The Good, The Bad, and The Ugly

The last 3 weeks we recapped the first quarter 2024 returns, and covered what the remainder of 2024 and 1q2025 might look like for stock markets under 3 different scenarios. Scenario 1, a continued soft-landing outcome like1995, Goldilocks plays on, which would project the S&P 500 to 5900-6000 in the first quarter of 2025.  The second scenario, a hard landing outcome, like late 2000 through early 2001 post the Dot.com bubble, when the fed induced an economic slowdown, but a recession ensued, and the markets dropped -30% into the 1q2001.  This scenario equates to 3500-3600 on the cash S&P 500.  This of course is where the market was in late October 2022 at the most recent major market low 18 months ago.  Scenario 3 we presented last week, which I title “muddling through with a shot of volatility creating a very wide range in the markets but not much net gain over the 1q high we struck around 5250, call it a range from 4800 to 5400. This is final scenario is actually the least likely outcome for a 4^th year presidential cycle, as politicians are busy trying to win votes and the November election election by keeping the economy chugging along.

This week, I give you a quick recap of the last two weeks behind the scenes and title it the “Good, Th Bad, and the Ugly”, a classic Clint Eastwood movie released in 1966.

First the good.  The good?  Regardless of what the government data is saying, what politicians on TV are spewing, what academics are hypothesizing, the real time data says, inflation, yes inflation expectations just peaked.  Yes, you heard that right. Inflation fears look to have just max out. Just as they did in late October of last year about 4-5 days before the stock markets troughed, and promptly rallied 1100 S&P 500 points in almost exactly 5 months.

Here’s a daily chart of real-time 5-year inflation breakeven rates.  You can use most any maturity, but they all look pretty much the same.

Peaked back at the end of October last year as the financial media was talking crashes and recessions and then dumped for a solid 6 weeks helping the S&P500 to rally back to its then ATH near 4650-4750.

Investors, I’ve repeated this many times in advance of inflation rallies and selloffs.  Inflation expectation and statistics in the USA are very seasonal! Nearly always peaking in late March through early May and heading lower.  Here’s a 10-year chart of 5-year inflation expectations.  The late 1q peaks are marked to make it easier to see.

That’s the good news. Peak inflation fears have historically meant short term stock lows and of course we have recently sold off about -5% over the past 4 weeks.

Second the “bad” news, and the most likely reason for the broad market selloff and even worse selloff in tech stocks and high growth stock the first 3 weeks in April. What’s that bad news?  The pivot higher, not lower, in 5-year real interest rates.  First recall in late October, the trend break lower of this real time data series was the kept indicator to our team that a significant, yet very normal 4^th quarter stock market rally was near.  It was the main reason why on our October 26^th, Thursday night livestream, our team messaged that the lows for the market should be the next few days, while others were spewing nonsense about similarities to the October 1987 stock market crash.

Here’s the real time chart of the 5-year real interest rate.  Remember investors, this is the interest rate that comes closest to accurately forecasting whether investors are willing to pay higher PE multiples for the market or lower PE multiples.  One can clearly see that the entire 1h2022 selloff transpired as real rates were skyrocketing higher from -2% in the time of negative real rates to back to +2% in September of 2022 which happens to be almost to the day, the S&P 500 troughed and most if not all of the high tech growth names found their footing for their big 12-18 month runs.

Investors, the markets can handle higher real rates over time, however, they hate changes in trend in this measure and what we saw the first 3 weeks of April was enough of a bounce in this measure that the computer algorithms triggered sell signals across quant land.  That is the bad, rising “real interest rates”.

Finally, investors, I give you “the Ugly”.  What’s the Ugly?  The Ugly is we continue to follow out the pattern of October 1998-2000, when the Dot.com bubble rally happened, but the Federal Reserve stayed too tight in monetary policy too long and eventually caused a recession in 2001, and the first leg down in a multiyear bear market that began after a big rolling top between late 1q2000 and 3q2000 with a drop of -30% into 1q2001.

I’m going to give you a few updated overlays that I have been sharing for over a year and leave you with a few hopeful ones too.  First the S&P 500 then and now overlayed.

Next the more tech heavy Nasdaq Composite then and now:

The Philadelphia semiconductor Sox index then and now overlayed:

Almost everyone’s favorite AI semiconductor play NVDA then and now.  Remember that NVDA came public in mid-1999 in front of the Dot.com runup and back then. NVDA was merely thought of as a video game and graphics accelerator chip company. AI wasn’t yet a clean in most peoples vision except maybe a few at Stanford, MIT, and Cal Tech.

And finally, I’m going to give you a more “hopeful” overlay, here’s one of a defense company LMT then and now. This one actually had quite a good 2000 year throughout the whole year after a relatively weak 1q2000.

So that’s it for this week folks.  The Good, The Bad, and the Ugly.  And while thefirst 3 weeks of April were certainly ugly for most high growth stocks, but not unexpected after a 5 month rally up?I don’t want to leave you on a down note.  Investors, even if we continue to play out in a similar way as post dot.com in 2000, recall that the markets hung in there for the better part of almost 5-6 more months.  In fact, the tech stock sector actually rallied strongly post April options expiration for 2-3 weeks before selling off again and making a slightly lower low in mid-May.  They then went on a strong rally led by semiconductors all the way back to near their prior all-time highs into July 4^th and mid-summer.

Investors, that’s it for this week Right now, our team doesn’t see the leading signs of a future recession this year but can say, that we will have one again in this decade, and recession in the stock market are a minimum of -30% down moves.

For investors or retirees 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.