Seasonality or More – Buy the Dip?

 

Global stock markets sold off violently last week, particularly on Friday. The technology-heavy Nasdaq 100 Index tumbled into a correction and the S&P 500 Index lost -3.2% in two days, its worst two-day
stretch March 2023. Later cycle, or slower cycle, “Garp” stocks, “growth at a reasonable price, healthcare, utilities and real estate companies, which pay dividends and are popular with investors when bond yields sink, were by far the best performers in the S&P 500 for the week.

Equity market losses were caused by a number of factors including 1- a “weaker” than expected US jobs report which showed continued slow job gains, with most gains from government sponsored programs and part time work and 2- the Bank of Japan discussing raising interest rates while other nations are lowering them, setting off a massive reversal of what is known as the Yen carrier trade.  From its Mid-July peak the cash S&P 500 had fallen about -6.45% as of this writing on 8/4/24, from about 5666 to a low of around 5300.  Why has this suddenly transpired, and volatility ramped higher?

On the first point, the weak jobs data raised concerns that our Fed is “late” to recognizing a weakening US economy.  The weakening US consumer was first discussed by our team way back in February after the last gasp XMAS spending spree. Concerns that the Fed will be late once again to recognize what is really going on and their “higher for longer” interest rate mantra, is just plain wrong.  Real time real interest rates have been flashing the yellow warning flag for months.  The warning that the Fed is actually “too tight, for too long” and the motto should be changed to “higher for wronger”.

As for the second excuse, the Bank of Japan hawkish interest rate outlook and tighter monetary policy setting off a reversal of the Yen carry trade, that one is really being my pay grade. However, simplistically speaking, a carry trade” is when an investor borrows in a currency with low interest rates, such as the Japanese yen for the last decade+, and then that investor reinvests the proceeds in a currency with a higher rate of return, most recently the example has been Australia.

With the Bank of Japan recent hawkish talk, the Japanese Yen currency is up about +8% against the U.S. dollar over the last month, trading at 148.84 a dollar on Friday 8/1/24.  *5 in a month doesn’t sound like a lot if your are trading Nasdaq stocks like TSLA or NVDA, but in the currency markets, where many investors leverage their positions 5, 8, 10 or more to 1, and 8% move against you is massive.  You are now on the hook to repay whatever you borrowed to buy these other investments +8% more.  This is at the same time, that most likely, the investments you bought have depreciated in value.  Double whammy to the downside to a leveraged investor.

So, getting back to more of my specialty in US equity and bond markets, I want to discuss my first point of the Fed, treasuries, and stocks, in more depth and compare the recent rally in real interest rates back to other period of times we’ve previously discussed.

In a but I’ll share with you the updated charts on the 5 Year Real time real interest rate we’ve discussed for the better part of a year. Remember investors, the Fed is trying to get inflation under control by controlling the “real interest rate” premium investors get paid for owning Treasury bonds above the inflation rate.  And according to the Real time interest rate markets, they succeeded in this goal but don’t seem to understand it.

Back in mid-June our team was discussing the Fed being too tight for too long in an effort for them to defeat inflation. We shared with our subscribers a reconstructed Treasury yield curve, and inflation break even yield curve and the most important of all to me, a real time real interest rate curve.  Back then we discussed that the rate that the Fed controls, shorter term real rates were too high, and the economy was cooling faster than most thought.  At the time, the 1-year real rate was at about 3.57% while the longer dated real rates beyond 3 years were closer to 2.  It got worse for a few weeks with the 1-year real rate peaking around 4.13% on July 23^rd.  Here’s an updated table with all of the interest rate data then and now.

What to make of this data?  Folks, the Fed is too tight. The bond market knew it weeks ago, and the stock market just came to that conclusion over the last few weeks+.  If one believes real market data, not government data or lagging stale surveys, inflation isn’t just cooling, it’s plunging.  I know it doesn’t feel like it at the grocery store, but that is what the market data is saying.  Used car prices? Tanking. Copper prices, you know that “doctor copper” tagline? At new lows, oil prices?  Where was the surge in gasoline demand for summer?  It didn’t happen.  But we’ve seen this play before.

