Oversold Markets Can Turn Into Market Crashes

The Ivory Hill RiskSIGNAL is still red (since January) and we are sitting on roughly 80%-85% cash. We got stopped out of a few positions last week so that is why our cash position increased. I would not be surprised to see additional stops hit this week as well. There is not a lot of ways to make money in this market right now unless you running a very quick and disciplined long/short intraday trading strategy focused on full cycle investing.


Unfortunately for many people, the Fed's insistence upon tightening into a global recession is eviscerating the historic capital market bubbles they created. Millions of investors' portfolios (who were not proactively positioned for this epic drawdown) are getting pummeled.


Making matters worse, 85% of countries are expected to be in a recession over the next 3 quarters, meaning your global economy is raising rates into a slowdown. I won't sugar coat this. It's getting pretty ugly.


Here's a quick look at some key numbers from the market havoc:



Let's take a step back for a moment and review what's happened so far this year.


Like everyone else, we experienced a sharp decline in January of this year. We were long value stocks, mega-cap tech, and low beta defensive stocks, which is exactly where we should have been considering the value over growth trade started in late 2020 and all of 2021.


On January 21, the Ivory Hill RiskSIGNAL fired off a sell signal to reduce exposure to stocks, which we raised 60%-70% cash. This was the first time our signal flipped red since March 4, 2020.


It's important to remember that the Ivory Hill RiskSIGNAL is a proprietary, math-based indicator specifically designed to mitigate downside risk. It is driven by mathematical market-based price ratios and trend indicators that attempt to avoid significant market selloffs by moving out of stocks during periods of high volatility and then aggressively deploying that capital back into the market once the storm is over.

We do not try to predict market direction. Volatility is predictable and can be positioned for in advance. I focus on volatility because it is often associated with down markets.



It is also important to know that our signals are rules-based, which means we follow them regardless of what we think is going to happen. The very essence of why I invented the signal was to completely eliminate emotions from the equation.


Investing with emotions, in my opinion, destroys long-term returns.

I will be the first to say it is not a perfect system and, by design, it is not predictive of market direction. The only person I know who had a perfect indicator that predicted market direction was Bernie Madoff, and we all know that story.



And Now, Back to Our Regularly Scheduled Programming.


The S&P 500 has wiped-out all gains from 2021.



This might sound like an exaggerated statement, but something looks seriously broken in this market. Both the large cap and small cap indices are retesting the June lows.


Last week’s market action was the second week in a row that the S&P 500 and Russell 2000 were down at least 4%, while longer-term Treasuries dropped at least 1%. This looks less like a reaction to inflation concerns and more like one to the idea that something is fundamentally broken here.


Long-term Treasuries are down 28% on the year. Bond yields continue to push higher even in the face of a deteriorating economy.


The 2 year Treasury yield topped 4% for the first time since 2007. The housing market crash is likely to accelerate from here.



China and Japan have begun manipulating their currencies. The Fed tightened conditions again last week and indicated they will continue to do so for the foreseeable future. Jerome Powell confirmed that a recession in the U.S. is probably unavoidable and won’t do anything to stop it. Is anyone paying attention to this?



It appears that we have moved into a situation where negative news is perceived as an indication of an impending recession, while positive news is interpreted as a sign of further Fed tightening, which indicates an immanent recession.


There is just so little optimism out there, in either case. Last week, it seemed like everyone who was sleeping for the last nine months woke up. People are starting to actually trust what Powell and Company is saying. The Fed will hike rates to the point it completely chokes off economic growth and


In only the fifth instance in the survey's history, the AAII investor sentiment survey revealed that 60% of respondents were bearish. Only four previous years—1990, 2008, 2009, and 2022—have ever surpassed that mark. To say we are in one of the biggest market anomalies in capital market's history is beyond any reasonable dispute.



Who knows how high the dollar goes here. It seems to be the only game in town in the forex market as other individual currencies keep dropping off the map.


The only way that the Japanese yen and Chinese yuan can stop their declines is through central bank intervention.



The British pound tanked as soon as the British government announced a new series of proposed tax cuts that would be funded by more borrowing. It’s interesting to note that one of the proposals included tax cuts for companies and that was exactly the kind of action under the Tax Cuts & Jobs Act that pushed U.S. equities to record highs. This is a much different environment today and I’m skeptical we’d see a similar reaction for U.K. equities this time around, but the plan does bear some similarities.


These are signs that we are on the verge of a potentially pretty incredible deflationary bust here. Default risk looks to be getting priced in here.



I'm very concerned about U.S. Treasury yields. I believe that there is a serious lack of liquidity emerging in this market, and it will likely only worsen as the Fed continues to tighten conditions for at least another six months. Because of the historically high levels of bond market volatility, crashes typically happen when these types of conditions are present. Most people, in my opinion, are only focused on what is happening in the stock market and ignoring the warning flags that are flashing in the bond market.



One of the most alarming parts of this bear market is that the VIX has only just crossed 30. The VIX has basically been sleeping as if nothing is happening right now. No bear market in history has bottomed without the VIX blowing out to 45+. History is suggesting more volatility is coming.



High yield credit spreads have reversed their downtrend and are rising again. This is one of the conditional items on my checklist to blowout before we can call a bottom.



GET READY FOR A HARD LANDING


The concept behind a soft landing is that the Fed can tighten just enough to keep inflation under control while still managing to keep GDP at least level. It's becoming increasingly difficult to imagine this happening. Everything that is currently happening indicates that the Fed will pay little regard to economic growth targets unless inflation significantly decreases from where it is at.


This entire situation demonstrates how erroneous the summer stock market rally was. Without any supporting data, investors convinced themselves that the Fed would switch its attention from controlling inflation to preventing recessions. It would bring about an early end to the hiking cycle. Sadly, that was never taken into account. At Jackson Hole and this week, Powell made it abundantly clear that the Fed would not stop hiking rates anytime soon. Without any help from the central bank, the market can only rely on the data, which is not good. If the Fed doesn't alter its stance on monetary policy for another 6 to 12 months, it's difficult to envision this economy not getting worse before it gets better.


Bottom Line


These are not easy times and this is the most difficult market any of us have seen in years, but we have been through markets like this before. The factors that have weighed on stocks, higher rates, high inflation, hawkish Fed, fundamentally look to have hit or are nearly at their peak, while the major stock indices are now sharply lower. This does not mean the market cannot go lower. Oversold markets can turn into market crashes. Sentiment, mean-while, has become extremely negative.


I am not going to speculate on whether the bottom is near because I don't think it is but I do feel that we are closer to the end of this than the beginning, and before a bottom is in I could see the market stabilizing for a period of time if 1) Inflation is declining and 2) The Fed signals it is close to the end of its hiking cycle. When those events occur, the market should stabilize unless any of the other umpteen possible black swan anomalies take control.


In the meantime, I am here for you, every day, to help you navigate this difficult and unsettled environment. And first and foremost, making sure I recognize additional threats to the market (that might cause downside risk) and ensuring we’re not blindsided by them.


For now, patience is key. Turn off the financial pornography news network and spend more time with your family because there is nothing you or I can do to control this market.


We are going to be patient and sit on our pile of cash and take small nibbles at macro opportunities until the Ivory Hill RiskSIGNAL tells us where the bottom is.


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 09.26.2022