Bonds Are Getting Killed, Conditions Have Changed
The farmers say ... “What does Wall Street know about farming?” Wall Street knows more than all the farmers put together ever knew, with all that the farmers have forgotten. It employs the ablest of the farmers, and its experts are better even than those of our admirable and little appreciated Department of Agriculture, whose publications Wall Street reads even if the farmer neglects them.
- William P. Hamilton, 1925
Fourth editor of the Wall Street Journal
Proponent of Dow Theory
We're buying into pullbacks since our long-term volatility indicators remain green. The market is in a narrow trading band, and the current pullback is a typical reset after the run higher last week. We believe the odds of the year's bottom being recorded in February are strong, but volatility will be the norm for the next few months. We're still sitting on a lot of cash and will be deploying it slowly. There doesn't appear to be a compelling reason to hurry back in, so buy on pullbacks and be deliberate about it.
It is worth noting why we are still being cautious. The trend in the S&P 500 shifted from bullish to neutral in January when a long-standing uptrend line was materially violated (blue line on chart below). Since then, the combination of new multi-month lows (below the October lows) and historically bearish technical patterns are raising concerns that a more pronounced pullback may be looming. Any new YTD lows would mean a confirmation of a new bearish price trend. Bottom line, stocks are once again overvalued according to our fundamentally based Market Expectations Table and bouts of volatility remain likely given the multitude of uncertainties in the markets.
The key level to watch on the charts going forward remains the 2022 low close of 4,171 in the S&P 500, as a break below would likely initiate more pronounced selling among trend-following, quantitative, and technical-based traders/systems as well as fast money traders covering weak-handed longs, not to mention short sellers jumping into the game. If this happens, we will be raising cash again but for now, we are going to stick to our rules based investment strategy. Remember, 85% of all trading is on autopilot - controlled by machines that can truly control the direction of the market so we do not want to fight obvious long-term technical indicators. All ships rise and fall with the tide - your stock can be a good buy today but if the quants take the market down your stock is going down with it.
Bonds are in free fall, with TLT, the 20-year Treasury bond ETF, down around -13 percent year to date. We are currently not holding any bonds. For the foreseeable future, the bond market appears to be nothing but suffering.
Ron Baron made a comment yesterday morning that I completely agree with: buy growth stocks to fight inflation. If inflation is 7%, you'll need to earn a 15%+ annual return, and growth stocks have proven a wonderful place to do that. I do not think there there is going to be quick rotation from value to growth anytime soon, there are a lot of growth stocks that are trading at a discount.
We are going to be deliberately layering into high quality growth and value stocks that use guardrails of strong balance sheets, abundant free cash flow, strong return on equity (>20%), and who are stable and able to improve margins with real-organic revenue growth.
Does this change my view on a recession in the next 6-24 months? Absolutely not. Markets can stay overbought for years before conditions dictate a recession. A lot of money has been lost trying to time a recession perfectly. We are watching our signals very closely and rest assured we will sound the alarm bell when it officially starts.
Scroll down to view this month's Market Expectations Table and our Q1 Market Update and Q2 Market Outlook.
And remember – the one fact pertaining to all conditions is that they will change.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President