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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!

Rate Cuts at New Highs

The Federal Reserve cut its target interest rate by 0.50% on Wednesday, with stock markets at or near all-time-highs. What does that signal for the economy and markets?

“Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices.”

warren buffet

Focus on economic data and the weirdest presidential election in memory took a pause on Wednesday as the Federal Reserve met and reduced interest rates by a half of a percent.

Side Note: We will publish an election report in the coming weeks with our analysis of the potential election outcomes.

When the Fed cuts rates, it is important to understand the context in which the cut happens.

Essentially there are two environments to consider:

  1. Deteriorating economy and market
  2. Stable/Improving economy and market

Today, there is little question that the economy and market are stable.

Things can always change. And can change quickly.

But as of right now, stocks are at all-time-highs and gaining momentum. Economic data is holding up just fine, and we’re not seeing stress in the places that would be concerning.

So why cut?

Why did the Fed cut rates now?

In the two rate cutting environments mentioned above (deteriorating or stable data), interest rate cuts take on different roles.

When economic data is starting to weaken and markets are showing signs of stress, rate cuts help to pump liquidity into financial markets.

In theory, lower rates help to lessen the negative effects of a recession.

The idea is that lower rates decrease the cost of debt (consumer, corporate and government debt), helping the overall economy reduce costs to offset the potential for reduced economic output during a recession.

But today’s data is not recessionary.

In fact, we’re simply not seeing many signs at all of stress in financial markets that would be worrisome.

That means that this rate cut is likely a “normalization” rate cut.

Normalization Rate Cut

Normalization rate cuts are nothing more than cuts that happen outside of a pending recession.

The Federal Reserve spent over a decade at “abnormal” rates. (Zero percent rates for well over a decade is not normal).

This week’s cut appears to be a normalization with regards to inflation, not with regards to unemployment or the economy.

When inflation went from 1% to 9%, the Fed raised rates to slow inflation.

Then, inflation went from 9% to 3%. So the Fed cut rates this week.

Not because the economy is falling off a cliff, and not because unemployment ticked higher. (Higher unemployment numbers occurred because the government is now beginning to count illegal aliens in the number of unemployed people).

Anyone else getting frustrated with data manipulation?

But we digress.

With the cut this week, the Fed simply made the rates more in line with what the market is telling them they should be, and it appears the Fed is doing two things:

  1. The Fed is continuing to normalize interest rate policy after the chaotic inflation during COVID (caused by the Fed and other government policies).
  2. The Fed Funds rate is substantially higher than the 2-year Treasury yield, implying that the Fed is too restrictive with current rates, especially given the decline in inflation.

Our first chart shows these two yields.

This chart shows the 2-year Treasury yield (orange) versus the Fed Funds Rate (blue).

When the 2-year Treasury is higher than the Fed Funds rate (on the left side of the chart), the Fed is being restrictive in its policy. This is because the market is pricing in rates that are higher than what the 400 PhD. economists at the Fed think should be the proper rate.

The opposite is also true. When the 2-year Treasury yield is lower than the Fed Funds rate, they are being restrictive, as the market is telling them that rates should be reduced.

That has been the case for all of 2023 and 2024.

In this sense, the rate cuts were justified.

If we don’t see any further deterioration in the economy, this rate cut should be bullish.

Based on the initial reaction in stocks, the market agrees.

Normalization cuts overwhelmingly happen at or near all-time-highs, and they typically don’t signal an end to the bull market.

What has happened in the past when the Fed cut with markets at highs?

Rate Cuts with Stocks at All-Time-Highs

Another important data point when it comes to rate cuts is the timing of the first cut.

Our friend, Ryan Detrick, with the Carson Group, consistently has excellent charts about historical market reactions.

The two charts below show the times since 1980 that the Fed has cut rates when the S&P 500 Index was within 2% of an all-time-high.

Historically, when the Fed cuts rates with markets at all-time-highs, the market is higher one year later 100% of the time with an average gain of nearly 14%.

Bottom line is that being bearish on the markets at this point does not appear justified by the data.

Again, this can change and change quickly.

But for now, things look pretty good.

