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The Downside Dominance in Fundamentals

I know I sound like a broken record, but as long as the RiskSIGNAL remains green, which it is along with our volatility indicators, any market pullbacks are opportunities to buy. This is rules-based-investing. Historically, August hasn't been favorable for stocks, with many individuals on vacation and various other elements influencing the markets. Moreover, September often brings its own set of challenges, with volatility usually not showing much improvement.

September Update on Market Fundamentals

Current Position: The data is showing slight fluctuations but continues to suggest a gentle economic slowdown. While disinflation is evident, it's not as pronounced as one might hope. The market does not expect the Federal Reserve to increase rates, but the anticipation for rate cuts is being deferred. Additionally, Treasury yields are hovering around their highest levels in decades.

This situation is showing two main points:

  1. The reason behind the recent stock market pullback (attributed to the rising Treasury yields), and;

  2. The broader economic fundamentals remain favorable for stocks at their current valuations. Consequently, this pullback can be viewed as a phase of stabilization within a market that's generally trending upwards.

Conditions Get Better If: The data consistently points towards either a "no landing" or a "soft landing" scenario. If core inflation steadily decreases, approaching a rate of 3.0% year-over-year, and the Federal Reserve confirms rate hikes are over without adopting a "higher for longer" narrative, coupled with a decline in Treasury yields, the market could be poised for a favorable shift. Such conditions would suggest that the market is transitioning into a 'Goldilocks' phase, potentially propelling the rally towards its previous all-time-highs. This would diminish the likelihood of a recession, normalize inflation rates, eliminate concerns over further Fed rate hikes, and alleviate valuation strains with the decline in bond yields. Essentially, this would be an amplification and continuation of the positive trends that have been propelling stocks upward since June.

Conditions Get Worse If: The economic data takes a downturn, suggesting a hard landing. If core inflation stagnates or shows an uptick, and the Federal Reserve either increases rates in 2023 or firmly commits to a "higher for longer" approach, combined with Treasury yields reaching unprecedented levels, it would intensify the valuation challenges for stocks. Such conditions would essentially destabilize the three foundational supports of the recent rally. Consequently, investors should brace for a significant drop in stock values, even beyond the recent market pullback. In this context, a decline exceeding 10% becomes a likely outcome, as it would negate most of the justifications for the stock market gains observed since June and throughout 2023. The market is currently has no rate hike priced in for the September meeting. If the Fed decides to raise rates again, look out below.

To extend or not to extend the duration

The allure of high short-term rates can often be misleading. Historical data from the last 45 years suggest it's wiser to lock in higher long-term rates before the yield curve normalizes. For example, once maximum inversion occurs, 2-year yields typically drop 312bps, and 10-year yields decline 139bps.

If your financial plan aims for a 5%-6% average annual net return on capital, why not guarantee a portion of that now? Given the current market conditions, the downside risks in equities far outweigh the potential for further gains. So, it might be a prudent strategy to lock in stable returns where possible.

Market Internals

While we view the current market as a buying opportunity, there are some disconnects getting built up in a couple asset classes.

In the current climate, it's unsurprising to see utilities lag the market. Yet, the extent of their underperformance is absurd. Utilities have declined by 10% this year, lagging the S&P 500 by nearly 30%—a disparity not seen in over three decades. The significant underallocation by asset managers to this sector suggests many investors might be ill-prepared for potential market changes.

This might be a forewarning of a turbulent phase ahead. If trends persist in this direction, we could face a sharp market downturn in the coming months, potentially leading to a recession by the end of the year or early 2024. It's prudent to avoid concentrated or speculative risks right now.

If the Ivory Hill RiskSIGNAL turns red, we will not hesitate to increase our cash levels as sticking to our rules at this point in the cycle is more crucial than ever.

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

—Written 9.7.2023


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