Market Analysis: The Coming RecessionIn this post, I will present a market analysis with a focus on recession metrics and indicators. Right now, many of them are sending a recession warning.
Home Prices -
U.S. home prices are surging higher at the fastest quarterly rate of change on record. (See chart below)
This extreme rate of change in home prices is occurring as U.S. 30-year fixed mortgage rates also explode higher at nearly the fastest quarterly rate of change on record. (See chart below)
Additionally, we see in the chart below that 30-year fixed mortgage rates have potentially broken out into a new uptrend on the longer timeframes. The best way to detect trend reversals is by using the Ichimoku Cloud. When the price closes above or below the cloud (the shaded area) it is considered to have "pierced" the cloud. Once the cloud is pierced to the upside, resistance becomes support. In this case, assuming the piercing sustains, we can see a sustained period of higher interest rates on 30-year fixed mortgages.
Exploding home prices and exploding mortgage rates occurring simultaneously is unsustainable. Examine the yearly chart of U.S. home prices below and notice the similarities between 2005 and 2022. Notice that the Stochastic RSI is extended to the upside, and that home price extends above the upper Bollinger Band. Looking at this chart one could reasonably conclude that in the coming years home prices are likely to revert to the mean (orange line), as they did during the Great Recession.
Many analysts try to contradict what this chart is suggesting by claiming that we are in much better shape now than during the sub-prime mortgage crisis prior to the Great Recession. But are we really? With spiraling inflation, every mortgage holder suddenly becomes relatively more sub-prime. We also did not see mortgage rates explode then as quickly as they are now.
Unemployment -
Analysts point out that the current low unemployment is a reason to believe a recession can be averted. But under the surface, that's beginning to change in a hurry. Below is a chart of most leading unemployment data published by the Federal Reserve: Seasonally Adjusted Initial Claims (Weekly).
In this chart, we see that in about a period of the past 4 months, the amount of new unemployment claims has risen by around 100,000 or about a 50% increase. Compare this to the chart from the 2007-2008, when the U.S. economy was beginning to enter a recession (the shaded area represents where the recession began):
In the period leading up to the Great Recession, we saw a rise of about 50,000 new unemployment claims or about a 15% increase over a similar 4-month period. Therefore, the rate of increase of initial unemployment claims (both in real numbers as a percentage) is higher now than when we entered the Great Recession.
Perhaps more worrisome is the difference in how accommodative the Federal Reserve was in response to rising unemployment. Here is how the Fed Funds Rate changed as unemployment began to rise in late 2007 into 2008:
As unemployment was rising, the Federal Reserve began to cut interest rates. Compare this to the current situation in the below chart which shows the Federal Reserve raising interest while unemployment is rising. This change in context is reflective of both the fact that the Federal Reserve is behind the curve with containing inflation and the fact that the Federal Reserve is prioritizing the current problem (inflation) at the expense of the future problem (unemployment).
We are experiencing a macroeconomic situation whereby rapidly rising initial unemployment claims are being paired with rapidly rising interest rates. This combination is unlikely to end with any other outcome than a recession.
For more details on unemployment data see here: www.dol.gov
To interact with the initial unemployment claims data on a weekly basis you can go here: fred.stlouisfed.org
Yield Curve Inversion -
The 10-year minus the 2-year Treasury yield is used to detect an impending recession. When the 2-year yield rises above the 10-year yield that creates a yield curve inversion, which can often indicate that a recession is coming. Right now the yield curve inversion is very steep. In fact, just recently, the yield curve inversion actually steepened to a level that was even worse than what we saw before the Great Recession.
Perhaps most alarming are the rates of change in interest rates. Look at the 10-year yield Rate of Change on a 3-month basis:
Here's the 2-year yield rate of change:
The federal reserve uses the 10-year minus the 3-month as a more reliable indicator for detecting an impending recession than the 10-year minus the 2-year. However, the rate of change for the 10-year yield has been so parabolic to the upside that the 3-month yield has been struggling to invert relative to it. However, that may soon change. Here's the 10-year minus the 3-month yield chart:
Volatility -
As you know, volatility is measured by the VIX. The yearly Stochastic RSI for the VIX is trending upward, signally the potential for greater volatility now and throughout the years ahead.
This part is a little confusing, but try to follow if you can: Volatility of volatility is measured by the VVIX and is considered a leading indicator of the VIX. Currently, the VVIX is so suppressed to downside that the K value of the Stochastic RSI oscilator has reached zero for only the second time ever. (The first and only other time this has happened was in 2008). While this may be more coincidental than predictive, it nonetheless suggests that volatility of volatility has nowhere to go but up. See below.
Margin -
Margin has already unwinded both in real numbers and as a percentage by a magnitude that is consistent with, and usually only occurs during, a recession. See chart below.
Credit to Yardeni Research, Inc. You can view their full report here: www.yardeni.com
Stock Market -
Several bellwethers in the stock market are showing that, while we may have a robust rebound from extremely oversold levels in the short term, the longer timeframes look quite bearish, especially for the interest rate-sensitive tech and growth sectors.
For more details, here is my analysis on the QQQ/SPY relative performance:
Tech and growth are not alone in the bearish context. Indeed, the bull run from the end of the Great Recession to the current period has been characterized by increasing prices but decreasing volume. This is generally bearish, and may reflect that quantitative easing was a large cause of the bull run. Now, quantitative easing is ending in the face of spiraling inflation.
Other Metrics -
There are many other metrics that are used to detect recessions (e.g. GDP, PMI, M2V). Some may even look toward shifts in demographic trends, rising geopolitical tensions, declining globalization and climate change as recessionary factors. While I cannot discuss every possible metric, one last metric worth considering is the corporate bond market.
In 2020, during the COVID-19 shutdown, in order to stabilize markets, the Federal Reserve rushed in to save corporate bonds from crashing fearing that high borrowing costs for corporations could cause liquidity issues. Corporate liquidity issues can cause a whole host of issues from bankruptcies to layoffs. Currently, however, corporate bond prices have fallen to nearly that of the COVID low when the Federal Reserve rushed in to buy, yet the Federal Reserve is only just beginning quantitative tightening and just now beginning to roll bonds off its balance sheet.
Finally, I will leave you with this note: The time-tested winning strategy is to continue contributing as much as possible to your retirement fund. If the stock market crashes, do not stop or lower your contributions or try to pull money out because you think the world will end. Rather, continue to contribute as much as you can afford no matter what to a retirement mutual fund with diversified holdings. Contributions during market downturns will buy you more shares of your retirement mutual fund relative to the number of shares your contributions bought prior to the market crash. When price rebounds (and it will) you would have been glad to stick to this investment strategy.
Yieldcurve
Is the yield curve about to turn? The 10Y-03MY yield curve is the lowest ever. It looks like it cannot go any lower. Is it about to turn? And will it bring DXY up with it? An option is to buy AMEX:MINT or LSE:IBTE to play that trade.
Major Recession on the Basis of Yield CurveThe US Treasury Yield Curve is currently inverted, meaning short term interest rates higher than long term interest rates.
This unusual occurrence, called a yield curve inversion, has historically been a very reliable indicator of an upcoming economic recession.
Since World War II every yield curve inversion has been followed by a recession in the following 6-18 months, and recessions are naturally correlated with decreased stock market returns.
The yield curve has not been this lowin over 40 years.
The yield curve indicator is always followed by a major drop.
Triggering of the yield curve indicator also (ALWAYS) lags the yield curve inversion.
In other words, the yield curve inversion must return positive before the indicator triggers.
This is due to the lagging effects of interests rates on the economy.
That being said, since the yield curve is currently severely low, we can expect (another) yield curve indicator to be triggered later.
Once it is triggered, I expect a long-term decline of the markets.
Based on historical data, the decline will last several months, if not years.
Best of luck (not financial advice).