What Does Well After the First Rate Cut?

Another bullish development over the summer was a broadening out of participation in the bull market.

We have consistently been saying that small cap US stocks should play catch-up to the mega-cap tech that has done so well over the past two years.

This is supported also by stock performance after the first rate cut.

The next chart, courtesy of Bank of America, shows that small caps tend to outperform following the first rate cut.

This chart shows that over the next 6 and 12 months, small caps should outperform large caps if this historical relationship continues.

The reason this works is that smaller companies are more sensitive to bank interest rates than their large counterparts.

A 0.50% decrease in interest rates go mostly to the bottom line for smaller companies with debt.

This increases profitability and free cash flow, so it is logical that this would be the case.

More Rate Cuts?

Should we expect more rate cuts?

The real discussion is around the future path of interest rates.

Some people are predicting another 2% of cuts by the end of 2025.

It is our position that if we see another 1-2 rate cuts of 0.25% each, that would signal that we are likely headed to a recession.

It also would make sense that the Fed did a larger, 0.50% rate cut (instead of just 0.25%), so they wouldn’t have the appearance of propping up markets too close to the election.

Bottom Line

Bottom line is that this cut does not appear to be a signal that doom and gloom is headed our way.

That can happen, but the probabilities are not high that it will.

Instead, this rate cut looks like a normal response to declining inflation, and not a signal that the economy is deteriorating.

The market will now start to focus on earnings and the election.

We’ll put out another report discussing the election in the next few weeks.

Until then, invest wisely!

Where Oceans Meet but Don’t Mix

He released the two seas, meeting side by side. Between them is a barrier neither of them can transgress.

– The quran 55:19-21

Financial markets work in cycles.

Some cycles are short, lasting only hours. Like those following Fed meetings.

Others, however, last decades.

And when longer-term investment cycles change, things don’t always mix well.

Like many characteristics of financial markets, we see this phenomenon in nature as well.

What implications will this transition of investment cycles have on financial markets?

The Meeting of Oceans

At the southern tip of South Africa, the warm currents of the Indian Ocean meet the frigid currents of the Atlantic Ocean, as seen in the illustration below.

The dividing line between the Atlantic ocean and the Indian ocean is similar to when long-term investment cycles change.

Unlike geographic boundaries, the dividing line where these two oceans meet is determined by the CONDITIONS on each side of the line.

And despite their proximity, the composition of nearly everything in each respective ocean is different from one another.

Lifeforms, currents, temperatures, and mineral composition of the water all differ depending on which side of the boundary you look.

What is common place and normal under one set of conditions is abnormal and unusual in the next cycle.

Today, we are dealing with the transition from a falling interest rate cycle to a rising one.

The investment cycle, much like the meeting point of the Atlantic and Indian Oceans, is a place where forces collide, currents shift, and the landscape changes in unpredictable ways.

The transition between cycles is not always a clean one, either.

It can be messy.

This is because with longer-term cycles, investors become engrained in their belief that the underlying causes of the previous market cycle will continue into the next cycle.

Inflation & Interest Rate Cycles

The cycle we’re dealing with today is the inflation and interest cycle.

Historically, the full cycle lasts 60 years.

That’s 30 years of rising rates followed by 30 years of declining rates.

We can see this cycle on our first the chart below, courtesy of Tom McClellan.

The declining interest rate cycle that likely ended last year is actually quite late getting started.

According to the 30-year cycle, rates should have begun moving higher in 2010.

But the Fed had a different idea, and placed their thumb on the scale to keep interest rates at zero for another decade.

The decline in rates began in 1982. And began moving higher again in 2022.

That’s 40 years of a financial tailwind of declining interest rates supporting higher and higher asset prices.

When interest rates fall, the cost of money decreases. And when the cost of money decreases, profits rise.

This creates a “virtuous circle” of investment, where the declining cost of debt makes investment projects more and more appealing as rates fall.

But the inverse is true also.

Rising interest rates push the cost of capital higher, putting downward pressure on profit margins.

This pressure on profits results in many stocks struggling to grow during rising rate environments, mostly due to the influence of interest rates on valuations.

