It’s One or the Other, Not Both

by JDH on February 18, 2023

Here’s the conundrum:

There are many negative forces at play for the stock market:

  • The Fed has increased interest rates 450bp in 11 months.  The Bank of Canada started at a rate of 0.25% in March 2022, and now is at 4.50%, an increase of 425 bps is less than a year.

But there is what appears to be good news for the stock market in the US:

  • Retail sales are at all time highs;
  • Unemployment is at 43 year lows, with new jobs (payrolls) up 500,000 in January.

As a result, the SPX is up over 7% since New Year’s day, and the TSX is up over 5.5%.

So is this a good news story, or a bad news story?  It can’t be both.

The month of January was a good news story.  Stocks up, inflation appeared to be peaking, so it appeared that the Fed was approaching a Pivot where they would stop raising interest rates and then lower them.

The US 2-year bond yield is at 4.62%, only down slightly from the 4.8% rate in November.  The five year is at just over 4%, and the ten year is at 3.82%, down from 4.3% in October.  So the short end is relatively flat, but the long end is down, leaving us with a still heavily inverted yield curve.

Inverted yield curves almost always indicate that the economy is in a recession or is approaching a recession.

How are investors responding?  They are moving money out of the stock market:

  • $4.2 billion inflow to Treasuries in the last six weeks (the best start to a year since 2004)
  • $1.0 billion has left for cash

So if cash is leaving, how can the market increase?  It can’t, which leads me to believe the bear market rally is over.  Here’s what the SPX may look like over the next few weeks:

Or not.   I of course can’t see the future.  Perhaps the breakout of the last few weeks was a true break out.  I doubt it.  It looks like a false break out to me, since it hasn’t held the highs from November.  I think a test back to the previous resistance level of 3,800 is likely over the next few weeks.

So, if this plays out, either move to cash, or pick up SH – Proshares Short and see what happens.

We shall see.  More next week.