No man has a chance to enjoy permanent success until he begins to look in a mirror for the real cause of his mistakes - Napoleon Hill
The Ivory Hill RiskSIGNAL is still clearly negative, and we are still sitting on a lot of cash and we have increased our allocation to Treasuries. As it stands, we are sitting in about 53% cash and 15% Treasuries.
As stated in my previous post the market was do for a trader's rally and there has been evidence of that over the past week or so and I wouldn't be surprised to see another 5-7% rip higher in the S&P 500.
Setting Expectations: I believe that all relationships in life are either made or broken based on expectations so I want to be front and center with how our positions would most likely react if a major market correction were to happened today.
Below is a stress test on how we sit today if we went through a major market correction. I have also included some boiler plate asset allocation models for comparison.
I used the BlackRock ETF model portfolios as a proxy and you can find those on BlackRock.com.
I do want to point out that Ivory Hill is not "most firms" so our holdings only look like this because the Ivory Hill RiskSIGNAL flipped red in January.
As you can see, we should not be that concerned if a major market correction happens anytime soon. While our strategy is defensive in nature, it is really an offensive move for when the market turns.
For the last several weeks I have been doing a lot of cross-sector and style-comparison analysis using Relative Strength readings against the broader market. This is an attempt to identify which corners of the market are performing the best in the current market conditions and which have been performing the worst.
One corner of the market I have been examining since the beginning of the year has been semiconductors, as the Philadelphia Stock Exchange's Semiconductors, or the SOX, fell by as much as 30% at the lows. But from a fundamental point of view, many of the big semiconductor names such as AMD and NVDA are now trading at upwards of 50% discount to their five year average P/E ratios, and that has my attention from a valuation angle.
I took a look at the charts and not only did the semiconductors hold the early May lows into the end of the month when the S&P 500 fell to new 52-week lows, but relative to the S&P 500, the SOX has been trending higher since late April and encouragingly broken out through a long-standing downtrend line on the Relative Strength reading. This is illustrated by the green line in the sub-chart of the SOX chart where I circled the breakout.
It is still early in the potential bottoming process and the latest strength in the SOX could end up being a “bear trap” due to portfolio month-end re-balancing, so we will want to see the latest positive price action continue into early June. But with the fundamentals suggesting that semiconductors are trading at a discount to their five-year average forward P/E ratios and the charts beginning to show some more encouraging signs that a bottom might be in for the shot to intermediate term. Only time will tell.
The Fed is raising the Federal Funds rate with a target of 3%-3.5%. In order to fight inflation the Fed MUST raise rates in order to slow economic growth so inflation comes down. It is highly unlikely they will reach this target (currently it looks to be mathematically impossible). The Fed is planning on raising rates 11 times and I would be very surprised if they got to 6 or 7 before lowering rates again.
The chart below is the history of the Federal Funds Rate (white) and the Federal Debt (orange).
As you can see the debt construct has only gone up and every single time the Fed has gone into a rate hiking cycle a recession has followed at some point in the future.
To learn more about this read my post How Does This Stock Market Rally Ultimately End?
This doesn't mean we are going into a recession tomorrow or even this year but it looks to be inevitable at some point. A lot of money has been lost trying to time a market top.
You are going to start hearing a lot of "Fed Speak "and for the most part you can ignore it because since 1913, no Federal Reserve board has ever announced a recession before it has happened. It would be suicide for market confidence so they will never admit it before it happens.
EVIDENCE OF THE BEAR MARKET
There is ample technical deposition that U.S. financial markets are in a bear market. The NYSE Composite has broken through its 100-week moving average. In the past 25 years, every recession and/or crisis has been accompanied by a break of this long-term moving average.
Bear markets are not uncommon and follow previous bull market tops. Over the last 120 years, there has been 14 bear markets that has a median decline of a 35% from top to bottom.
SHORT-TERM MARKET OUTLOOK
Despite the mounting evidence that economic conditions are slowing, the US economy looks like it will likely avoid a recession in the short-term because:
The May jobs report showed the labor market hiring is still expanding at a healthy rate.
The latest manufacturing and services data, while it has been trending lower over the. last month, is still in expansion territory.
The 10Y/2Y Treasury yield spread is at 30 basis points, showing that the bond market is not pricing in a recession.
These things should keep the economy out of a recession this year, while the bigger risks are more likely to appear in 2023.
The good news is also allowing the Fed to continue its aggressive rate hiking to slow inflation. The futures markets are pricing in a 50 basis point rate hike at the next two meetings, which is a logical estimate at this point in time.
This bundle of economic data last week is supportive for stocks, but the Fed indications has caused Treasury yields to rise at the same time as stocks again. This means as long as the market continues to reprice in concerns about inflation and interest rates, we can expect to see stocks and bonds acting positively correlated again (eye roll).
When the market thinks the Fed is acting too aggressive on rate hikes, we should see traditional negative correlation between stocks and bonds again.
I would expect to see headlines this week that say "the bottom is in" but that doesn't mean we're out of it yet. Bear market rallies are not unusual and stocks could easily establish new lows during these types of conditions.
The S&P 500 rallied 11% during the first half of March of this year and by April it had established a new low for 2022. Look at this compared to the COVID crash.
With a lot of numbers still trending in the red and likely to continue doing so through the end of 2022, there’s a good chance we could see stocks falling again during the summer months.
I don’t think we can call a legitimate bottom in stock prices until we finally see a big spike in the VIX and a blowout in credit spreads - this would be an early signal that we are approaching a bottom. We haven't hit that yet.
Only time will tell but until our signals flip green we will continue to remain in a cautious posture.
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 6.5.2022