IronBridge Private Wealth

Forward with Confidence

Market Commentary

Selloff Over or Just Getting Started?

The S&P 500 officially fell 20% from it’s highs this morning.

But last Thursday morning, it was down only 7% from its highs.

Then Trump unleashed his tariff “plan”. Stocks were down over 10% in two days last Thursday and Friday, and another 4% at the open this morning.

This was a mini-crash.

A quick, but relatively normal pullback turned into a bloodbath on fears that tariffs will cause a recession and further market volatility.

This report is brief and to the point, and we will go over more in our webinar tomorrow. The registration link is further down in this report.

What happened?

  • Stocks had a mini-crash on Thursday and Friday, falling over 10% in just two days, after Trump announced tariffs that were much more widespread than many anticipated.
  • Concern over tariffs caused a technical selloff similar to last summer’s Japanese Yen selloff.
  • Market behavior the past few days has been similar to the COVID-lows.
  • This selloff has been about the unknowns with tariffs, as opposed to a deeply engrained structural problem like mortgages in 2008.
  • At this point we don’t anticipate this turning into a deeper bear market, but we can’t rule that out yet either.
  • We do think we are at or near a short-term low in stocks.

What to Do?

  • Don’t panic.
  • Keep the selloff in context…markets were only down 7% from all-time highs last Thursday morning.
  • Wait until a stronger rally develops to assess whether or not to reduce risk, not while fear and panic are extremely elevated.
  • This is not a dip to sell into, despite the elevated fear.
  • Stay calm, and reassess market dynamics on a rally.

Why do we think this could be a low?

There are a number of signs pointing to this being a near-term low in markets either today or tomorrow.

  • Sentiment at extremes
  • VIX spike higher
  • Treasury yields reversing higher
  • Option flow data is bullish
  • Capitulation signals
  • Broad, indiscriminate selling
  • Bullish divergences
  • Panicky conversations with clients

These data points are all quite bullish.

And while they don’t guarantee that the overall pullback is over, it does increase the likelihood that we have seen an interim low in prices.

We will look at charts of these in more detail in tomorrow’s webinar.

Tariffs Discussion

We will also discuss tariffs in more detail tomorrow, but here are our initial thoughts on tariffs:

  • Tariffs by themselves are not good, but if their implementation results in the elimination of all or a majority of income taxes in the US, it will be hugely beneficial.
  • The stated goal of the Trump administration is to use tariffs to eliminate income taxes of various kinds. A proposal today aims at eliminating capital gains taxes by the end of this year.
  • A broader stated goal by the administration is to eliminate the IRS entirely by reducing spending via DOGE and replacing income tax revenue with revenue from tariffs and a national sales tax.
  • Tariffs are inherently inflationary.
  • Tariffs are more steps towards economic de-globalization, which started with the semiconductor bill passed by the Biden administration. De-globalization is also inflationary without efficiency and productivity gains.
  • Potential productivity gains by the implementation of AI could be deflationary.
  • Small caps and mid caps may have an advantage over large caps going forward due to less overseas revenue and a lower impact from tariffs.

If you are looking to reduce risk, our advice is to wait until volatility has calmed down, which we expect over the coming weeks, if not sooner.

Don’t forget to register for our webinar tomorrow at 4pm central time. Click to register.

Volatility Spikes Occur Around Lows

Dramatic spikes higher in volatility tend to be a characteristic of a low point in markets.

This latest pullback appears to be no different, despite the harshness of the move.

In fact, we should probably get used to environments where volatility spikes very quickly like we have seen the past few days.

We know, that doesn’t make it feel any better.

But this type of move tends to occur at or near the end of major selloffs, as shown in the chart below.

The bear market of 2008 had multiple spikes in the VIX that only resulted in short-term rallies of a few weeks.

But during other selloffs, the VIX moving near or above 50 marked the end of the selling. Today, the VIX touched 60, the highest level since the Japanese Yen selling last summer.

We have now seen two days (Thursday and Friday) that were both down at least 4%.