Stock Valuations and Interest Rates

One of the easiest places to visualize the effect of interest rates on the stock market is via valuations.

The next chart shows a scatter plot of the P/E ratio of the S&P 500 versus the 10-year US Treasury yield.

The yield of the 10-year Treasury is shows on the x-axis from left to right. The y-axis is the forward P/E ratio of the S&P 500 index.

Each blue dot shows the P/E ratio at the end of each month for the past 20 years, along with the corresponding 10-year US Treasury yield.

What this chart tells us is that there is a DIRECT correlation between interest rates and valuations.

And the formula is pretty easy: higher rates = lower valuations.

Most of the market is respecting this phenomenon.

The “Magnificent 7” is a term used for the largest seven companies in the index: Apple, Microsoft, Amazon, Nvidia, Meta, Google and Tesla.

This “Magnificent 7” is still trading as if interest rates were almost zero.

In the chart above, the red dot shows these seven stocks.

At an average valuation of 29.5, they are 72% more expensive than the rest of the S&P 500.

They may have better future growth prospects than other stocks, but this is still a very obvious data point where investors are assuming the lessons of the previous cycle will repeat in the next one.

The implication is that at some point in the next few months or years we should see reality start to set in for these big tech stocks.

That means that eventually we will start to see mid-caps, small-caps, international stocks and other investments start to outperform big tech stocks.

We’re seeing this in our system. We have recently added small caps, mid-caps and international stocks to client portfolios.

If interest rates put downward pressure on valuations, what does that mean bigger picture for the stock market?

Let’s look at the last two rising rate cycles for clues.

Rising Interest Rate Cycle (early 1900’s)

The last two times US markets experienced a rising interest rate cycle was in the 1970’s and the early 1900’s.

Let’s look at the early 1900’s first.

The next chart shows the Dow Jones Industrial Average from 1895 to 1925.

During this time, interest rates moved from a low of 3.7% to a high of over 6%.

This was the last interest rate cycle that happened before the existence of the Federal Reserve.

Over this period, stocks returned a whopping 1.4% per year compounded return.

Not great.

Interestingly, both GDP and earnings grew over the same period of time, much faster than the overall growth in equities.

This is because higher rates kept valuations low compared to the low rates of the previous cycle.

That’s great, but can we really compare today’s world to the one 100 years ago?

After all, isn’t everything different?

Sort of.

The one common denominator is us.

Humans are the key to the investment cycle.

With all of our flaws, behavioral oddities and penchant for making the same mistakes over and over and over, we bring our inherent biases to our actions whether we know it or not.

Sure, we think we’re smarter. After all, we have all the information in the world at our fingertips via our smart phones. But we tend to use it to view cat videos. So are we really that much more advanced?

But we digress.

So what about a more recent rising rate cycle?

Rising Interest Rate Cycle (1970’s)

The last time the US economy went through a rising rate cycle was in the 1970’s.

How did this compare to the period in the early 1900’s?

Answer?

Not any better.

In fact, stocks returned 0% over nearly 20 years.

Stocks had a nice move higher post-WWII, but ran into the same valuation wall as it did in the early 1900’s.

Higher interest rates simply make it more difficult for stocks to grow over time.

There are many factors that go into the relationship between interest rates and valuations:

  • High interest rates compete for capital. Cash paying 5% has attracted dollars that otherwise would have gone into stocks.
  • The current value of a future stream of cash flows goes down as the discount rate goes up.
  • Financing costs increase, reducing profitability.

One thing is for sure: we must pay attention as these cycles change.

Mini-Cycles Within the Larger Cycle

If we have indeed made the transition from a declining rate environment to a rising one, we should expect broad stock markets to struggle more than they did in the previous cycle.

In these environments, bull markets will likely be measured in months instead of years.

In both previous rising rate cycles, stocks had mini-bull markets that lasted from 24-36 months.

They were typically followed by bear markets lasting 18-24 months.

During the 1970’s, we saw 5 mini-bull markets, and 5 mini-bear markets, shown in the next two charts.

During each mini-bull market, prices met or slightly exceeded new highs on each subsequent move.

