Market Optimism is Building While The Inversion is Coming
It is amazing how fast things change in today's market. High-frequency traders, also known as quantitative traders, identify profitable trading opportunities based on mathematically-driven computer systems and research. It has grown increasingly more evident quantitative traders can push the market in the direction they want it to go, causing much of the extreme volatility we see today. The systems are gaining momentum and becoming so fast; they can buy and sell based off a few words from individual statements seen throughout the day.
Roughly 85% of all trading is on autopilot—controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast. - The Wall Street Journal
This is one of the reasons why I am not a fan of buy and hold investing, nor do I like the idea of asset allocation. The market does not think or feel. It is what it is, which is why our method is active investment management.
Remember, markets are cyclical. Unstable rallies followed by market drawbacks can be detrimental to a portfolio’s performance, primarily because on a percentage basis, you must earn more than you lost to get back to even. The table below demonstrates how much an investment needs to gain to break even for a number of downward price movement scenarios.
The Ivory Hill Volatility Signal has firmed up considerably – still no "risk-on" signal (or buy signal) yet but things are looking a lot better in the short-term.
The market is now overbought and should pull back in the next few days, or a week from now. That is not a bad sign because if we get a new signal and a technical pullback does happen, it will give us some “pennies from heaven” to buy at lower prices. Again, we do not have a confirmed "risk-on" signal yet, but confidence is starting to buildup. Last week, I said the low of February could have been the low for 2022, but only time will tell. Don’t try to jump into the market too fast. Remember what happened to General Custer? Instead of waiting for reinforcements, he moved out too fast and got killed quickly along with the rest of his men.
The bond market is getting crushed as the 20-year treasuries are now down about -12% YTD and -19% from their 2021 high. This is this first bear market in bonds in over three decades, and it looks like the selling is just getting started. I have not been a fan of target date funds, and this is the reason why. They are going to have a very hard road ahead for the foreseeable future.
If the Semiconductor index (SOXX) holds today it will be back above its 200-day MA which is a positive sign for that sector.
What’s The Real Impact of Rising Rates?
The rise in Treasury yields has accelerated and the Fed is using essentially every opportunity to tell the public that rates are going to rise even more in the coming months. So as we all embark on this potentially steep rise in rates, I wanted to take a minute to see what effect rising rates have had on the “real economy,” because one of the biggest risks to the market right now is an economic slowdown—and understanding when rates reach a level where that might occur is very important.
To do this, I looked at rates of several important consumer loans: 30-year mortgages, 5/1 ARMs, 60-month auto loans, HELOCs and credit card debt.
And the conclusion for all these loans was clear: Rates aren’t yet at levels that we think will restrict growth (and in some cases they are still far from levels that would restrict growth).
With the exception of the 30-year mortgage (which arguably is the most important of these consumer loans), none of the other major consumer loans are meaningfully above levels seen in January 2021, when economic growth and inflation were both more subdued.
5/1 ARMs, HELOC rates, car loans and credit card rates are all essentially at the same place they were in January 2021, and in all these cases they are below levels in January 2020 (pre-pandemic), a time when consumer balance sheets weren’t as strong as they are right now.
Now, mortgage rates have risen, and they are above pre-pandemic levels. But they are still well below the January 2019 levels, and that’s notable because early to mid-2019 was the last time we saw a meaningful loss of economic momentum, which prompted the Fed to halt balance sheet reduction and rate hikes in mid-2019.
Bottom line, while Treasury yields have risen, and that’s caused mortgage rates to accelerate, the majority of other important consumer loan rates have not risen substantially.
What Does This Means for Markets?
The Fed will kill this market and eventually choke off economic growth, but how many hikes and how long it takes is a function of 1) How low rates are at the start and 2) How strong growth is when rates begin to rise.
Right now, rate “lift off” is starting very low and economic growth remains very strong, and this analysis of consumer loans reinforces this point: It’s going to take a while for the Fed to choke off the economic recovery, even if they raise rates 50 bps at the next meeting. That underscores the point that a 10s-2s inversion is a warning that it’s coming—not an immediate sell signal.
AND it could be a while before the yield curve inverts...
And remember – the one fact pertaining to all conditions is that they will change.
Feel free to use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President