SHY/HYG - Daily, Inverted Candles, SPX overlay - Credit spread(4/10/2023) Monday - I wanted to publish this chart so we can follow the effect the credit spread had on the S&P 500 (SPX). As you can see the inverted candles correlate well with the SPX. Note the candles are inverted and the SPX is not, just to show better correlation. At the time of publishing there has been a significant move in credit that supports underlying conditions for the S&P 500. This is opposite what the FOMC is trying to accomplish as it causes more inflation.
With CPI coming out this week, Bank earnings start Thursday, and then the FOMC goes into blackout before the next Employment situation report for April. A lot can change. Being the last situation report was on Friday (US Markets closed observing Good Friday and Easter), Im not sure that report has been digested yet either.
On Mondays I post a market video and will include this link among the links to the yield curve inversions, and the IEF/LQD (Financial Conditions), unfolds. We can watch the bar replays. I added links to these charts below also.
4/10/2023 (Monday) SPY Analysis and Market Macro Deep DiveIn this Video I discuss The technical analysis of the SPY ETF which is a proxy the S&P500 that is often a tell on general market movements. I also discuss broader market Macros I have been watching including last week's and next weeks economic events. We also discuss some recession indicators, and other charts that show headwinds and tailwinds to equities.
In the Trading View App, You can use the links below and hit play, so you can see the action from the dates the charts were published. I will keep this going so we can follow outcomes to analysis.
Please Like and Subscribe , or on Trading View, Follow and Boost!
See you Next Monday for the next Market analysis!
What’s next for Gold & S&P 500?Having covered Gold & the Equity Index last week, this week we will look at how we could leverage both to trade on the move we’re watching!
Quite a happening market we first covered Gold two weeks ago.
Firstly, the interest rates market had a sizeable correction, with the 10Y-2Y yield now trading at close to -0.45% instead of the -1% range just 3 weeks ago.
Secondly, with FOMC out of the way, we have some clarity on what the Fed thinks of the current bank contagion episode as well as how markets reacted to the Fed’s statement.
With all these in mind, one thing we want to point out is the relationship between yield curve inversions across the different tenures of the curve. Comparing the past 2 episodes of yield curve inversion on the shorter and longer end of the curve, we note a few things here.
Firstly, the 10Y-2Y inversion generally leads the 2Y-3M inversion. Secondly, the past 2 times when both sections of the curve were inverted, we saw a significant sell-off in equities happening soon after. Thirdly, the inversions also marked the start of the next leg up for gold.
With peak inversion likely to pass for the 10Y-2Y curve and 2Y-3M inversion at the all-time low now, we see some potential to buy Gold and sell Equity Indices, as we’re raised over the past 2 articles!
When we use the S&P500 Futures Contract and the Gold Futures contract to view the ratio of the S&P500 / Gold, this ‘Selling’ point becomes clearer!
With the past 2 periods falling 59% and 69% respectively and lasting more than 700 days, this trade could take a while to play out, but the risk to reward seems attractive.
As to the hypotheses of why this relationship might exist, it could reside in the idea that abrupt rate cuts likely merely take place in a time of financial distress, hence the selloff in equities and flight to safe-haven assets like gold. When rates fall off, the non-yielding assets like Gold would start to look more attractive to yield-hunting investors, which could have added fuel to the Gold rally, too.
Taking a conservative target of 35% lower from the current ratio level of 2, we position a short in the S&P 500 / Gold ratio by selling 1 S&P 500 Futures and buying 1 Gold Futures, at the current price of 1980 for CME April 2023Gold Futures (GCJ3) and 4010 for the CME June 2023 (ESM3 ) S&P 500 Futures, the notional value of the position for the long & short leg is almost equal at;
Long GCJ3: 1980*100 = 198,000
Short ESM3: 4010 * 50 = 200,500
Setting up such a spread trade requires some monitoring of the difference in notional value to ensure that the position is properly hedged. Each 0.25-point move in the ESM3 contract is equal to 12.5 USD while a 0.1-point move in the GCJ3 contract is equal to 10 USD. Trading this spread would be eligible for a margin offset of up to 70%, meaning that the capital required to set up this trade is much lower.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference:
www.cmegroup.com
www.cmegroup.com
$TNX US02Y are CRATERING, Yields falling hardLast week we mentioned that #yields cratering like they did was not normal.
Currently they are all at support with $TNX holding better than short term yields. The 10Yr has BOUNCED a bit off support.
In a positive note it does lessens the inverted Yield curve :D
We'll see how this scenario holds.
What's happening today is more SPECULATION than anything else. The belief is that the #fed will stop raising rates due to the the bank closures that are happening.
IMO I don't think it'll stop them but MAY slow them down a bit.
The Fed Reserve HAS to pick between #economy & #stocks.
While the Fed has been friendly to equities and markets in the past its main concern in the US Economy. They also care about the US #dollar.
Interest Rates are Moving Again - Breaking Above Recent High2 year, 5 year, 10 year and 30 year yield are all showing a similar characteristic:
· Low established in 2020
· Major support trend started forming since then
· Seem to have completed its retracement with a double-bottom
· Resuming on its major support trend
· Target to break above its recent all-time high set on Oct 22
Chart illustrated a 10 year yield futures market.
Interest rates and yield moves in tandem, why?
Borrowers (for eg. home owners with loan) take reference from interest rates and lenders (or investors) take reference on the yield. Interest rates and yield moves in tandem.
Meaning if yields are indicating an upward momentum driven by mainly the investors, interest rates will soon to follow or vice-versa.
Though interest rates are making a U-turn from its recent low and breaking above its all-time high.
Are you seeing opportunity or feeling stress with more volatility ahead?
My strategy:
• Have lesser long-term hold on stocks
• Trading into the indices - Sell into strength and trading into the volatility
• Investing into commodities related asset
• Buying into dip(s) on yield futures
CME Micro Years Yield Futures
Minimum fluctuation
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Sweet Divergence Since the start of January, most leading macro markets have experienced a reversal around their 38.2% Fibonacci retracement levels. However, BTC has shown resilience and fought the cross-asset sell-off. This divergence is likely driven by the fact that there has been over $1 trillion in net liquidity added to the market since the bottom in October, primarily driven by the People's Bank of China and the Bank of Japan, helping to off-set the damage the Fed is doing to risk-on assets such as the crypto market. Considering BTC tends to be somewhat of a liquidity sponge, it tends to outperform other assets when there is a boost in liquidity. However, the jury is still out on whether BTC's performance indicates the end of the bear market for crypto or a temporary outlier. Despite BTC's recent outperformance, it's still catching up to significant rallies in other markets between Q4 2022 and Q1 2023. An important note is that the S&P 500 has never seen a bear market bottom before the unemployment rate began to rise, and this is yet to be the case. Furthermore, the yield curve is currently the most deeply inverted it has been since the 1980s, ultimately signalling that long-term interest rates are lower than short-term interest rates. An inverted yield curve has been a perfect predictor of the last seven recessions since 1960, ultimately implying that it's likely the market isn't out of the woods yet.
When yields and risk assets diverge, historical patterns suggest that other assets quickly catch up to the sell-off. Although yields have moved exponentially since last month's CPI data, markets expect them to stabilize at last year's high levels. It would likely take very hot inflation data and a significant rate hike following the next FOMC meeting on the 22nd of March to trigger the next leg lower for risk assets. Until then, BTC is expected to continue ranging, waiting for its next cue.
In other news, a recent article by Forbes threw Binance into the fire after they released an alleged hit piece on the exchange and its founder, Changpeng Zhao (CZ). The article drew parallels between the exchange and the now-defunct FTX after Binance allegedly transferred $1.8 billion to hedge funds such as Tron, Amber Group and Alameda Research between August and December 2022. However, CZ then hit back at this, arguing that the article referred to some old transactions from Binance's clients. He then reiterated that the exchange always holds user funds 1:1 and that this can be referenced through Binance's proof-of-reserve system.