With stocks down again today, this marks only the 4th time in history we’ve seen selling like this.

What happened next was bullish over the near term, as shown in our next chart below.

Returns following this type of volatility has been strong historically.

Average returns were over 11% when looking one week out.

This is a small sample size with only 3 occurrences, so we can’t take too much concrete information from it. But it shows that markets tend to bounce back strongly, at least over the near term.

Largest Two-Day Declines

The two-day decline last Thursday and Friday was the 5th largest two-day decline in history.

What has happened after previous large declines?

The first chart below from Charlie Bilello (twiiter @charliebilello) shows the ten largest two-day declines in S&P 500 history.

There is no question about it, these have been buying opportunities, not selling opportunities. Returns have been much higher than average following selloffs like this.

If we look more closely at the chart above, all of the declines took place in 1987, 2008 or 2020. Not great company.

But this type of volatility not only tends to have strong returns looking over a 1-year timeframe or more, it also has marked the low point of major bear markets, as shown in the next chart below.

The top half of this chart shows a two-day performance of the S&P 500, while the red dots on the bottom half of the chart show when two day returns fell more than 10%.

Each of these occurred near the ultimate low of major bear markets.

But what about on a shorter time horizon?

Let’s look at what happened when we had very fast corrections.

Fastest 10% Corrections

Before the tariff selloff last week, markets were already moving quickly lower.

In fact, the S&P 500 had the 6th fastest 10% correction from all-time highs in history recently.

What happened next?

This chart shows that on average the market is nearly 15% higher on average after only 6 months.

This tells us that the speed of this overall correction also suggests that forward returns should be strong over the shorter-term as well, not just over the longer-term.

Bottom Line

The data suggests that we should expect an interim low any day, followed by a strong rally.

This doesn’t mean the decline is over, but economic and earnings data would have to deteriorate badly for further declines in stocks to occur. We are not ruling that out, it is just not the likely scenario at this point.

Earnings reports are starting this week, so we will have plenty of commentary from CEOs on the impact of tariffs on their business.

We will discuss more in our webinar tomorrow.

Invest wisely!

Correction Nearing an End?

Volatility over the past month was fast, but positive signs suggest the recent correction may be over.

Volatility may be rising simply because investors must digest more information every day. – Alex Berenson

Market volatility is never fun.

But the recent volatility has felt more intense than previous pullbacks.

Why and what are we doing?

Context:

  • While volatility has increased, stocks are less than 10% from their all-time-highs.
  • Since 1950, the S&P 500 averages a decline of 16% once per year. We are currently less than what an average intra-year decline looks like.
  • It feels bad, but so far it is a normal but very fast pullback.

What Next?:

  • Following back-to-back 90% up days this past Friday and Monday, the recent pullback has a high probability of being over.
  • Expect volatility to stay high, but prices should hold the recent lows and start to work higher.
  • A bounce is expected to last 2-3 weeks, but could be slightly faster or slower.
  • The strength of the bounce will determine next steps:
    • A strong bounce would suggest a grind higher to new all-time-highs this spring/summer.
    • A weak bounce, followed by additional downside acceleration, would trigger cash raises across portfolios.

A few reasons why:

  • Two major sources of uncertainty from the Trump administration: tariffs and governmental spending.
  • Corrections happen in markets, and this appears fairly normal at this point.
  • The 10% correction happened in only 16 days, amplifying the anxiety of the volatility.

What are we doing?

  • The fast pullback triggered our volatility override triggers. This means that volatility was high enough where selling on a decline is not beneficial.
  • The market should have a bounce, which most likely began on Friday, March 14th.
  • The strength of that bounce will determine next steps.
    • A weak bounce likely leads to reduced risk exposure on a rally.
    • A stronger bounce suggests a move back to new highs.

Let’s dig in.

Corrections Happen

The S&P 500 Index just fell 10% from its all-time-highs.

That sounds like a lot, but this happens quite often.

In fact, the S&P 500 averages a pullback of 16% once per year.

