Oct. 6, 2023

September’s Problems Weigh Heavily

During September, markets pulled back from their summer highs (fueled by a bubbly love affair with AI-futures) while new inflationary pressures emerged, including sharply rebounding oil prices and higher wage demands from striking UAW automotive employees, striking Kaiser Permanente healthcare workers, and pending strikes by the Las Vegas Culinary and Bartenders Union, the Los Angeles Service Employees International Union, and the American Airlines flight attendants union. Meanwhile, Congressional dysfunction over budget priorities and deficits has led to temporary government funding measures and a vote to vacate (fire) the Speaker of the House – both of which weigh heavily on credit rating agencies as they consider downgrading US debt.
 
Other than that, the economy and employment still appear to be strong. Oh – but doesn’t that create a case of “good news is bad news.” Continuing strong business activity implies that the Fed must work even harder to quell inflation by slowing down the economy. Thus, they will keep interest rates “higher for longer” and pull more liquidity out of the economy (quantitative tightening) – resulting in lower personal and business spending, lower sales, lower earnings, and thus lower valuations/prices for stocks. A thought to ponder:  Will the Fed handle the depth and duration of a recession with the same proficiency demonstrated in their handling of inflation?

StormGuard^TM Has Decisively Triggered

StormGuard reflects what investors are already doing, and are likely to continue doing. StormGuard began its sharp downward move in August and it only picked up steam in September, seeming to confirm that the market’s recent runup was simply part of an extended bear market rally supported by excess Covid liquidity, and not the start of a new secular bull market.

Anatomy of a Bubble

A classic market bubble is triggered by an attention getting event, fueled by momentum, and driven by emotion. Everyone loves getting in on something with great upward momentum until valuations get too high and the upward trend stops and a few folks start booking profits and everything unwinds with negative momentum. Given the excessive valuations of many technology firms it may be that we are at the place marked in purple on the chart. That said, keep in mind that elections, congress, other bubbles, and major world events can interrupt and overtake a particular bubble. As investors, we know that there are no guarantees, and that the game is one of improving the odds of being on the right side of the trade versus the wrong end of a bubble.

Inverted Yield Curve Trouble

The bond Yield Curve is said to be inverted when short-term interest rates are higher than long-term rates. An inverted yield curve has been a reliable indicator that a recession will soon follow. Note that a recession tends to follow an inversion. When the inversion ends it is because longer term bond yields increase to reflect that the bond market now believes higher rates from the Fed (a sign of trouble) will be around for much longer than a short while.

Long Policy Lags

In this table from First Trust, the columns show the dates when previous yield curve inversions occurred, when the triggered recession occurred, and the lag-days between inversion and recession. The information in the orange cells shows how long of a lag it has been since the last yield curve inversion and how it compares with the policy lag for other recessions. What the table shows is that this lag is not out of the ordinary as it is still shorter than average by at least a few months.