From a technical perspective, it is clear from the weekly chart that Bitcoin has been trading between two significant demand and supply zones. The bulls will be hoping for a weekly close above the $25,000 supply zone, which would light the way towards the massive $28,800 to $30,000 resistance, the Head and Shoulders neckline. An important contributor to the bullish scenario is that EMA20 and EMA200 are beginning to converge, with a potential cross in the coming weeks. The importance of this should be considered, as EMA20 crossing below EMA200 back in September accurately predicted short-term market direction. Bears will rejoice at the fact that many traders believe that a final Elliot Wave 5 sell-off is to come. This would likely result in a break below the $15,500 - $16,500 November market bottom.
As we advance, all eyes will be on the CPI data releases. U.S. CPI data on the 14th will likely dictate the outcome of the rate decision of the FOMC on the 22nd. Volatility will be high around these dates, so caution should certainly be exercised, especially in leveraged positions.
Interest rates are moving againWhat is moving this week? Our weekly eyeball into the different markets.
Interest rates likely to be breaking its all time high again, get ready for another volatile month ahead.
Difference between yield and interest rate:
Borrowers take reference from interest rates and lenders take reference on the yield. Interest rates and yield moves in tandem.
Minimum price fluctuation:
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Things are looking very ugly, day by dayRate hike will continue as Jerome has no way out now. 50 basis points is my projection. Experts cannot see any concrete signs that economy is under control, in which they are right.
Wall St banker's narrative are switching from soft landing, to crash landing.
US money supply has shrinked while yield curve remain heavily inverted. Uh ohh.
Congress voted to end emergency allotment. This means millions of Americans will lose $3 Billion a month food stamp benefits.
Debt levels across all segments & categories are at record high.
Layoffs are still on-going and is not stopping.
Stay liquid and conserve ammunition. The bottom is not in yet.
By Sifu Steve @ XeroAcademy
Yield Curve InversionThe chart above is a yearly chart of the ratio of the 10-year Treasury yield (US10Y) to the 2-year Treasury yield (US02Y). The chart is meant to highlight how extreme the yield curve inversion is getting. Typically a yield curve inversion is indicative of an impending recession.
Usually, the 10-year treasury should have a higher yield than the 2-year treasury since there is more risk involved when you invest in a longer-term treasury. Just recently, the 10-year treasury yield has reached a record low ratio of only about 85% of the 2-year treasury yield. In other words, investors are being compensated less for taking more risk.
As the chart below shows, the rate of change (on a quarterly basis) in the 2-year Treasury yield has been parabolic.
Below is the rate of change (on a quarterly basis) in the 10-year treasury which is typically more stable than the rate of change seen in shorter-term treasuries. The chart shows that the 10-year treasury yields have also been moving up at an unprecedented quarterly rate of change.
Many analysts look to an inversion of the 10-year yield with the 3-month yield, which has not yet occurred. The failure of the 10-year yield to invert relative to the 3-month yield is likely due to the unprecedented rate of change in the 10-year yield, which has historically remained relatively stable. If the 10-year yield is moving up at a higher rate of change than the 3-month yield, this can delay or prevent an inversion altogether.
Check out my analysis from July for a more in-depth discussion on why the failure (or delay) of the 10-year yield to invert to the 3-month yield might be signaling that we've entered into a new supercycle, in which higher yields may continue for the long term:
Inflation is plateauing and likely to end flat in 2023Inflation is plateauing and likely to end flat in 2023, so what will that impact the markets?
Though inflation peaked at 9% last year and has been declining to 6.4%, CPI seems to be plateauing and may close flat in 2023, but this is not good news at all. Why? Because the Fed wanted to see the CPI or inflation coming down to 2% in a sustained manner.
Studying across the 2-, 5-, 10- and 30-years yield, we are seeing all the 4 yields almost breaking above its October 2022 all time high again. As long as the inflation remain flat at this current level, the Fed will continue its moderate rate hikes.
Therefore, we are expecting more volatility ahead with a flat inflation number.
This is definitely bad news for the stock investors, but not for the traders. Since 3rd week of 2022, I have exited from my long-term hold for the U.S. stock markets to trading the U.S. indices with much anticipated inflation and volatility.
Also, trading into the Micro Yield Futures. Since it is on an uptrend, I prefer to focus mainly on buy on dip strategy.
CME Micro Years Yield Futures
Minimum fluctuation
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
No Landing in the Twilight ZoneCBOT: Micro Treasury Yields ( CBOT_MINI:2YY1! , CBOT_MINI:5YY1! , CBOT_MINI:10Y1! , CBOT_MINI:30Y1! )
Is the US economy heading towards a “no landing”, as opposed to a “hard landing” or a “soft landing"? There is a heated debate among economists and market strategists.
What is a "no landing"? It is a new term drawn up by Wall Street, which describes the economy continuing to grow while the Fed raises interest rates to fight inflation.
Stock investors have a hard time making sense of the latest data from inflation, employment, and corporate earnings. The Fed’s future policy actions are unclear. As a result, the US stock market moved sideways in recent weeks.
Treasury Market in Disarray
With a widening negative yield curve, bond investors are convinced that a US economic recession is on the horizon. Let’s refresh our knowledge on this subject.
Yield curve shows interest rates on Treasury bonds with short-term, intermediate, and long-term maturities, notably 3-month T-Bill, 2-year and 10-year T-Notes, 15-year and 30-year T-Bonds.
Bond investors expect to be paid more for locking up their money for a long stretch, so interest rates on long-term debt are usually higher than those on short-term. Plotted out on a chart, the various yields for bonds create an upward sloping line.
Sometimes short-term rates rise above long-term ones. That downward sloping line is called yield curve inversion or negative yield curve. An inversion has preceded every U.S. recession for the past 50 years. It’s considered a leading indicator of economic downturn.
On July 21st 2022, the 2-year yield stood at 3.00%, above the 2.91% 10-year yield. Since then, we have been in negative yield curve environment for seven months. The 10Y-2Y yield spread has widened to -76.9 bps, but a recession has not yet occurred.
Below are current yields indicated by CBOT Treasury futures as of February 17th:
• 30-day Fed Funds: 4.665%
• 2-year Treasury: 4.618%
• 5-year Treasury: 4.014%
• 10-year Treasury: 3.848%
• 30-year Treasury: 3.883%
We observe that the longer the duration, the lower the yield. The 5Y, 10Y and 30Y yields all price below current Fed Funds rate target of 4.50-4.75%.
The US economy seems surprisingly strong, despite the Fed trying to cool it with eight consecutive rate hikes. However, negative yield curve contradicts the notion of “No Landing”.
Trading Opportunities in Micro Yield Futures
Investors currently expect the Fed to raise interest rates in March and June meetings, with the terminal rate consensus at 5.3% at the end of this tightening cycle.
Clearly, Treasury futures market has not priced in the pending rate hikes. The most underpriced interest rate is the 10-year yield. At 3.85%, it is 90 bps below current Fed Funds target and 1.45% below expected terminal rate.
On February 17th, the February and March 2023 contracts of CBOT 10-Year Micro Yield Futures (10Y) were quoted almost the same rate, at 3.850% and 3.853%, respectively. Investors apparently brushed off the upcoming rate increase in March.
My trading rationale: US businesses continue to expand, which provides solid support for the long-term debt market. With short-term yield rising fast, borrowers would flock to lower rate debt, pushing up demand for the longer-term credit. In my opinion, a 10-year yield below 4% is not sustainable.
For confirmation, let’s take a look at various market interest rates for 10-year duration:
• US Corporate AAA Effective Yield: 4.61%
• US Corporate BBB Effective Yield: 5.64%
• US Mortgage Rate, 10-year fixed: 6.24%
• Bank Certificate of Deposit, 10-year: 4.10% (Discover Bank)
Monthly contracts for the 10Y are listed for 2 consecutive months. Contract notional value is 1,000 index points. A minimum tick of 0.001 (1/10 of 1 bps) is worth $1. This means that a 25-bps increase will translate into $250 per contract. It would be a 77% gain in contract value if we use the $325 initial margin as a cost base.
