were, not only for his mother but for all of us, I'm concerned that the economy isn't prepared for how difficult this financial chemo will be for the American consumer and the economy. The problem has been identified, and a treatment plan has been drafted, but the real work has yet to begin.
That is why I am concerned about the economy's future. The impact of all this Fed tightening and QT has yet to be priced in by the market. Hopefully, my concerns are overblown. But I'm concerned that they aren't, and while I still believe stocks could rally in the short term if we get some good news on inflation (peaking), earnings (solid), or geopolitics (Russia/Ukraine cease-fire), we must proceed with caution because the financial chemo to cure the economy of inflation hasn't even begun.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President