What’s Driving The Markets? 10 Things You Can Do To Prosper In The Current Market

After a significant down move in the stock market in April (S&P down -7.6%), May did not start off much better. The markets plunged -4.8% until Friday (May 13) and reversed course and sustained a rally up over 2%.

The immediate reaction from many of the talking heads on TV financial shows Friday afternoon and from analysts everywhere is: Did we put in the bottom?

It is very typical in a deep correcting market (only the Russell 2000 and NASDAQ are actually in bear markets, down 20% or more at this time), to get a significant corrective wave up.

We may have actually started this wave on Friday, but how long it will last and if it will endure is anyone’s guess.

While we (and nobody else for that matter) really don't know if that yet happened, our first reaction is emphatically NO! Most of the major indices (S&P 500, Dow, NASDAQ, Russell 2000) all have had a lot of damage done and are in bearish phases.

Actually, more value has been lost in the NASDAQ index than even the Dot-Com crash in 2000-2002. See the chart below:

What’s Driving The Markets?

As we have stated on numerous occasions, behavior in the stock and bond markets is often reflective of WHAT IS EXPECTED TO OCCUR in the future and not what is going on at the moment.

Let’s examine these 10 indicators in more detail and the influence they may be having on the markets today: (Not listed by priority)

1. Commodity Prices
   Building supplies, industrial metals, raw materials and especially oil prices are spiking and at or near all-time highs. This week the national average for oil hit the all-time high over $4.50 a gallon (much higher in parts of the US) and Diesel fuel is almost near $6.00 a gallon making the transportation industry incur significant costs which should eventually help fuel inflation higher.
2. Employment Picture
   The one bright spot of the economy is so good, it is overall creating a negative in many other areas (see below) including inflation and global supply chains issues. With approximately 4.5 million people leaving the job force last year and 11 million plus job openings currently in the US, this has fueled higher wages and higher labor costs.
3. Geopolitical Risk/Turmoil
   There are enough conflicts and world issues to write a whole page on. The turmoil between Russia-Ukraine as well as potential threats by China, instability in the middle east and North Korea all provide a backdrop for additional risk worldwide. These factors have driven the US dollar to recent highs and help collapse the Chinese yuan and Japanese yen, both currencies that have weighed negatively on the US markets.
4. Global Supply Chain
   The global supply chain has been broken for some time resulting in goods being hard to obtain (baby formula, building supplies, fertilizer for crops), while their prices are rising at a dramatic and punishing pace. In addition, China is still locked down in several large port cities due to COVID and it doesn’t seem that normal shipments will resume anytime soon.
5. Inflation/Stagflation
   Inflation is very high. Much higher than expected. After a dismal report in April showing March yearly inflation running better than 8% it was widely expected the reading would subside and we would see April’s inflation slowing. Instead, it came out above 8% again and higher than expectations. During recent polling, 94% of Americans say that their number one concern is rising prices (inflation). We also continue to see ongoing signs of stagflation.
6. Investor Sentiment
   By most measures (from different sources) investor sentiment is the worst it has been in many years, perhaps going back to the financial crisis of 2008-2009. This lack of optimism and fear that the markets could go down further has translated into a massive amount of outflows from the stock market and bond funds. This has exacerbated the downward trajectory of the markets. Until such time that many retail and 401k investors feel better about the markets, they are unlikely to recommit funds to stocks or bonds. We now know that many people’s behavior during the bear market of 2008-2009 was to go to cash late and not recommit to the markets in some cases for years. However, in the near term, we call this a neutral reading as these bearish signals often lead to quick rebounds and rallies that are usually not sustainable.
7. Mish’s Modern Economic Family
   The components that make up the Modern Economic Family are all in bearish phases. However, they all look oversold (outside the Bollinger® Bands on Real Motion) and with Friday’s rally may be in for a short-term bounce. However, given the damage in each of the charts, it may need a long sideways period before they retain any type of bullish phase.
8. Monetary Policy
   To curb inflation and fight many of the aforementioned problems, the Fed has started an aggressive action of raising interest rates and forecasted that their target before year-end is to get to 2.0%. After raising rates by 0.25% in March and then 0.50% in May, we are likely to see a continuation down this path. This is their soft landing approach. Will it work? We shall see. However, given the hot labor market and extreme inflation we are experiencing, many economists believe that three things could happen: 1) the Fed raises 0.75% at a future meeting and that may shock the markets; 2) the Fed raises more than the 1.9% targeted and have to go up to 2.5%-3.0% to get inflation well under control; 3) we have a hard landing and end up in a recession. There is an old axiom, Don’t Fight The Fed. That is especially true when they are lowering/accommodating (good for stocks) and when they are raising/tightening (bad for stocks).
9. Money Flows
   We have commented the past few weeks that asset liquidations out of stock and bond funds has accelerated and we have seen billions each week moving out of investments and into either cash or being used to support lifestyles, home purchases, and improvements. This has exacerbated the downward move of the stock and bond markets and is not likely to reinvigorate the markets anytime soon.
10. Yield Curve-Interest Rates
    The 10-year US Treasury rate is up approximately 100% since one year ago when rates were at 1.5% coming out of the Pandemic. They now sit around 3.0% and have helped bring down stock market valuations and move bond prices much lower (making the yield higher but value of the bonds much lower). Borrowing costs for everything from cars, to houses to corporate borrowing rates have gone up quickly. Plus, 30-year Mortgage Rates have risen from 3.25% to 5.5% on their way to 6.0%. This will not help the housing industry. Unless and until we go into a recession, we are not likely to see interest rates much lower. This will continue to weigh on stocks as analysts are already repricing price-earnings ratios factoring in higher raw material costs along with higher borrowing costs for most corporations.