April contract starts trading on March 1st. If it is quoted similar to the March contract, there is potential to gain. Whether we compare with market rates of debt instruments of the same 10-year duration, or with risk-free Treasury rates of different durations, a 10-year yield pricing below 4% is a bargain. Besides, the FOMC meeting on March 21st-22nd would likely give the contract a big boost, as long as the Fed raises rates. In summary, I would consider a long position for April 10Y contract at or below 4% yield.
What about the idea of yield curve reversal and the narrowing of 10Y-2Y spread? It may still happen, but its timing is unclear at this point.
Micro Yield futures are designed for shorter-term trading with contracts listing for only two calendar months. This is different from CBOT 2-year (ZT) and 10-year (ZN) futures which are listed for 3 consecutive quarters, currently through September. The traditional Treasury futures contracts would be better instruments for a yield spread strategy.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
$DXY is pumping again & so are yieldsFrom Friday
People discounted the US #Dollar $DXY but it came back beating historical tendencies (usually breaks lows before eventually coming back
1, 2 & 10 Yr $TNX
Huge inverted #yield curve =expecting turbulence short term
#inlfation may FORCE #FEd to keep raising bit more
Time to buy short duration treasury bonds?The Fed funds rate is higher than the 30 year treasury interest rate.
The last time that happened was in 2000 and 2008.
What happened back then was that the stock market and the 2 year treasury interest rate both dropped significantly.
Will history repeat itself?
The yield curve has to un-invert eventually… right? (Part 2)This week, we thought it will be interesting to review the trade from last week given the reaction post-FOMC, as well as discuss an alternative way to set up this trade.
Firstly, let’s review the post-FOMC/employment data reaction.
- Nonfarm Payrolls surprised to the upside, as over half a million jobs were added way above the estimates of a sub 200K number.
- Unemployment rate continues to fall further, reaching a 53-year low of 3.4%
A clear re-pricing has occurred since last Friday’s better-than-expected jobs data and Wednesday’s Federal Reserve meeting. With markets now expecting 1 more rate hike in May, bringing the peak rate up from the 475 -500 bps range to the 500-525 bps range.
Keeping this in mind, we go back to our analysis last week to understand this situation and historical precedence.
While the time for a pause in rate hike seems to be pushed back, in the grand scheme of things, we think that this has only kept the window of opportunity for this trade open for longer and at a more attractive entry point now.
Without repeating ourselves too much, we encourage readers to take a look at our idea last week which explores the historical correlation between the peaking of yield curve inversion and the pause in Fed rate hikes.
Link to our last week’s idea:
This week, let’s tap into a different instrument. Here, we aim to take a short position on the 2Y-10Y yield differential by creating a portfolio of Treasury futures to express this view.
To do so, we would have to first select the 2 instruments, the 2-Yr Treasury futures is a straightforward choice for the short end. But for the 10-Yr leg, we have a choice of the '10-Yr Treasury Note Futures' vs the 'Ultra 10-Yr Treasury Note Futures'. Digging into the contract specification, the 'Ultra 10-Yr Treasury Note Futures' provide a better proxy for the true 10-year duration exposure as the delivery requirements are for Treasuries with maturities between 9year 5 months and 10 years. In comparison, the underlying of '10-Yr Treasury Note Futures' has a maturity between 6 year 6 months and 10 years.
With contract selection out of the way, the next step is to calculate the Dollar Neutral spread. This requires us to identify the DV01 of the front and back legs of the spread and try to match them. This is to ensure that the entire position remains as close to dollar neutral as possible, so we can get a 'purer' exposure to the yield difference between the front and back legs, and parallel moves are negated. CME publishes articles on this topic to explain the setting up of a DV01 spread clearer than we can explain. You can find them attached in the reference section below.
You can handily find the DV01 of the Cheapest To Deliver (CTD) securities on CME’s website.
In this case, we are looking at the 2Yr and Ultra 10Yr Treasury Futures to set up the trade. With the DV01 of the 2Yr at 34.04 and the DV01 of the Ultra 10Yr at 96.26.
The spread ratio can be calculated as 96.26/34.04 = 2.83. Rounding this to the nearest whole number, we would need 3 lots of2-Yr Treasury Future and 1 lot of Ultra 10-Yr Treasury Future, to keep the DV01 equal (neutral) for both legs of this portfolio.
Given our view of the 2Yr-10Yr yield spread turning lower, we want to short the yield spread. Yield and prices move inversely, hence, to short the yield spread, we long the Treasury Futures spread as it is quoted in price. We can long 3 ZTH3 Futures (2Y Treasury Future) and short 1 TNH3 futures (Ultra 10Y Treasury Future) to complete 1 set of the spread. However, since the 2-Yr Treasury Futures has a notional value of 200,000 while the Ultra 10Y Treasury Futures a notional of $100,000, the price ratio will be 6:1 when the position/leg ratio in the spread trade is 3:1. As such the current level would provide us with an entry point of roughly 494 with a minimal move in Ultra 10yrs representing 15.625 USD and that in 2Y representing 7.8125 USD.
While slightly more complex in setting up, this trade allows us another alternative to express the same view on the yield curve spread differential. Being able to execute the trade via different instruments allows you to pick the most liquid markets to trade or take advantage of mispricing in the markets.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference
www.cmegroup.com
www.cmegroup.com
www.cmegroup.com
www.cmegroup.com
The yield curve has to un-invert eventually… right?Those who have been reading our past 2 ideas will know we’ve been harping on and on about expected rate path and policy timelines. Why the recent obsession you ask? Because we think we’re on the cusp of major turning points.
So, for the third time, let’s look at the market’s expected policy rate path.
With FOMC coming up this week, we are expecting a 25bps hike followed by some commentary/guidance on the next cause of action. Based on CME’s Fedwatch tool, markets are expecting a last hike of 25bps in the March FOMC before a pause in the hiking cycle. Now keep that in mind.
One interesting relationship we can try to observe is how the 2Yr-10Yr yield spread behaves in relation to where the Fed’s rate is. We note a few things here.
Firstly, the ‘peak’ point of the 2Yr-10Yr spread seems to happen right around the point when rate hikes are paused. With the Fed likely to pause as soon as March, we seem to be on the same path, setting up for a potential decline in the spread.
Secondly, the average of the past 3 inversions lasted for around 455 days, and if you count just the start of the inversion to the peak, we’re looking at an average of 215 Days. Based on historical averages, we are past the middle mark and have also likely peaked, with current inversion roughly 260 days deep.
Looking at the shorter end of the yield curve, we can apply the same analysis on the 3M-10Yr yield spread.
The ‘peak’ point of the 3M-10Yr yield spread is marked closer to the point when the Fed cuts, except in 2006, while the average number of days in inversion was 219 days and the average number of days to ‘peak’ inversion was 138 days. With the current inversion at 105 days for the 3M-10Yr Yield spread, we are likely halfway, but the peak is likely not yet in. (Although eerily close to when the Fed is likely to announce its last hike, March FOMC, 51 days away).
Comparing the 2 yield curve spreads, we think a stronger case can be made for the 2Yr-10Yr spread having peaked and likely to un-invert soon.
Handily, CME has the Micro Treasury Yield Futures, quoted in yield terms, which allows us to express this view in a straightforward manner allaying the complications with DV01 calculation. We create the short yield spread position by taking a short position in the Micro 2-Yr Yield Futures and a long position in the Micro 10-Yr Yield Futures, at an entry-level of 0.623, with 1 basis point move equal to 10 USD.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference:
www.cmegroup.com
www.cmegroup.com
Interest rate up to at least 6.5% in 2023, why?The Fed chairman has given the market a very important clue on 13 Dec 22.
At what level will he consider an interest rate cut?
He said “I wouldn't see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way,” meaning only if CPI is heading nearing 2% then it is hopeful to see a rate cut.
Market consensus for CPI to range between 5% to 8..9% for this year. If this is true, the Fed is likely to continue to hike the rate moderately at 0.25% in each meeting just to bring inflation down.
I am seeing this as the best case scenario.