But each time markets would try to push to new highs, inflation would rise and a mild recession would occur. Stocks would fall to the low end of the range, and a mini-bear market would ensue.

This is the definition of a choppy market.

And this is the market that we may very well have over the coming decade.

Flash forward to today, and we’re in a bull market that has lasted 13 months thus far.

If the current cycle is anything like previous ones, we could see this mini-bull last a bit longer, possibly into mid-to-late 2024.

But chances are we should not expect a long-term bull market like we had during the 1980’s, 1990’s and 2010’s.

Bottom Line

The ebb and flow of interest rates and inflation create a dynamic environment that demands careful navigation.

In the coming years, it will become increasingly important to adjust exposure to risk based on non-emotional signals.

It will also become increasingly important to generate yield and not just rely on market appreciation to meet your financial goals.

A higher interest rate environment allows you to reduce risk and volatility over time.

But this rising interest rate cycle is not a two-year cycle that began in 2022 and ends in 2023.

Higher interest rates will likely be with us for many years into the future.

Invest wisely!

Market Video: Orderly Correction & Commercial Real Estate Risks

In this Market Insights video, we discuss the current state of the market and delve into the stress that is starting to show in the commercial real estate sector.

We also analyze the GDP for the third quarter and present three scenarios that could unfold in the coming months and years.

Join us as we explore these topics and gain valuable insights into the market’s performance.

  • 00:45 S&P 500 Index
  • 02:13 Russell 2000 Small Caps
  • 04:54 Performance of Different Markets
  • 05:46 Delinquent Loans in Commercial Real Estate
  • 06:33 Delinquency Rates in Retail, Lodging, and Office
  • 09:23 GDP for the Third Quarter
  • 10:29 Scenarios for the Future

Please don’t hesitate to reach with any questions.

Invest wisely!

Price versus Earnings

The stock market is never obvious. It is designed to fool most of the people, most of the time.

Jesse Livermore, stock trader and author

Stock markets are complex.

Unfortunately, there are many variables that move markets higher or lower.

However, not all variable are created equal.

Two of the big ones are the P/E ratio and earnings.

The P/E ratio (or price-to-earnings ratio) is a simple measurement that takes price per share of a stock or index and divides it by the earnings per share.

If a stock trade at $100, and earns $5/share, its P/E ratio is 20. ($100 divided by $5).

Another way to think about this is that the P/E ratio is a gauge of how much an investor is willing to pay per dollar of earnings.

One interesting aspect of the market increase this year is that it has been exclusively due to an increase in valuations.

Last October, the P/E ratio for the S&P 500 index was 16.3.

Today, it is 20.6.

Meanwhile, earnings for the S&P 500 have fallen 9.3% since last summer.

The chart below shows this discrepancy.

In this chart, the P/E ratio of the S&P 500 (shown in green) has mirrored the price of the S&P 500 (shown in blue).

Meanwhile, earnings (in orange) have consistently fallen over the past year. Granted, there is a glimmer of hope with the slight increase so far this quarter.

This discrepancy between the P/E ratio and EPS is the result of market participants paying more per dollar of earnings, and is essentially a sign of speculation.

However, this discrepancy could actually be a good sign.

Why?

This type of behavior typically happens when markets exit a recession.

Prices tend to move higher first, before the fundamentals start to reflect a more positive environment.

The next chart shows this same dynamic coming out of the 2009 lows.

The S&P and its P/E ratio rose in tandem after the lows in March of 2009, while EPS continued to fall.

There are major differences to consider in the comparison with 2009:

  • Today, valuations are elevated by historical standards at 21. In 2009, the P/E ratio was 12.
  • Interest rates today are over 5% and rising. In 2009, they were zero with no expectation of going up anytime soon.
  • We had one of the largest recessions in history in 2009, while we haven’t had one at all today.
  • Sentiment was extremely pessimistic in 2009, with optimism the overwhelming sentiment today.

So while today’s environment is very different from that of 2009, the behavior of the markets is very similar.

If earnings can start catching up to valuations, that will help remove the risk of a major decline in stocks.