The primary question anytime this happens is this: Will this turn into something bigger and more damaging, or is the selloff over?

The real answer is “nobody knows”.

But like most things, we like to look at previous examples to help guide our expectations.

The first chart shows the times the S&P 500 Index fell more than 10% from all-time-highs, but didn’t fall far enough to get to a 20% decline.

The results are bullish.

Previous times markets fell 10% but not 20% from all-time-highs led to above average returns over the next 1-, 3-, 6- and 12-months.

Both 6 and 12-month returns were very good at 12% and 14.7% respectively.

This pullback feels worse than others, partially because it was so quick. It took only 16 trading days to fall 10% from the all-time-high.

This is the 6th fastest 10% decline in history.

What happened in previous times we saw prices drop so fast?

The results are also bullish.

Similar to times when the market was down 10% but not 20%, forward returns are good after speedy declines.

What about insiders? Are we seeing part of the “smart money” crowd sell?

Tech Insiders are Buying

When discussing stocks, “insiders” are simply anyone with material, non-public information. In other words, they have information about a company that has not been publicly disclosed.

When insiders are buying, they are investing their own money to buy more of their company’s stock.

This is typically a positive sign that people who know about the company’s growth prospects are using a decline in the price of their stock to purchase more.

When insiders are selling, this often signals that the business could be having trouble or may be seeing a slowdown.

We’re seeing very strong insider buying within the technology sector, as shown in the next chart.

Source: SentimenTrader

Previous times that insiders were buying this quickly resulted in strong forward returns in the technology sector, averaging over 20% returns over the next 12 months.

This is another bullish sign for stocks for the next year.

Trump Policies

We still think that we have yet to learn about the extent of corruption in Washington, DC.

In the meantime, tariff uncertainties continue to influence markets.

The narrative risk will continue to be confusing, especially if you’re not prepared for it.

But market data will continue to drive our decision-making. For now, at least, that data remains positive, despite the anxiety in markets and uncertainty from Washington.

Bottom Line

As mentioned earlier, a major positive development is the consecutive 90% up days. This is a very good development, showing big money was buying on the dip.

That combined with a handful of other indicators suggest that there is a good likelihood the correction is over.

However, we should continue to expect to have uncertainty out of Washington DC, and we should also expect to have relatively big moves on a daily basis.

We will continue to monitor developments and make adjustments to your portfolio as necessary.

Invest wisely!

Thoughts on Recent Market Volatility

After an extended period of calm in financial markets, volatility has exploded higher the past two days. What caused it and should you be worried?

Hoping for the best, prepared for the worst, and unsurprised by anything in between.

Maya Angelou

Webinar

We are holding a webinar on Tuesday, August 6th to answer your questions and discuss current market volatility.

Look for information in a separate email.

What is Happening?

A few data points have spooked the market recently:

  • Japanese Central Bank raised interest rates, causing a “carry trade” to unwind. (This is the main culprit).
  • Yield Curve briefly un-inverts.
  • A jobs number was relatively weak last week.
  • Geopolitical concerns around Iran and Israel.

Should We be Worried?

Not yet.

Market volatility is always unnerving, but at this point the data suggests that this is a temporary move lower that should not result in the start of a major bear market.

However, we do expect large moves both up and down over the coming week(s).

We will update you as necessary.

What Should We Look For?

Most importantly, we should see selling pressure reduce in the next 48 hours:

  • If the selling is temporary, we should see a big snap-back rally this week.
  • If the selling is NOT temporary, we should still expect a big rally, but it will quickly be reversed over the next week or two.

Are we Selling?

Not yet.

We have “volatility overrides” as part of our investment process. This means that if certain panic conditions are present, we do not sell positions that meet this criteria.

Today, our process identified the current move as a panic move.

The last time the market gave us panic signals was at the COVID low in March of 2020.

Are we Buying?

We added exposure to small caps on Friday, and will likely continue to add on this weakness.

We did not buy or sell any positions today, but do expect to allocate to risk as the selloff fades.

That said, we will not hesitate to raise cash if needed.