Today’s content:
Strategy in an inflationary environment:
i. Commodity – Buy them
ii. Stock market – Trade them
Can inflation be hedged and can we trade into the interest rate uptrend?
CME Micro 30 Year Yield Futures
Minimum fluctuation
0.001 point = $1
0.01 point = $10
0.1 point = $100
1 point = $1,000
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Forget the "Santa rally"Forget the "Santa rally," it's time to brace ourselves for a potentially tumultuous 2023 as concerns mount over bond market developments and their impact on Q1 earnings
Santa is tired, Kids
It is uncertain whether the annual "Santa rally" will occur in 2022 due to the bear market. There are concerns about the recent developments in the bond market and their potential impact on Q1 2023 earnings. Some stocks, such as Amazon, have approached their 2020 lows, which raises the possibility of a "sell the rumor, buy the fact" situation. In the past, when the NASDAQ has experienced a 20% annual drop, negative consequences have followed in subsequent years, with particularly poor performance in the first year. The 10-year treasury yields have reached their highest levels since November and the Federal Reserve may be unable to provide support as it did in 2008, putting portfolios at risk in the coming year. Most strategists expect market prices to remain around current levels by the end of the year, though some have forecasted SPX values of 3400, 3650, and 3725. A shooting star-style weekly candle on the Bond market has signaled potential significant drops in the S&P 500, ranging from 18-20%. There has been a rotation in market performance in the past month, with sectors such as energy, utilities, financials, staples, healthcare, and defensive stocks performing well, while semiconductors, tech, consumer discretionary, clean energy, and solar have struggled. This trend, known as stagflation, has also been reflected in the performance of assets like gold and the GDX. Valuation compression has also been observed in the market, particularly in the clean energy sector. The VIX, or volatility index, has reached levels similar to those seen during the Global Financial Crisis, raising concerns about a potential fear-driven market in 2023. The U.S. two-year yield and 10-year yield have also risen, with the potential for inflation to increase due to recent Covid outbreaks and supply chain disruptions. The high yield market has weakened, with the rejection of topping islands and a deviation from the usual two.
Hairy Bonds
Why is the bond market like a box of chocolates? You never know what you're gonna get! Bonds have recently experienced a sharp decline, largely due to expectations for the federal funds rate and the potential for further COVID-19 lockdowns. This is also contributing to concerns about inflation and the ability of the Federal Reserve to effectively combat it. As a result, the performance of bonds has been impacted, as they tend to do better in environments with rate cuts. The Federal Reserve's slower pace of cuts suggests it may take longer to support the economy and potentially puts additional pressure on economic fundamentals and company valuations. The S&P 500 has seen significant losses on specific days in 2022, including September 13th, May 18th, June 13th, April 29th, and May 5th. These days have resulted in drastic percentage moves, with some as high as 4.3%. In the past month, there has been a rotation in market performance, with sectors such as energy, utilities, financials, staples, healthcare, and defensive stocks performing well, while semiconductors, tech, consumer discretionary, clean energy, and solar have struggled. This trend, known as stagflation, has also been reflected in the performance of assets like gold and the GDX. Valuation compression, or a decrease in the price-to-earnings ratio, has also been observed in the market, particularly in the clean energy sector. It is important to continue monitoring key levels and considering the potential impact on portfolios.
Yield those Funds
FUN FUNDS!
The Federal Funds rate, also known as the benchmark interest rate, is the rate at which banks lend and borrow overnight funds from each other to meet their reserve requirements. It is set by the Federal Reserve, the central banking system of the United States, and is used as a tool to achieve its monetary policy objectives.
Over the past two decades, the Federal Funds rate has had a significant impact on the stock market, particularly the S&P 500 index (SPX). In general, changes in the Federal Funds rate can affect the stock market in a number of ways, including through the cost of borrowing, the level of economic growth, and investor sentiment.
During the early 2000s, the Federal Reserve implemented a series of interest rate cuts in response to the dot-com bubble and the 9/11 terrorist attacks, which helped to boost the stock market. The SPX reached an all-time high in 2007, just before the onset of the global financial crisis. In response to the crisis, the Federal Reserve implemented a series of aggressive interest rate cuts, which helped to stabilize the market and contribute to the recovery of the SPX.
Since the recovery from the financial crisis, the Federal Reserve has generally maintained a low interest rate environment, with the Federal Funds rate hovering around 0%. This has been supportive of the stock market, as low interest rates can make stocks more attractive to investors by reducing the opportunity cost of investing in stocks relative to other asset classes.
However, as the economy has improved and the stock market has reached new highs, the Federal Reserve has begun to gradually increase the Federal Funds rate. While the impact of these increases on the stock market has been relatively limited so far, some analysts have raised concerns that further increases could lead to a slowdown in the market.
Currently, in 2022 leading into 2023, there are no signs yet of the Federal Reserve cutting or tapering rates as the market continues to decline, marking a period of demand destruction. This suggests that the Federal Reserve may be hesitant to use monetary policy as a tool to support the market in the current environment. Instead, the Federal Reserve may be looking to continue rate hikes towards 2000 or 2008 levels.
See chart
In addition: also see
Interesting Inflation!
The "Interesting Inflation" indicator is a technical analysis tool that is designed to provide traders with information about the rate of inflation in the United States. It is designed to work on monthly charts and uses data from the Consumer Price Index (CPI) to calculate the average rate of inflation over a specified period of time.
On the chart, the light blue to orange line represents the average rate of inflation, while the dark blue line represents the trend in the inflation rate for the month of December. The green line represents U.S. interest rates.
The indicator includes a number of inputs, including a toggle to show the inflation rate for the month of December and a setting to enable or disable the display of U.S. interest rates. It also includes a number of plots, including plots for the U.S. inflation rate and U.S. interest rates.
To use the "Interesting Inflation" indicator, traders can simply add it to their chart and adjust the input settings as desired. The indicator will then display the average rate of inflation and, if enabled, the U.S. interest rates on the chart. Traders can use this information to understand the current inflation environment and to make informed decisions about their trades.
In addition to the average rate of inflation, the "Interesting Inflation" indicator also includes a plot for the inflation rate in the month of December. This can be useful for traders who are interested in understanding the trend in inflation over the course of the year and how it may affect the market.
In November 2022, the United States saw a 7.1% increase in prices compared to the previous year, according to the monthly consumer price index (CPI) for goods and services. The CPI, which measures the rate of inflation, shows the percentage change in the price of a basket of goods and services over time. Inflation in the United States has been particularly high in 2022 due to the COVID-19 pandemic, supply chain issues, and the Russian invasion of Ukraine. The annual inflation rate in the United States has risen from 3.2% in 2011 to 8.3% in 2022, indicating a decrease in the purchasing power of the U.S. dollar.
According to data from the International Monetary Fund, the U.S. CPI was approximately 258.84 in 2020 and is expected to reach 325.6 by 2027, compared to the base period from 1982 to 1984. In November 2022, the monthly percentage change in the CPI for urban consumers in the United States was 0.1% compared to the previous month.
Inflation is a significant economic indicator and is being closely watched in countries around the world. Brazil saw an inflation rate of 8.3% in 2021 compared to the previous year, while China's rate stood at 0.85%.
Like a Bottle!
The yield curve represented in blue on the bottom is the graphical representation of the relationship between bond yields and their corresponding maturities. In general, long-term bonds tend to have higher yields than short-term bonds, as investors demand a higher return to compensate for the additional risk associated with tying up their money for a longer period of time. This results in a normal yield curve, where long-term yields are higher than short-term yields.
However, in some cases, the yield curve may become inverted, with short-term yields exceeding long-term yields. This can occur when investors are concerned about the future outlook for the economy and are willing to accept lower returns on long-term bonds in exchange for the added security of a shorter investment horizon.
One specific aspect of the yield curve that is often monitored is the spread between the 10-year and 2-year yields. When the 10-year yield is lower than the 2-year yield, it is known as a yield curve inversion. A yield curve inversion is often viewed as a bearish sign for the stock market, as it can indicate that investors are concerned about the economic outlook and are becoming more risk-averse.