Bottom line

While we are not out of the woods just yet, there are many positive developments happening.

With elevated valuations like we have now, the possibility of entering a long-term bull market seems low.

But the possibility of a major bear market is decreasing as well.

That means a sideways, choppy market for a long period of time could be what ends up happening.

In that type of environment, income and dividends will be important.

It will also be very important to not chase every market rise, and to not feel FOMO when markets go through periods of positive price action.

In a sideways market, the turtle wins the race.

Invest wisely!

Scrooged?

stern looking mature man in victorian costume carrying a cane . Model is wearing a dark suit , top hat, glasses and prosthetic make up , the look created is also similar to a Dickens victorian type character .

Men’s courses will foreshadow certain ends, to which, if persevered in, they must lead,” said Scrooge. “But if the courses be departed from, the ends will change.”

charles dickens, “A christmas carol”

In Charles Dickens’ famous book, A Christmas Carol, Ebenezer Scrooge begins the story as a mean-spirited and angry old man.

But he undergoes a transformative experience that changes him into someone who cares for others and embraces the spirit of giving.

The quote above by Mr. Scrooge is not the easiest quote to read.

If we paraphrase it, it may read something like this:

“If you go down a dangerous path, bad things will probably happen. But if things change, they might not be so bad after all.”

Currently, equity markets are trying to show more of a giving spirit like that of the transformed Scrooge.

But there are still MAJOR macro-economic signals with a grumpy, “old-Scrooge” like demeanor.

But will they will turn into positives in the coming months?

Grumpy Scrooge

First, let’s look at the more concerning indicators.

Specifically, there are three data points worth watching that are showing elevated risks for 2023:

  1. The Inverted Yield Curve
  2. Leading Economic Indicators
  3. Money Supply (M2)

These indicators tend to be excellent predicters of recessions when they turn negative.

And right now they are VERY negative.

Inverted Yield Curve

The yield curve is simply what a specific investment instrument yields at different maturities.

To understand the current yield curve environment, think of it like this:

Let’s say you want to invest in a Certificate of Deposit at a bank. You speak to a banker, and ask for the rates on a 2-year CD and a 10-year CD.

Logically, you expect the 10-year CD to be at a higher interest rate. You are, after all, committing funds to the bank for a decade.

But the banker tells you that the 2-year rate is paying 4.6%, while the 10-year rate is only 3.8%. This is an “inverted” yield curve.

When the yield curve on US Treasuries inverts, it has been the single best predictor of a recession in the past 100 years.

Right now, the yield curve is more inverted than anytime in the past 40 years.

The chart below shows the difference between a 2-year US Treasury bond and a 10-year one.

US Treasury yield curve is the 2-year yield versus the 10-year yield. It is currently inverted by the most in nearly 50 years, signaling a deep recession is likely in 2023.

When the line is above zero, the curve is “normal”. Below zero and it is “inverted”.

The past three times the yield curve was inverted was in 2008, 2000 and 1987. It became inverted before the markets had extreme stress, and each time led to a recession and tremendous market volatility.

This chart above only goes back to the 1970’s, but it’s the same well before that as well.

The depth of this inversion is worrisome too.

At roughly 0.83%, this is a very steep inversion, and one that is signaling not just a recession, but a deep one.

Leading Economic Indicators

Another key data point to monitor is the Leading Economic Indicator Index (LEI). We discussed this in our Thanksgiving report (read it HERE).

The LEI is another excellent recession predicter.

It’s so good, in fact, that EVERY time in the past 70 years we’ve seen the LEI at these levels a recession has followed.

The chart below, courtesy of Charles Schwab and Bloomberg, shows that the negative LEI is below the average level where recessions begin.

Schwab Bloomberg leading economic indicators showing negative data and at a level below where recessions typically begin.

LEI is telling us that a recession is imminent (unless this time is different, which is a dangerous assumption in financial markets).  But LEI is not a good timing tool…it does not tell us when a recession might begin.

It only tells us that one is close. 

And the rate of change does in fact suggest that a recession is likely to be worse than “mild”.

Another way to look at LEI is to look at the diffusion of the data.