These next charts are weekly 10-year charts.  The first is the most recent 10 years.  It’s the real time 5-year real interest rate.  Clearly forming what technicians call a head and shoulders pattern and having broken the relevant MVAs decisively the last week.

And here is the exact same chart with the same MVAs back during the Dot.com capex peak in mid-2000 and then again during the pre-GFC peak in mid-2007

Before you panic, remember these were both periods before the Fed found QE, quantitative easing and many other programs they used to dull or delay economic and market downturns.

A few things to note from these charts.  As one can see from both 2000 and 2007, this same real interest rate broke its MVA at first, and then rallied for 4-5 months before rolling over again and succumbing to a slower economy and heading lower.   So, what did the SP500 do back then back pre-QE programs?  Believe it or not, in late July 2000 the cash S&P500 fell about -6.8% in the second half of July, a normally weak seasonal period for stocks.  Early in the GFC in summer of 2007, what did the S&P 500 do on this same interest rate move?  Yep, you guessed it it dropped about -6.44% the last few weeks of July in 2007. Yes, I admit it did go down another -3% or so for a few days but did rally sharply.

The markets did not cascade lower from there in a straight line?  No, in fact, both of these summers, that eventually ushered in a bad period of 18-month stock returns for stocks and recessions in 2001 and 2008, the markets rallied considerably into early September in 2000 and mid-October in 2007.  By considerably, I mean +8-9% taking the cash S&P back to near new ATH in 2000 or in the case of 3q2007, absolute new ATHs. Here is the cash SP500 back during both periods.

A similar move now would take the cash S&P 500 above 5666 toward 5800.  Not a projection or guarantee of course but with volatility now where it is, and the weaker economic data out in full display for the Fed, we would expect a parade of dovish Fed comments over the coming month.  Additionally, earnings will for the most part be ending this past week, and companies should be back in stock buy back mode. Particularly with their stocks now down 5-25% from recent highs, and cash flow still reasonably good.

Since the July CPI report markets have been volatile and moved down quickly. Historically, we have only seen one significant meltdown around the commencement of a cutting cycle, and that was in 2001. Otherwise, historically we have seen semi-orderly but highly volatile daily returns in equities within +/- 60 days of the first cut during cutting cycles.  Here’s a great chart of the SP500 returns around the first FOMC cut from Steno Research.

While the previously discussed 2000 and 2007, the cutting cycles did end in recession. they were pre-QE and characterized by a lack of liquidity. Quantitative easing in significant size has been implemented since then, and you know what that has historically done to tame volatility in markets.

Even with the recent selloff in the markets and particularly tech stocks, market breadth has broadened out and the equal weight is less than -3% off its closing high.   That’s a good thing on the good bad scale.

If over the years you have found yourself reacting emotionally in your portfolio to Presidential elections and their uncertainty, or when volatility is high like it is now,

now is the time to step back, take a deep breath, give your advisor a call and talk walk through your long-term financial plan.  If in the past you’ve felt emotional and compelled to sell stocks, when volatility was high, and they were down. Maybe its time to reverse that habit if it hasn’t worked in the past.  Maybe its time to allocate a little more into equities on a pullback?  I don’t know because I don’t personally know you.  But if you have a good relationship with your advisor, and not just an investment account relationship. Get on the phone and give them a call and see what might work for your longer term financial plan.

Our main message for the 2^nd half of June and first half of July was with the markets making fresh all-time highs, if you are going to make reallocation decisions to shift money out of stocks and equities into less volatile assets, its best to do it when indexes are up and volatility is low. Now volatility has ramped up quickly.  Given so,  Maybe it’s time to think about doing nothing or maybe doing a little nibbling if your plan has the flexibility to do it.

If you are uncomfortable with wider range of possible equity outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorber “insurance” for a stock portfolio.  Information on this exciting new strategy of ours can be found at OakHarvestFunds.com.

From the whole team here, thank you and have a great weekend.

Do you need a retirement plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at 877-896-0040 or fill out this form for a free consultation: https://click2retire.com/Connect