Historically, yield curve inversions have preceded recessions and bear markets, as investors become less willing to take on risk and demand safer, lower-yielding investments. As a result, a yield curve inversion can be an important signal for traders to consider when evaluating market conditions and making investment decisions.
One historical example of a yield curve inversion preceding a market crash is the global financial crisis of 2008. In early 2007, the yield curve inverted, with the yield on the 10-year Treasury bond falling below the yield on the 2-year Treasury bond. This was a clear warning sign that investors were becoming increasingly concerned about the economic outlook and were seeking out safer, shorter-term investments.
As the year progressed, the financial crisis deepened, with the housing market collapsing and major financial institutions experiencing significant losses. The stock market, as measured by the S&P 500 index, reached its peak in October 2007 and then began a steep decline, eventually bottoming out in March 2009.
The yield curve inversion was just one factor contributing to the financial crisis and market crash, but it was an important warning sign that investors should have paid attention since it is currently inverted, which has historically preceded a recession within the next two years. However, the size of the inversion does not necessarily determine the severity of the recession. While the current inversion is larger than previous ones, it does not necessarily mean that the upcoming recession will be worse. In addition, the stock market's recent behavior is not indicative of a burst bubble, meaning that the potential decline in the market during the recession may not be as severe as previous ones
It's worth what you pay for it
In the first quarter of 2023, earnings will be in focus for the market. The recent sell-off in stocks, particularly those such as Amazon that have almost reached 2020 lows, has raised concerns about what will happen next. The 10-year Treasury yields have risen to their highest levels since November, which could indicate a longer period for the Federal Reserve to combat inflation and support the economy. These factors, along with the high rates of Covid outbreaks and the potential for stagflation, have contributed to the rotations seen in the market, with energy, utilities, financials, staples, healthcare, and other inflation plays performing well, while semiconductors, tech, consumer discretionary, clean energy, and solar have struggled. The VIX, or volatility index, has also reached levels similar to those seen during the Global Financial Crisis, raising concerns about a potential fear-driven market in 2023. The U.S. two-year yield and 10-year yield have also risen, with the potential for inflation to increase due to the recent Covid outbreaks and supply chain disruptions. The high yield market has also weakened, with the rejection of topping islands and a deviation from the usual two to one ratio with the S&P 500. These factors could all impact market performance in the coming year.
Fearing Futures
The US dollar futures are currently looking strong, with indications of accumulation in the market. This is supported by the recent closure of nice wick rejections off the lows and a move above 104. The two-hour chart shows evidence of accumulation at this point, with a critical bottom and big rejections at a certain level, as well as a double bottom formation. If the market breaks above 104, there is potential for a bigger trade to reach 107. Despite negative sentiment towards the US dollar recently, most trend lines show a break through. It is important to note that a strengthening US dollar may not be positive for the US stock market. Gold has been exhibiting a series of higher lows and has broken to a new high. However, it is important to be cautious when trading gold at this time of year due to large spreads and illiquidity. Gold is currently rejecting these levels and it is important to monitor the weekly chart for any potential break and close above a certain price, which could lead to a drop met by strong demand. Oil stopped at 81 and has fallen off, with wick rejections in the 81-82 range. The two-hour chart for oil is difficult to interpret at this time, with no new lows. It is important to monitor the market for a break below a certain price, which could indicate a potential move to the downside.
King Elon, the Musk
The performance of Tesla (TSLA) has been a key focus in recent market analysis. According to the provided text, TSLA has recently moved above the 104 level, indicating some form of accumulation in the market. This is supported by the presence of "nice Wick rejections" at this level and the establishment of a new high, followed by a pullback to the 618 Fibonacci level where buyers were found again. While sentiment towards the US dollar has been negative, the trend lines suggest that the currency may continue to strengthen, which may not be positive for the US stock market as a whole. However, TSLA's performance may not be directly impacted by this trend. Instead, the focus is on whether TSLA can break above the 104 level and potentially reach a bigger trade with a target of 107. It is recommended to buy dips in TSLA at this time, although caution is advised due to the potential for large spreads and illiquidity in the market around the new year. Overall, the performance of TSLA will be closely watched in the coming week, as key indicators such as long leg doji candles suggest indecision or equilibrium in the market. It is important to exercise patience and react to developments rather than attempting to predict them, as the market for TSLA may be challenging to trade in the short term. The Tesla stock price has experienced significant volatility recently, with the stock reaching new highs and then falling off. This has resulted in many traders experiencing stop loss triggers and margin calls. The market has been bearish on tech stocks, particularly those with high valuations, and this has weighed on the overall market. It remains to be seen how the market will react to Q1 earnings, but it is expected to be a significant event that could impact the direction of the market. In the meantime, traders should keep an eye on key levels and be prepared for potential volatility.
Weighing a Giant
Apple's weekly close is significant because if it goes below the low formed in June, it may indicate that the biggest stock in the world is facing significant headwinds. There may be rallies, but they may be sold due to the stock approaching key levels. The Gap close for Apple is also relevant to Amazon, which is approaching its 2020 low at around 81.33. This may cause some buyers to recommit and trigger a lot of sell signals, as well as margin a lot of people's stop losses. Semiconductors have continuously sold off due to concerns about valuations and the impact on tech stocks, particularly in the market. It is possible that this could be due to selling rumors ahead of Q1 earnings. The Dax has been more technical and has sold off after reaching a resistance level. If the market trends sideways over the next few days, it may trap options money. The US30 has held up relatively well, but it has not yet reached a new high above 33,000. There may be gaps left behind in the area between 32,500 and 33,000. The US500 has formed a bearish flag and may test its 200-day moving average. If it breaks down from this pattern, it may indicate that the market is heading lower. The Nasdaq has been underperforming and may test its 50-day moving average. The Russell 2000 has been lagging and may test its 50-day moving average. The US dollar has been in a range and may test its 200-day moving average. Gold has formed a bearish flag and may test its 200-day moving average. Oil has formed a bearish flag and may test its 50-day moving average. The 20th is a significant options expiration date with almost 5 million units, and there is a large number of puts stacked compared to calls. This may indicate that the market may rally initially and then sell off later. Bitcoin has pulled back to a key level and needs to rally through 17,000 again to potentially reach 17,500 to 17,600. However, the current outlook is negative and there is a potential for it to go lower. The market trend has been for rallies to be met with sell demand due to risk-on and risk-off assets, with Bitcoin being a risky asset. In general, it is expected to trade between $9.5k and $11.5k
See charts:
TLDR
Bond market developments and their potential impact on Q1 2023 earnings
Santa rally may not occur in 2022 due to bear market
Some stocks, such as Amazon, approaching 2020 lows
NASDAQ has experienced 20% annual drop in past, negative consequences in subsequent years
10-year treasury yields at highest levels since November, Federal Reserve may not provide support
Market prices expected to remain around current levels by end of year, some S&P predictions of 3400, 3650, 3725
Shooting star-style candle on market signals potential significant drops in S&P 500
Rotation in market performance in past month, with energy, utilities, financials, staples, healthcare performing well, and semiconductors, tech, consumer discretionary, clean energy, solar struggling
Stagflation trend reflected in performance of assets like gold and GDX
Valuation compression in clean energy sector
VIX at levels similar to Global Financial Crisis, potential fear-driven market in 2023
U.S. two-year and 10-year yields have risen, potential for inflation due to Covid outbreaks and supply chain disruptions
High yield market has weakened, rejection of topping islands and deviation from usual two
Earnings in focus for market in Q1 2023
Sell-off in stocks raises concerns about future, 10-year Treasury yields at highest levels since November
Factors such as high Covid rates and potential stagflation contributing to market rotations
Potential for additional fiscal stimulus, potential for vaccine rollouts to impact market
It is important to monitor key levels and consider protective measures for portfolios heading into 2023
If you want to continue, good luck, Chuck!