Diffusion measures how widespread any strength or weakness is within the data. In the next chart, the diffusion index ranges from -50 to 50.  A reading below zero tells us that the majority of the data is weakening. 

Leading economic indicators diffusion index has an active recession signal.

When the diffusion index is below zero, it is indicating that a majority of the underlying data is weakening.  A reading above zero tells us the opposite, that most data is improving. 

When the diffusion goes below zero, it is a warning sign that economic trouble could be happening.  But a recession has not followed every time diffusion has turned negative.

Only when the index gets to minus-4 has it signaled that a recession is imminent.  The index is currently at minus-6. This is another excellent predicter of a recession, and it tells us that one is very likely to occur in 2023.

Money Supply (M2)

Another important, but little discussed aspect of financial market performance is the money supply.

There are various ways to measure the overall supply of money in a society. One of the broadest definitions is called “M2”. It measures the total amount of liquid funds in cash or near cash within a region.

This number includes cash, checking deposits and non-cash assets that can easily be converted into cash, like savings accounts and money markets.

If you’d like to learn more about M2, Investopedia has a nice article about it HERE.

M2 has a very high correlation to inflation. More accurately, changes in M2 have a very high correlation to inflation.

The next chart shows this phenomenon, courtesy of our friends at Real Investment Advice in Houston.

The black line is the year-over-year change in M2 (moved forward 16 months), while the orange line is CPI.

M2 is telling us that inflation is likely to head much lower in the coming 12 months.

On the surface, this would appear to be a good thing. After all, isn’t inflation one of the problems that markets face right now?

Maybe it is a good thing.

But the real problem is the extent of the decline.

After a massive increase in M2 during COVID, the rate of change has collapsed.

The problem arises in how big this decline has been.

It is not signaling that inflation should moderate. It suggest that inflation may turn into outright deflation.

The only way this happens is if we enter a moderate-to-deep recession. When major data points align like these three do right now, we must pay attention.

The New, More Giving Scrooge

While there are plenty of reasons to believe that 2023 is going to be a bad year again for stocks, not everything is bad.

Let’s look at some good data points right now:

  • The consumer remains strong. Shoppers spent a record $5.29 billion this Thanksgiving, an all-time record high. Yes, inflation had some to do with this, but at this point inflation is not having a meaningful impact on the consumer, at least; not yet.
  • Unemployment is low. The unemployment rate remains below 4%, primarily due to the services sector being strong.
  • Inflation is slowing some. CPI for October came in at 7.7%, below estimates of 7.9%. November’s CPI data will be published tomorrow. As we can see from the M2, we should expect inflation to slow in the coming months.
  • The Fed may be close to pausing. The market is anticipating a 0.50% increase at their meeting next week, with an additional 0.25% at their February meeting. Currently, markets expect that to be the end of interest rate increases for now. Historically, when the Fed Funds rate gets above the 2-year treasury yield, the Fed pauses interest rate increases. This will likely happen this week, so they very well could be done raising rates for a while.

Unemployment is a big data point here. Once the unemployment rate starts to rise, it has a direct impact on spending.

And consumer spending is roughly 70% of the US economy.

The main problem with looking at unemployment and other actual economic data is that they are backward-looking.

Once unemployment increases, we are already likely in a recession (even if it is not officially announced yet).

Which makes the forward-looking data points that much more important to consider.

Bottom Line

Despite the recent calm in markets, this is not a time for complacency.

Over the past 50 years, every time markets were volatile and NOT in a recession, NONE of the three indicators listed above were negative.  

Now, all of them are negative. And all of them were negative prior to recessions.

This tells us that the likelihood of a recession next year is extremely high. In fact, the data suggests that it should be more of a question about the extent of the decline, not whether one occurs.

Fortunately, it is not a foregone conclusion that a recession will be deep and painful. There is still plenty of time for things to change into something more positive.

Hopefully, this angry Scrooge-like data will transform to be something less angry and more joyous towards everyone.

But as we always say, hope is not an investment strategy.

For now, we must deal with the realities of the environment at hand.  And the current environment has major risks that should not be ignored.

Invest wisely!

