Risk is not defined by volatility, but rather ill-conceived investment. - Michael J. Burry
Today, the Dow Jones Industrial Average was up 528 points on hopes that inflation is still above 7%, all while the VIX was up 9.5%. The price action today basically summarizes the 2022 stock market. This is not a healthy movement and investors need to prepare for some violent volatility ahead.
The fear index is up 45% YTD and we are firmly in the chop bucket. This type of volatility is where professional traders make their money.
The Ivory Hill RiskSIGNAL is still red, and we are sitting on roughly 73% cash for our non-institutional clients.
All of the components of the Ivory Hill RiskSIGNAL is indicating that this is the time to be VERY cautious if you are planning on holding stocks for the long-term. Despite the fact that this isn't a guarantee, it does indicate that a large market downturn is more likely to happen sooner than later.
I should mention that I think this has a rather short time frame because conditions this risky don't last for very long and these signals have been firmly red for a while, so we should find out rather quickly if this is a head fake or the apocalypse.
We've been buying very small positions in ETFs that show positive trends and have low tail risk and then quickly reducing or getting out of those positions once they turn positive.
I estimate that we are going to be in a declining market growth environment until around Q2 of 2023, so taking quick wins gives us the opportunity to make money while most investors are going down with the indexes.
While we have been getting stopped out of some positions, I fully believe that if we can add a few percentage points to your portfolio while the market goes down another 20%–30%, this will only add extra firepower to your portfolio when this market does turn. And believe me, when the market turns up, we will be firing on all cylinders.
To be crystal clear, this is going to be a grind, and in this market, we need to dig deep and put our nose to the grindstone. We will maintain our healthy position in cash but we are not going to sit on our hands and tell everyone to buy growth stocks "because they're cheap," as I've heard some advisors say lately. We are going to protect your hard-earned capital and put in a consistent effort using our unemotional mathematical system.
The market's price action last week is reinforcing the idea that stocks are at a high risk of a major crash, and depending on the inflation report and the Fed announcement this week, this crash could start to accelerate.
Defensive stocks have basically outperformed the S&P 500 all year, and they are not letting up. This is telling us that market watchers are getting more defensive than they have been this year.
Lumber is still in a downward trend, indicating that housing likely has a lot farther to fall. Remember that most people's wealth is in their homes.
To set the stage: Do you remember at the beginning of the year when the stimulus cash drove housing prices through the roof and real estate agents weren't even writing offers if they weren't above the asking price?
When inflation moved out of the stock market and into everything else, the Fed was forced to aggressively raise interest rates, and mortgages followed.
The 30-year mortgage rate began 2022 at just over 3%. By October, these rates were above 7% for the first time since 2002. This massive increase in rates priced out more than 40% of the average US home buyer. Mortgage activity has dropped by 90%!
Home prices have no choice but to continue to nosedive, and I believe this is just getting started.
Consider the following:
8% of new mortgages this year are underwater.
40% of those buyers have less than 10% equity in their homes.
While every market is different, the worst of them include, Colorado, Virginia, and California have roughly 60% of new mortgages with either limited or negative equity backing them. Yikes!
There is a possible upside to this. Interest rates are no longer moving based solely on what the Fed is or isn't doing. They are acting like a true safe haven (for now).
US Treasuries are up over 15% since late October.
As I said in my last post:
If we keep seeing a negative correlation between stocks and bonds and confirm it with falling lumber prices and utilities doing better than stocks, that's the market firing a red star cluster, which means stocks may be in for a wild ride down.
We are still seeing the same market conditions, and that doesn't look good for buy-and-hold investors.
CORPORATE BLACKOUT PERIOD STARTS DECEMBER 19TH: This matters way more than the CPI report. This is when corporations cannot buy their own stock until they give the public an update on how their quarter went.
I am expecting corporate earnings for Q4 to be very bad. We have already seen some bombs out there, and this will only accelerate this process.
Investors have been selling stocks at a rate of $17 billion per week on average. The last time we saw this was in October of 2008.
The yield curve is the most inverted since the 1980s. Again, the sell signal is the reversion.
The consumer is not strong. The US government panicked and printed trillions of dollars and gave stimulus checks to most people who did not need them. Consumers have drained their savings accounts and are now maxing out their credit cards and working two jobs just to put food on the table. Oh, and inflation is still at 40-year highs. Do I need to keep going on this?
There is a misguided narrative going around that a Fed pivot is a bullish signal. That couldn't be farther from the truth. Based on history, every single time the Fed pivots, stocks crash another 20-30%.
I am confident the Fed will raise rates by 50 basis points this week, followed by another rate hike in February. I would expect to see them wait and see what happens after that.
Finally, energy has been falling since the middle of last month. When commodity prices rise, that is an early indicator that inflation is going up and the Fed will likely raise rates.
When commodity prices start to soften, this is an early indicator that supply is increasing faster than demand and the impact of rising rates has finally started to take its toll on the economy.
This tells us that we are likely getting closer to a Fed pivot, and inflation should continue to come down, but I still believe it will be stubborn and take a lot longer to come down to the Fed's target rate of 2%. While the market expects inflation to gradually decline, I believe that core and services inflation will remain stubborn. If the CPI number comes in above 7.3%, things could start to get ugly.
We are going to sit on our pile of cash and take small nibbles at macro opportunities until the Ivory Hill RiskSIGNAL tells us when to get back into the market.
Be prepared to sit in this position for another six months or so. Our forecasting model is still telling us we could be sitting here until the second half of 2023. Q3 2023 is looking better and better, so that's what we have to look forward to.
And remember—the one fact pertaining to all conditions is that they will change.
Feel free to reach out to me and use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President