The Blackest of Rocks
In a recent article, BlackRock Vice Chairman Philipp Hildebrand explains that the Great Moderation, a four-decade period of stable activity and inflation, is over and that we are now in a new regime of greater macro and market volatility. This new regime is characterized by a recession that is foretold and central banks that are on course to overtighten policy in an effort to tame inflation, leading to persistent inflation and output volatility, rate hikes that damage economic activity, rising bond yields, and ongoing pressure on risk assets. Hildebrand and the BlackRock Investment Institute team suggest that a new investment playbook is needed to navigate this new regime, with three key themes: pricing the damage, rethinking bonds, and living with inflation. They recommend balancing views on risk appetite with estimates of how markets are pricing in economic damage, taking more granular views by focusing on sectors, regions, and sub-asset classes, and considering tactical and strategic investments in inflation-linked bonds.
According to Mr. Hildebrand and the team at BlackRock, we have entered a new regime characterized by persistent inflation and output volatility, central banks pushing policy rates to levels that damage economic activity, and ongoing pressure on risk assets. This new regime is being driven by production constraints such as aging populations leading to worker shortages and the pandemic shift in consumer spending from services to goods causing shortages and bottlenecks. Central banks' policy rates are not equipped to resolve these production constraints and are left with a trade-off between crushing demand to achieve their inflation targets and allowing for more inflation. As a result, a recession is likely on the horizon, but as the economic damage becomes more apparent, central banks may stop their rate hikes even though inflation will not fully return to target levels. There are also long-term trends such as aging populations, persistent geopolitical tensions, and the transition to net-zero carbon emissions that are expected to continue to constrain production capacity and cement this new regime.
In the report "Navigating Markets in 2023" published by BlackRock, it is noted that navigating markets in 2023 will require more frequent portfolio changes.In determining tactical portfolio outcomes, BlackRock plans to consider two assessments: their assessment of market risk sentiment and their view of the economic damage reflected in market pricing. BlackRock is currently at its most defensive stance, with options for turning more positive, especially on equities. The company is also underweight in nominal long-term government bonds in each scenario in the new regime, which is their strongest conviction in any scenario. BlackRock can turn positive in different ways, either through their assessment of market risk sentiment or their view on how much damage is reflected in market pricing.
A recession is imminent as central banks attempt to control inflation. In contrast to past recessions, loose policy will not be used to support risk assets. As a result, the traditional strategy of "buying the dip" is not applicable in this context of increased macro volatility and trade-offs. Instead, it is necessary to continuously reassess the extent to which central bank actions are damaging the economy and factoring this damage into investment decisions. In the U.S., the impact can be seen in rate-sensitive sectors, such as the housing market, as well as declining CEO confidence, delayed capital spending plans, and a depletion of consumer savings. In Europe, the energy shock is exacerbated by tightening financial conditions. The ultimate economic damage will depend on the measures taken by central banks to reduce inflation. The author's approach to tactical investment is influenced by their assessment of market participant risk appetite and the extent to which damage is reflected in equity earnings expectations and valuations. They expect central banks to stop raising rates and for activity to stabilize in 2023, but do not believe that earnings expectations currently factor in even a mild recession. As a result, the author is currently underweight on developed market (DM) equities on a tactical horizon. However, they are prepared to become more positive as valuations better reflect economic damage and risk sentiment improves.
The recent increase in yields has made fixed income assets more attractive to investors who have been seeking yield for a long period of time. Blackrock takes a specific approach to investing in this environment, rather than taking broad, aggregate exposures. They believe that the case for investment-grade credit has improved and are raising their overweight position both tactically and strategically. They believe that these assets can hold up in a recession due to the fortification of company balance sheets through debt refinancing at lower yields. Agency mortgage-backed securities, a new tactical overweight, can also serve a diversified income role. Short-term government debt is also attractive at current yields, and Blackrock has created a separate tactical view for this category. In contrast, Blackrock does not believe that long-term government bonds, which have traditionally protected portfolios during recessions, will serve this purpose in the current environment. They argue that the negative correlation between stock and bond returns has reversed, meaning that both can decline simultaneously. This is due to the likelihood that central banks will not implement rapid rate cuts during recessions that they have caused in an effort to bring down inflation to policy targets. Instead, policy rates may remain higher for longer than the market expects. Investors may also demand higher compensation, or term premium, to hold long-term government bonds due to high debt levels, increasing supply, and rising inflation. Central banks are decreasing their bond holdings and Japan may cease purchases, while governments are continuing to run deficits, leading to the private sector having to absorb more bonds. As a result, Blackrock remains underweight on long-term government bonds in both tactical and strategic portfolios.
High inflation has caused cost-of-living crises, leading central banks to take action to bring down inflation. However, there has been little discussion about the impact on growth and employment. Blackrock believes that the narrative around the "politics of inflation" is on the verge of shifting as the negative effects become more apparent and the "politics of recession" take center stage. They also believe that central banks may be forced to stop tightening in order to prevent financial cracks from becoming more severe, as seen in the UK when investors reacted negatively to fiscal stimulus plans. Despite the impending recession, Blackrock expects that inflation will persist above policy targets in the coming years. They attribute this to normalization of spending patterns and a decrease in energy prices, as well as long-term constraints such as aging populations, geopolitical fragmentation, and the transition to a low-carbon world. Blackrock's strategic views have reflected this new regime, with an overweight to inflation-protected bonds for several years. However, market expectations and economist forecasts have only recently started to acknowledge the persistence of inflation. Blackrock believes that markets are underappreciating inflation and, as a result, have a high conviction, maximum overweight to inflation-linked bonds in strategic portfolios and maintain a tactical overweight regardless of how the new regime plays out.
Blackrock says, the best way to predict the future is to examine what their companies are saying. They have a 2023 playbook that is ready to adapt quickly depending on how markets price economic damage and their risk stance evolves. Blackrock prefers short-term government bonds for income, due to the increase in yields and the reduced need to take on risk by seeking yield further out the curve. They are adding to their overweight position in investment grade credit, which they believe may be better positioned than equities to weather recessions due to higher yields and strong balance sheets. They also like U.S. agency mortgage-backed securities for their higher income and credit protection through government ownership of the issuers. Blackrock's expectation for persistent inflation relative to market pricing keeps them overweight in inflation-linked bonds. They remain underweight on long-term government bonds and overall underweight on equities, as they do not believe that the upcoming recession is fully reflected in corporate earnings expectations or valuations, and disagree with the assumption that central banks will eventually support markets with rate cuts. Instead, they plan to focus on sectoral opportunities resulting from structural transitions, such as healthcare amid aging populations, in order to add granularity while staying underweight overall. Among cyclicals, they prefer energy and financials, with energy sector earnings expected to ease from historically high levels while still holding up amid tight supply and higher interest rates benefiting bank profitability. They also like healthcare due to attractive valuations and likely cashflow resilience during downturns.
“We expect views to change more frequently than in the past. Our stance heading into 2023 is broadly risk-off, with a preference for income over equities and long-term bonds. “
The Great Moderation, which allowed for relatively stable strategic portfolios, will not be effective in the current regime. Instead, they believe that portfolios will need to be more nimble. They do not expect a return to conditions that will support a joint bull market in stocks and bonds like the one that occurred in the prior decade. They argue that the asset mix is more important now and that getting the mix wrong could be four times as costly as it was during the Great Moderation. This is because the zero or even positive correlation between the returns of stocks and bonds means that it will take higher portfolio volatility to achieve similar levels of return. Blackrock sees private markets as a core holding for institutional investors, but is broadly underweight due to the potential for valuations to fall and the expectation of better opportunities in the future. They maintain a modest overweight on developed market (DM) equities, but believe that the overall return of stocks will be greater than fixed-income assets over the coming decade. Within fixed income, they prefer to take risk in credit, specifically public credit rather than private. They remain overweight on inflation-linked bonds and underweight on nominal DM government bonds, with a preference for short maturities to generate income and avoid interest rate risk.
