Market Update
(all values as of 10.30.2020)

Stock Indices:

Dow Jones 26,501
S&P 500 3,269
Nasdaq 10,911

Bond Sector Yields:

2 Yr Treasury 0.14%
10 Yr Treasury 0.88%
10 Yr Municipal 0.94%
High Yield 5.72%

Commodity Prices:

Gold 1,878
Silver 23.72
Oil (WTI) 35.71

Currencies:

Dollar / Euro 1.17
Dollar / Pound 1.29
Yen / Dollar 104.44
Dollar / Canadian 0.75
 

Where is the U.S. in the Business Cycle?

This is a credit cycle, not a business cycle.  All depends on the price and availability of credit.  Having said that, this is the late stage of the cycle where in the past, the Fed took away the punch bowl by raising interest rates.  They appear intent on reprising that role, based in part on the theory that wage growth is about to accelerate as the labor market tightens.  Shamrock’s market strategist thinks this is wrong.  About 60% of the employable population is actually working vs. the  high at 64.5% in 2000.  That 4.5% difference amounts to over 12 million people, some of whom need training and some need to physically move to where the jobs are located.  New skills will be needed and people re-trained.  Susan Berger, chartist extraordinaire, commented recently that there have been five technology cycles during the last 250 years of Kondratieff Winters.  They are:

1.       The Industrial Revolution – 1771

2.       Steam and Railways – 1829

3.       The Age of Steel and Heavy Engineering – 1875

4.       The Age of Oil, Electricity, Mass Production and Autos – 1908

5.       The Age of Information and Technology – 1971

The current phase of Kondratieff’s Winter is witnessing another burst of innovations.  Artificial intelligence, self-driving cars, designer drugs, space travel, stem cell rejuvenation of organs, all these are signs that a new economy is unfolding.  Where are we in the U.S. cycle?  Late stage, but the money printers (cheap credit) have not yet run out the clock.

Credit Problems Spreading

Immediately prior to the last seven recessions, the U.S. experienced an inverted yield curve.  Despite the Fed raising interest rates and announcing plans to unwind their balance sheet, investors continue to flood into Treasuries. 

The spread between the 10-year Treasury and the 2-year is around 80 bps now, down from 265 bps just 3.5 years ago.  It has a way to go before dipping below zero, but this is the lowest level it has been since Q3 of 2007, just before the Oct. 11 2007 peak in the S&P 500 of 1576.  The ensuing slide in the SPX took it down to 666 on March 6, 2009, a drop of 58%.

Fed Chair Janet Yellen and company are trying to prick a bubble, and desperately hope the process will be smooth and easy.  After all, if injecting trillions into the markets with Quantitative Easing lifted markets slowly and steadily, why wouldn’t its removal?

The terminology being used for the Fed’s actions is “tapping the brakes,” but with two increases in six months, and more expected by the end of the year, combined with a balance sheet selloff, it feels a quite a bit more severe than a “tap.”  The Citi Macro Surprise Index below shows that economists are adjusting their expectations downward quickly, but the actual data is falling even quicker than their reduced numbers.  The last time the Macro Surprise Index was this low was in 2011, when Ben Bernanke started “Operation Twist.”

 

Biggest Risks to the U.S. Economy?

The stock market rise in 2017 is a result of improved corporate earnings and anticipation of corporate tax reform.  However if tax reform is not passed in 2017 and pushed to the 2018 legislation agenda, will equity prices decline precipitously?  We have seen the market continue to rise on weak GDP growth (revised up to 1.4% for the 1st quarter of 2017), but without lower corporate taxes that improve corporate earnings, stock valuations are too expensive.  As long as the markets believe that tax reform or tax cuts are coming, the markets are ok.  If something happens which ends the legislative effort to raise corporate profits, then stocks prices are too high.

Loose monetary policy has helped fuel the stock market rally.  While the Fed has raised rates twice in the past 6 months, a mistake here could push the economy into recession.  The Fed, according to their own dot plots, must believe there are four rate hikes coming over the next year or so and that they will be able to unwind a portion of their balance sheet as well.  Many economists expect about $50 billion per month to roll off the Fed balance sheet, which may be too high an estimate.  The point is, the U.S. economy is not strong enough to withstand an increase in the price of credit resulting from four rate hikes and a Fed balance sheet unwind at the same time.  We believe this type of monetary tightening would cause a recession and a crash in parts of the U.S. market.  The world market economy/markets would be similarly affected.   One conclusion, is that the Fed is making an unforced error by trying to hike rates and start the unwind at the same time.  One of the reasons typically given for an unwind is so the Fed has more room in the next crisis to ease; by expanding their balance sheet.  The Fed’s balance sheet holds about 25% of all U.S. government debt while the Bank of Japan holds about 33% of all Japanese Government Bonds.  They have room to expand their balance sheet and make it effective without causing a market/credit problem first by tightening too fast, after a 17 year credit cycle has loaded the economy with debt.  This is how a credit induced problem is triggered.

Fed Chair Janet Yellen recently made the following statement.  “We will not have a new financial crisis in our lifetime”.  Whenever people say “this time it is different”, usually signals a change is imminent.  With abundant credit and low inflation the world appears to have entered a Goldilocks scenario for growth.  However, are there unseen risks right around the corner?

Everyday 11,000 baby boomers enter retirement and look to their investment portfolio to replace their paychecks.  Believing another financial crisis will not occur in their lifetime can give investors a false sense of security.  Combining a strategic portfolio (fully invested) with a tactical strategy that can go to cash during severe market stress can help protect wealth when the next crisis appears.  Please contact us to discuss your total portfolio in order to insure it is prepared to face the next major market downturn.