Despite all of the chaos, the Ivory Hill RiskSIGNAL remains firmly green. We are sitting on roughly 60% short-term treasuries and money market. We have been layering into longer-term treasuries and gold.
Although our long-term and short-term signals indicate positive market conditions, our intermediate-term signal turned red last week. This is generally not a good sign and it doesn't appear to be a false signal. I anticipate this choppy market will persist until a definite uptrend is established or conditions start to break down again.
The S&P 500, Nasdaq, and Russell 2000 are all clearly overbought. The markets could run up a little more from where they are at right now but I expect them to take a breather over the next week or so.
As long as the long-term signal is green, we will likely start incrementally buying into equities on the pullback.
Between Fed Chair Powell and Janet Yellen, I’m not sure if they could be more confusing and disorganized, which is a cause for concern.
As expected, the Fed raised rates last week by 0.25% with the comment that there might be one more rate increase. After coming close to destabilizing the banking system and our economy, he finally realized that they are killing everything just to kill inflation, which is unwise but unfortunately inline with most hiking cycles in history.
I can't predict the future and I have no idea if another bank will collapse but clearly neither does the Fed.
It's worth noting that the Federal Reserve has 400 PhDs working for them, not just rank and file employees, but 400 PhDs! With all that brainpower, you'd think one of them would pick up a phone and call the CEOs of these regional banks and have a conversation about how raising rates at the fastest pace in history is affecting their business. But this is what we are stuck with.
QUICK NOTE ON THE POTENTIAL FED PIVOT
I need to clarify something for everyone. There is an uneducated narrative going around that cutting rates (I didn't say pause) will help lift stock prices and that couldn't be farther from the truth.
Based on history, almost every single time the Fed cuts rates, we have seen a major market sell off. AND, for the first time EVER, the Fed is raising rates into declining economic conditions making this sell off even more likely.
It may seem obvious, but the macroeconomic factors that could force a Fed pivot are not favorable for stocks, especially in the short to medium term, given past inflationary cycles. This is because the Fed usually starts cutting rates when they have gone too far (and they already have gone too far).
For over a year, Powell has repeatedly stated that the Fed's main goal is to control inflation, but this may no longer be the case. The market is still anticipating a 0.25% at next month's meeting and then a 60% chance of a rate pause in May. After that, who knows. Don't get caught up in the FOMO when the Fed pauses because they can still go back to hiking rates again like they have in the past.
This story ends the same way it always does. The Fed will raise rates until economic growth is completely choked off.
Just like they did in 1999/2000, 2005/2006, and 2018.
I am bearish on anyone who says "this time is different"
Let's dive into this quarter's macro.
$LUMBER
Lumber prices responded positively to the infusion of Fed liquidity, but they rapidly fell back again due to mounting pressures in the real estate sector.
This means we should start to see home prices rollover at an accelerated pace this spring when transaction volume tends to pick up as crashing lumber prices is an early indicator that housing has farther to fall.
$GOLD
As expected, gold has been behaving just as it should in this environment. A) not losing as much value on down days, B) pushing slowly and steadily higher.
I have emphasized previously that gold prices should not be underestimated, and they have indeed increased by around $150 per ounce in the past month and up over 22% from the September 2022 low.
This development is significant because it indicates that traders have been gradually transitioning to safer investments for some time now, and this trend appears sustainable which is likely bad for stocks.
It is worth noting that gold is currently overbought and will eventually drop back down to the 1930 level, which would present an excellent buying opportunity.
PURCHASING POWER IS WALKING OFF A CLIFF
Real earnings growth has been in a decline for a RECORD 23 months in a row.
It's important to take a moment to absorb this fact - the standard of living in the United States of America has been decaying every month for the past two years.
CREDIT CARD BALANCES
The most recent data for the fourth quarter indicates that credit card balances have increased at the highest rate in 20 years. This is not a positive indicator for consumer spending, as it suggests that people are relying on credit to cover their daily expenses. It implies that individuals have depleted their savings accounts, and their wages are insufficient to support their families.
COST OF CREDIT IS SQUEEZING CONSUMERS
The expense of revolving credit is currently at levels not seen in several decades, indicating a greater possibility of defaults in the future. When individuals lack sufficient funds to purchase goods and rely on credit cards, they may find it difficult to pay off their debts later.
Defaults can happen when the minimum payment on a debt rises due to an increase in interest rates, causing the borrower to struggle with meeting payments and potentially defaulting on the debt.
HOUSEHOLD FINANCIAL CONDITIONS
When Janet Yellen says "the consumer is strong" I have no idea what data point she is looking at. The percentage of households who expect their financial situation to improve is at an ALL-TIME LOW.
HOUSING AFFORDABILITY
According to the National Association of Realtors, housing affordability is at an ALL TIME LOW - worse than the Global Financial Crisis...
LIQUIDITY
The M2 liquidity growth has recently reached an ALL-TIME LOW, indicating a significant contraction in the money supply. Essentially, this means that there is a reduction in the amount of money available in the system.
CREDIT DEFAULT SWAPS
Credit default swaps in the financial sector have been experiencing a significant surge for several weeks. Additionally, credit default swaps in U.S. Treasuries have been increasing for over a year and are currently at their highest level in a decade.
At the beginning of 2022, the Federal Reserve initiated a rate hiking cycle, which sparked a surge in credit default swap prices. Interestingly, the Treasury correction was mainly due to duration risk rather than credit risk, and credit spreads fluctuated but did not indicate a significant risk of increasing defaults.
There appears to be two factors influencing this trend - rising interest rates lead to higher interest expenses for the government, which impacts its ability to spend and raise new debt, and the debt ceiling debate.
The last time the government faced a potential default on its debt was in 2011, and in the year and a half leading up to the debt ceiling debate, swap prices steadily rose, indicating increased market risk. Although the debt ceiling may be more of a political issue than an actual credit risk, it still has a significant impact on risk asset returns.
During the 2011 debt ceiling debate, stock prices declined significantly.
The Congressional Budget Office has predicted that the government may exhaust its ability to issue new debt as early as July. This risk is currently being underestimated, as the focus is mainly on the banking crisis. While the probability of the government defaulting on its debt is low, it is likely that both sides of Congress will continue to take a firm stance right up until the deadline, increasing the likelihood of a repeat of the 2011 debt ceiling crisis.
The looming debt ceiling debate could trigger another significant sell off this summer.
YIELD CURVE
The yield curve is currently inverted at -0.51 and has started to revert back up.
Remember, when the yield curve breaks above the red line and stays there, that has historically meant that stocks go down.
CREDIT SPREADS
Credit spreads have begun to increase, and once they break above the 4.5 mark (indicated by the red line), they tend to continue rising. In order to consider the possibility of a true bottom, it will be necessary to see a significant increase in credit spreads.
VOLATILITY INDEX
The current $VIX level of 19 is close to entering the investable zone. When combined with the fact that the S&P 500 is currently overbought and the VIX is oversold, it is likely that we will observe a VIX rebound while the market takes takes a breather next week.
It's important to keep in mind that historically, no bear market has ever bottomed without the VIX spiking to 45 or higher.
While the macro is pointing to doom, I am cautiously optimistic on the RiskSIGNAL as it is holding up well but over the next month or so the decisions being made by the Federal Reserve and the Treasury, could help or hurt us and I am leaning on the side of hurt us right now.
The key to success in this game is sticking to a sound, rules-based process, rather than chasing the next shiny investment.
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.
Best regards,
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com
—Written 03.30.2023