Summary:
With one positive, one neutral and eight negative macro view indicators, the investment landscape continues to be overall negative. However, there are areas of positive investment themes, many of which we have exploited. These include energy, agriculture, mining, inverses on stocks and interest rates and special stock opportunities in large and small cap securities.

What to do Now? (What steps you can take to put yourself in a position to prosper)

1. Watch for market breadth and conditions to improve. Some of these are rather obvious like stability in prices or rising above the 50- and 200-day moving averages.
2. Watch for the large volatility and daily swings to begin to subside. This may be a sign that some of the risk and emotional erratic trading swings are beginning to quiet down.
3. Be careful using leverage. This includes options, margin and other types of accounts that may create too much risk.
4. Get good advice. If you are not getting it with the professionals you are working with, search out others you may be more comfortable with. Or call us and we will put you in touch with someone who may be more suitable for your portfolio.

Market Insights

Risk On

• With the selloff to start this week, all 4 key indices look like they are ending the week at the beginning of a mean reversion mode. (+)
• Friday’s recovery to the end of the week was led by speculative sectors including Semiconductors (SMH) +5.4% and Consumer Discretionary (XLY) +4%. (+)
• The McClellan Oscillator is bouncing off of oversold levels for both the SPY and QQQ, indicating the early stages of mean reversion. (+)
• Volatility (VXX) was unable to clear recent highs even during the recent selloff. (+)
• Sentiment determined by the percent of stocks above key moving averages improved significantly, another indication of mean reversion. (+)
• US Treasury Bonds (TLT) are also showing early indications of mean reversion, indicating on a short-term basis that the Fed may have overreached. (+)
• The speculative Semiconductors (SMH) improved on a relative basis to the rest of the market, leading Mish’s Modern Family this week and likely mean-reverting. (+)
• Despite inflationary pressures, Gold (NYSE:GLD) and industrial metals broke down into distribution phases. (+)

Risk Off

• SPY vs. Utilities remains in risk-off mode. (-)
• The top-performing sector throughout the week was Energy (XLE) +6.2% which is not surprising given that it is the only sector on our list that is positive Year-to-date +45.5% (-)
• Despite the end of the week recovery, the New High/New Low ratios for both SPY and QQQ are all still sloping down and under 20%, a longer-term negative indication. (-)
• Risk Gauges decreased to Risk-Off across the board. (-)
• After getting beat up last week and reaching oversold levels on both price and Real Motion, Soft Commodities (DBA) had a strong recovery this week and closed back in a bullish phase. (-)
• Oil (USO) is back in a full bull phase after a brief fakeout and looks poised for more upside if it can clear recent highs. (-)

Neutral

• Volume patterns improved to neutral across the board with a roughly equal amount of distribution and accumulation days over the past two weeks. (=)
• Growth Stocks (VUG) definitely improved against Value (VTV), but not enough to flip VUG into a buy signal. (=)
• This week saw a recovery in foreign equities (EEM and EFA) that outperformed the recovery in US equities on a relative basis. (=)
• The US dollar (UUP) continued its recent run, up another 1.3% week-to-date. (=)