Market Review

Let’s go over a few charts today:

  • VIX Index (Volatility)
  • Credit Spreads
  • Japanese Yen Carry Trade

We will discuss more tomorrow in our webinar.

Volatility Index

The VIX index is giving us the best view of the spike in volatility.

The move we have seen since last week is quite amazing. Here’s the chart:

The blue line on top is the S&P 500 index (SPY), and the VIX index is in orange in the bottom pane of the chart.

This has been quite a spike higher, with the VIX approaching 70 today. It closed at 38 which is a good start.

Volatility doesn’t spike higher like this very often.

When it does, it has been an extremely good indicator that the selloff is either over or almost over.

This type of move typically does not mark a top in markets.

Quite the opposite in fact…this type of move usually signals that a low in price has either occurred or is close.

Credit Spreads

This is a warning sign that requires the most attention.

Anytime we see big moves lower in stocks, credit spreads widen a little as investors sell high-yield bonds and buy US Treasuries.

That is what we are seeing now, as shown in the next chart.

When this line goes up, it signals stress in the bond market.

Specifically, this shows the difference in yield between junk bonds and the 10-year US Treasury yield.

At 190 basis points, this means that junk bonds rated BAA only pay 1.90% above the 10-year treasury yield.

During the 2008 financial crisis, spreads jumped nearly 600 basis points, or 6%.

Normal spreads are 2-3%.

At readings of 1.9%, we are still below historical ranges.

For now, this indicator is not flashing warning signs, but the recent increase requires monitoring.

Japanese Yen Carry Trade

We saved this for last because it is the most complex.

We’ll try to simplify it.

A typical “carry trade” goes like this:

  1. Borrow money at low interest rates;
  2. Invest that money in assets that have higher return potential;
  3. Pay off the loan and keep the return minus the cost of the debt.

It’s essentially a fancy way to arbitrage, or make a spread between the cost of capital and the return you may get on the borrowed funds.

With the Yen carry trade, there are more factors at work.

One of the biggest factors is the currency conversion.

When money is borrowed in Yen, it is typically then converted to another currency, like the US Dollar.

That money is then invested in stocks or bonds.

The total return on the borrowed money is the return on the invested capital, plus or minus any return due to the currency moves.

When the Yen appreciates versus the US Dollar, it takes more dollars to pay off the initial loan in Yen. That means returns are diminished.

It then becomes stuck in a feedback loop.

The more assets that are converted back into Yen, the stronger the Yen becomes.

A stronger Yen puts more pressure on the carry trade, resulting in more selling.

More selling reduces return on the borrowed funds, resulting in a scramble to get out at any cost, as the return on the borrowed funds is eliminated by the strong Yen.

So let’s look at what the Yen has done.

Let’s review two charts:

  • Short-Term chart going back to last year;
  • Long-Term chart going back to the early 1990’s.

Let’s start with the short-term chart.

The move higher in the Yen appears to be a very large move.

When this line moves higher, the Yen is stronger. This hurts the carry trade.

When it moves lower, the Yen is weaker, helping to support the carry trade.

This move higher has resulted in a fast deleveraging of this carry trade.

Selling has been indiscriminate as investors try to reduce the damage from the strong Yen.

But like credit spreads, it’s helpful to take a broader view, so let’s look at the long-term chart.

Just like credit spreads, the short-term move looks bad.

But by zooming out, we can see that the move hasn’t been all that unusual.

It may signal a massive trend change in favor of the Yen, but it is too early to say that with any conviction.

Bottom Line

The declines over the past two days have not been pretty. But at this point there is not enough evidence to get too defensive.

We will have plenty of information in the coming days, and will keep you posted on our analysis.

We will discuss this more in-depth in our webinar tomorrow, so keep an eye out for that email.

Invest wisely!

AAII Investor Presentation

IronBridge presented to the Austin chapter of the American Association of Individual Investors on March 26, 2018.  Topics discussed were 6 strategies for Late Cycle Investing, identifying characteristics of previous market tops, and an overview of the current market environment.  Click the link below to view the presentation.

