This week our long-term volatility indicators flipped green while our short-term and intermediate signals remain in the red. Typically, we would start wading back into the markets at this point in time. With that said, the market is way overbought so a technical pullback is a high probability, therefore being a bit patient at this crossroad is prudent and re-entering at a modest pace is strongly advisable. There is lot of road left in 2022, and we are only in the third round of a 12 round fight so there is no reason to start chasing this market. There are a lot of discounts on high quality merchandise like Salesforce, AMD and Microsoft to name a few, but in looking at the charts we are hitting major resistance, especially on the Nasdaq which is hitting its 200-day moving average.
I want to be crystal clear, I am looking for a buyable selloff over the next month.
There are lots of reasons for the current market turnup, such as it looks like the Russian Oligarch money has been completely sold off, and bonds have gotten slaughtered so bad that stocks are the only option. 20-year Treasuries are now down over -11% YTD and this might just be the beginning. There will be a lot more rate increases this year so bonds could easily continue to burn lower.
For a brief moment on Tuesday, the 10Y/2Y Treasury yield turned negative. Does that mean we should officially start the clock on recession watch? Not quite, but a recession is imminent. Generally, you want to see this spread stay in negative territory for about 5-10 consecutive trading days before being able to say that a recession is coming. Considering that the 10Y/2Y spread was 0.90% less than three months ago and has since dropped to 0% probably means it’s safe to assume that this will enter negative territory in the next few weeks. In other words, it’s time to start planning for a recession.
Does this mean that another drop in equity prices is imminent? Absolutely not. In fact, there’s history to suggest that stocks could keep going up for a while. In the past three yield curve inversions that took place before the tech bubble, the financial crisis and the COVID recession, the S&P 500 posted green in the following year in each case.
Perhaps most interesting is the fact that stocks posted their biggest post-inversion declines only after the 10Y/2Y spread reverted back into positive territory. Of course, with inflation at 8% and the Fed about to aggressively raise interest rates, we have a couple of additional factors to deal with that we haven’t in the past. Risk asset prices could move either way, but there’s a case to be made that equities have another leg higher here before the real bear market risk sets in.
I expect rhetoric around yield curve inversions to increase in the coming weeks as more parts of the curve invert, so I again want to clearly point out two important characteristics of an inversion: First, a 10s-2s inversion is not the sell signal. Historically speaking, stocks rally for about a year after a 10s-2s inversion, and the average return is around 15%.
Remember, the inversion is just the warning. When the curve reverts back into positive territory that is the alarm bell.
So, a curve inversion is not a reason to sell—it’s a signal that the time in the bull market is limited, and that we need to be prepared for the real downturn - and you can count on us to be prepared. Second, many in the financial media are saying "it’s different this time" because of the pandemic, QE, global bond investors, etc. I acknowledge all those influences on the 10 year, but every single time the yield curve has inverted the media has deemed them “different this time,” but none were different. Every single time we had a recession in the next 6-24 months.
And remember – the one fact pertaining to all conditions is that they will change.
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President