Women and Money: An Evolved Approach

Inspired mature grey-haired woman fashion designer thinking on new creative ideas at workplace. Smiling beautiful elegant classy middle aged older lady small business owner dreaming in atelier studio.

Women at all age levels are redefining how they think about their financial journey. This includes career paths, planning for flexibility, taking charge of family finances, or being successful on their terms.

There are some generational differences among Gen Z, Millennial, Gen X, and Boomer women—but not as much as you’d think. And two main differences that set them apart from men hold across generations:

  1. Women are better investors than men1
  2. Women are more likely to approach financial planning as a partnership with a trusted advisor2
  3. Women value a financial advisor that listens to them more than men do3

Women tend to outperform men partly because they are more patient investors and trade less. This results in better performance over time and lowers costs.

As to the second result, the easy reach is to point out the men are reluctant to ask for directions when driving too. But it’s a little more complicated than that, and the reasons why women seek financial advice change as they move through their lifecycle.

How they want to partner with a financial advisor is also different. Women want to be sure that the advisor listens to them and understands and respects their priorities.

Gen Z and Younger Millennials

Younger women (Gen Z and younger Millennials) are generally comfortable and confident about money and financial planning.

They’ve grown up with more salary transparency, the proliferation of money-related apps to help with budgeting and investing, and the optimism of youth. They are interested in financial planning that fits their busy lives. They make good salaries, still have debt, are single or newly partnered, and want to get a good foundation in place.

They gravitate to financial planners that offer the planning they need in a way that they can relate to. This includes cash-flow planning, debt reduction strategies, maximizing employee benefits, and above all – helping them improve their financial literacy.

This generation of women understands the value of starting early on the path to financial independence and wants financial planning advice that can help them build a solid foundation.

Older Millennials and Gen X

Portrait of smiling beautiful millennial businesswoman or CEO looking at camera, happy female boss posing making headshot picture for company photoshoot, confident successful woman at work

As women approach the mid-point of their careers, money becomes more complex.

Careers are in full swing, and growing wealth brings to the fore the costs of making a mistake.

These women may not have worked with a financial advisor before. Whether single or partnered, they realize that all the different pieces of their financial lives need to come together in a comprehensive plan.

For them, it’s about creating the option to stop work, scale back work, start a business of their own, or do more meaningful work that may not be as highly paid – while maintaining a current lifestyle and still save for financial goals in the future.

They realize the value of working with a financial advisor that can help them put together all the pieces of their lives:

  • Equity compensation
  • What to do with an annual bonus
  • Tax planning
  • Saving for education
  • Taking the right amount of investment risk
  • Buying a second home or income property
  • Creating opportunity with their wealth

These women want a trusted partner that explains the “why” to them, and guides them to make choices that are right for them.

As things change, they value being able to make changes to a plan to accommodate new goals or different circumstances.

Older Gen and X-Boomers

These women are driving the decision to work with a financial advisor for themselves and their families. Very often, something has sparked the need to partner with a financial advisor to solve an immediate problem.

  • A change of job
  • A spouse’s health issue
  • Aging parents
  • Imminent retirement
  • Death of a spouse
  • Tax issues

Having a trusted partner to help them sort through the issue calmly in a non-judgmental way is paramount. They want someone to help them fix problems, provide solutions, and ensure that no other avoidable situations are on the horizon.

They may realize that a spouse has always done the financial planning and that it may be time for them to understand the specifics of their wealth. They may want to plan for a retirement that allows them the time they have always wanted with their family.

This group has the most anxiety around money and the least excitement.4 They need to develop trust and have an investment plan that helps them achieve their goals – without taking on too much risk.

The Bottom Line

Women are taking control of their and their families’ wealth at all points on the age spectrum.

They value working with a financial advisor, but they are clear in their need to have someone who listens, prioritizes their goals, is a trusted partner, and truly understands how they want to build and maintain wealth.

1.Fidelity 2021 Women and Investing Study.

2, 3, 4. U.S. Bank. Women and Wealth: Exploring the Gender Gap. 2021.

This work is powered by Advisor I/O under the Terms of Service and may be a derivative of the original.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.