[maxbutton id=”5″ url=”https://ironbridge360.com/wp-content/uploads/2018/03/IronBridge-ChartBook-AAII-Presentation-March-Final.pdf” text=”AAII Presentation” ]

 

2018 Outlook

It’s that time of year again…the talking heads and ivory tower financial geniuses all disguise their wild guesses as well thought out analysis as to where markets will be at the end of next year.

Without question, there is value in thinking deeply about where markets may be headed. However, we believe that an effective outlook report helps identify potential catalysts that could change the direction of various markets, not a platform for a current day Nostradamus.

In this report, you won’t find specific projections on where the markets will be 12 months from now. (Spoiler alert…nobody knows).

What you will find is a collection of what we believe to be the most important characteristics of the current environment that have the highest potential to give us clues on what may be in store for 2018.

We hope you enjoy our Outlook Report, and welcome your feedback and discussion.

We also hope you and your loved ones have a safe and joyous holiday season, and a very prosperous 2018!

[maxbutton id=”5″ url=”https://ironbridge360.com/wp-content/uploads/2017/12/IronBridge-2018-Outlook-1.pdf” text=”2018 Outlook Report” ]

 

Central Banks and Global Stocks: Just Add Zeros

The Federal Reserve met today and decided to leave interest rates unchanged. But is this really important?

The Fed has raised interest rates multiple times in the past 18 months, but equity markets have continued moving higher and bond markets haven’t shown much volatility. More importantly than the decision on interest rates today was its statement on their balance sheet.  The Fed said that they would begin “implementing its balance sheet normalization program relatively soon.”

Global central banks have been printing trillions of dollars over the past 10 years.  The chart below via Bloomberg shows the combined balance sheet of the US Federal Reserve, the European Central Bank and the Bank of Japan, plotted against a global index of stocks. Notice a pattern?

This is why watching the Fed is so important.  However, while most people focus on interest rates, it is actually more important to focus on what central banks are doing with their balance sheets. If expanding their balance sheets has resulted in higher equity prices, it is logical to think that shrinking balance sheets could have the opposite effect.

These balance sheet have expanded by “printing” digital currency. It would be like you or me going into our bank account online and adding a couple “zeros” to the end of the number.  By a couple, I mean 12.  The Fed then takes these extra zeros and buys government bonds.  Theoretically, the sellers of these bonds then put the cash to work in the real economy.

But what has happened is that this cash has been put to work in the stock market, resulting in increased corporate buy-backs and generally rising stock prices.

In Fed-speak, “normalization” means “smaller”.  This could be accomplished in a few different ways:

  1. As bonds mature, don’t repurchase new bonds. In other words, remove a couple zeros.
  2. Sell existing bonds back into the open market.  Sell a couple of those zeros.
  3. Create inflation that reduces the relative size of the current bonds compared to future purchasing power.

The key question is “if normalization begins, what happens next?”  I wish we knew the answer to that question. In my opinion, central banks don’t know the answer to that question either.  The Fed provides their version of Policy Normalization here: https://www.federalreserve.gov/monetarypolicy/policy-normalization.htm

However, we can look at the maturity schedule of the balance sheet to see how much this normalization means in dollar terms.  The chart below from PIMCO shows this maturity schedule. I see risks of normalization in the large increase of maturing assets in Q1 and Q2 of 2018.  This could be the “tell” for future market volatility, since the Fed has not begun to actually normalize yet.

So what are we supposed to do?

  • Identify outcomes.  The fed has pushed stocks further than many people thought, and could continue to push them even higher for longer if normalization is gradual.  On the other hand, normalization could result in increased volatility and elevated downside risk.
  • Know your exit.  Don’t blindly hold assets without a defined exit strategy.
  • Be prepared for market volatility.  Both financially and emotionally. If volatility occurs, you and your portfolio will be prepared for it. If it doesn’t, enjoy the tranquility.

In the meantime, pay attention to what the Fed does with those zeros.

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