Blackrock says that the aging population is a significant factor in the current production constraints and will continue to be a problem in the future. As the population ages, the share of the U.S. population that is of retirement age and therefore not in the workforce is increasing. This is a major contributor to the decline in the labor force participation rate, which measures the share of the adult population that is in work or actively looking for work. The aging population is also negative for economic growth because it means that the available workforce will expand much more slowly in the coming years, leading to reduced production capacity and continued inflation pressure. Additionally, rising government spending on care for the elderly is expected to add to debt. Within equities, Blackrock views the healthcare sector as attractive due to its focus on developing medicine and equipment to meet the needs of an aging population.
To conclude their playbook:
“A bottom-up look at what our
companies are telling us is
probably the best lens we have
into the future.”
The 2023 playbook is ready to
quickly adjust depending on how
markets price economic damage
and our risk stance evolves.
They prefer short-term government
bonds for income: The jump in
yields reduces the need to take risk
by seeking yield further out the
curve. U.S. two-year Treasury yields
have soared above 10-year yields.
See the chart. They break out shortterm Treasuries as a neutral.
They add to their overweight to
investment grade credit. Higher
yields and strong balance sheets
suggest to them investment grade
credit may be better placed than
equities to weather recessions.
They like U.S. agency mortgagebacked securities (MBS) for their
higher income and because they
offer some credit protection via the
government ownership of their
issuers. And their expectation for
persistent inflation relative to
market pricing keeps them overweight
inflation-linked bonds.
Long-term government bonds
remain challenged as they have
described, so they stay underweight.
In equities, they believe recession isn’t
fully reflected in corporate earnings
expectations or valuations – and they
disagree with market assumptions
that central banks will eventually
turn supportive with rate cuts. They
look to lean into sectoral
opportunities from structural
transitions – such as healthcare
amid aging populations – as a way
to add granularity even as they stay
overall underweight. Among
cyclicals, they prefer energy and
financials. They see energy sector
earnings easing from historically
elevated levels yet holding up amid
tight energy supply. Higher interest
rates bode well for bank profitability.
They like healthcare given appealing
valuations and likely cashflow
resilience during downturns.
A new strategic approach
The Great Moderation allowed for
relatively stable strategic
portfolios. That won’t work in the
new regime: They think they will need
to be more nimble.
They don’t see a return to conditions
that will sustain a joint bull market
in stocks and bonds of the kind they
experienced in the prior decade.
The asset mix has always been
important, yet their analysis posits
that getting the mix wrong could be
as much as four times as costly as
versus the Great Moderation. See
the difference between the orange
bar and yellow markers on the
chart. Zero or even positive
correlation between the returns of
stocks and bonds means it will take
higher portfolio volatility to achieve
similar levels of return as before.
They see private markets as a core
holding for institutional investors.
The asset class isn’t immune to
macro volatility and they are broadly
underweight as they think valuations
could fall, suggesting better
opportunities in coming years than
Now.
To read their full report with graphics see this link:
www.blackrock.com
Fear the VIX
If you're a bear on the market, a VIX at 45 might have you doing a happy dance - but for bulls, it could be a different story. The S&P 500 index is a widely-recognized measure of the performance of 500 large publicly-traded companies in the United States. It is often used as a benchmark for the overall health of the U.S. stock market and has generated an average annual return of around 9% since its inception in 1957. The index reached an all-time high in early 2020 but experienced a steep decline due to the COVID-19 pandemic, although it has since recovered much of those losses and is currently trading near all-time highs.
The CBOE Volatility Index, or VIX, is a measure of the expected volatility of the S&P 500 index over the next 30 days. It is calculated using option prices on the S&P 500 index and is commonly referred to as the "fear index." A high VIX suggests that investors expect the stock market to be more volatile in the near future, while a low VIX indicates that investors expect relatively stable market conditions.
For a bearish investor, or someone who expects stock prices to fall, a high VIX may be viewed as an opportunity to profit from falling stock prices. This is because a high VIX can be a sign of increased uncertainty or fear in the market, which may be caused by negative factors such as economic recession, geopolitical tensions, or natural disasters. On the other hand, a high VIX may be seen as a warning sign for bullish investors, who may decide to reduce their exposure to the stock market or implement protective measures to mitigate the potential impact of market volatility.
However, it's worth noting that the VIX is not a perfect indicator of market conditions and can be influenced by a range of factors beyond just the level of fear or uncertainty in the market. Additionally, a longer-term mindset bull, or someone with a long-term bullish outlook on the stock market, may actually welcome a spike in the VIX as it can sometimes signify a market bottom, or a point at which stock prices have reached a low point and are likely to start rising again. In this case, the high VIX may be viewed as an opportunity to buy into the market at a discounted price, with the expectation of generating returns over the long run. As such, it's important for investors to consider their individual investment goals and horizon when evaluating the significance of the VIX and other market indicators.
On the Chart Al La Carte
On the chart, we can see the daily movements of both the S&P 500 index (SPX) and the VIX. Historically, there has been a correlation between a spike in the VIX and a market bottom in the SPX. One of the most notable examples of this relationship was during the Global Financial Crisis (GFC) in 2020, when the VIX reached over 80. The reversal of the VIX marked the bottom of the market on March 16, 2020, a few days before the SPX hit its bottom on March 23.
Since the GFC, we have seen similar, although smaller, spikes in the VIX and corresponding market bottoms. These include October 28, 2020, January 24, 2022, March 8, 2022, March 19, 2022, June 16, 2022, and October 12, 2022. It's important to watch for divergence between the VIX and the SPX to understand if a market bottom may be forming.
See chart
One strategy that some investors use is to watch for divergence between the VIX and the SPX. When the VIX is rising and the SPX is falling, it may be a sign that the market is approaching a bottom. Conversely, when the VIX is falling and the SPX is rising, it may indicate that the market has reached a bottom and is starting to recover.
One example of divergence between the SPX and VIX occurred in late 2018, when the SPX was in a long-term uptrend and the VIX was trending downwards. This divergence may have indicated that the market was approaching a top and that investors should be cautious about taking on additional risk.
Another example of divergence occurred in March 2020, during the COVID-19 pandemic. The SPX experienced a steep decline due to the economic impact of the pandemic, while the VIX spiked to over 80. This divergence may have indicated that the market was approaching a bottom and that it was a good time for investors to start looking for opportunities to buy into the market.
One example of a technical analysis tool that can be used to understand the relationship between the SPX and the VIX is the "Vix_Fix" indicator. This indicator uses a number of inputs, including the lookback period for standard deviation, the Bollinger Band length, the Bollinger Band standard deviation, the lookback period for percentile, and the highest and lowest percentiles, to calculate the Williams Vix Fix (WVF). The WVF is a measure of the momentum of the SPX and is plotted on the chart as a histogram. The "Vix_Fix" indicator can be used to identify periods of divergence between the SPX and the VIX, as well as to identify potential points of market reversal. When the SPX is pushing lower and the VIX is pushing higher, it may be a sign that the market is approaching a bottom. Conversely, when the SPX is rising and the VIX is falling, it may indicate that the market has reached a bottom and is starting to recover.
See chart
In conclusion, it is important for investors to keep track of various economic indicators, such as the S&P 500 index, VIX, federal fund rate, and yield curve, in order to make informed investment decisions. While a bear market may be welcomed by some investors, it is important to consider the potential impact on the economy and individual investments. Understanding the historical trends and correlations between these indicators can help investors navigate bear markets and make the most of their investment strategy. It is also crucial to consider a range of factors and not rely on a single source of information when making investment decisions. Overall, staying informed and understanding the market can help investors make the most of their investments, even during a bear market.
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2 Year-10 Year Yield curve deeply invertedIf there is any tell-tale sign that a massive recession is coming, it is this: 2-Year - 10-Year yield curve inversion. If you look back in history you would see that every time this yield spread has inverted, the economy and the stock market has gone into a recession. The problem is that this is the deepest inversion from an historical perspective - deeper than 2008 inversion. This can play out very badly for the S&P500, and the stock markets in general.
Will S&P500 be in big trouble because of this?
