Big One Incoming

The 3M/10Y bond yield inversion is the second longest ever. The longest yield curve inversion preceded 1929. Two other long ones preceded 1973-1974 and 2008, two of the worst bear markets after the Great Depression. The Other long one came ahead of the early 1980s back-to-back recessions, the worst recession since the Great Depression at that point. The current market has the qualities of the 2000 tech top mania speculation in tech and crypto, it has valuations on par with 1929 and 2000, along with curve inversion on par with markets that collapsed from valuations far lower. This might finally be the start of something that will dominate history books for a century.

2024 Bear Market in One Chart

A bear market has this chart completing the symmetry.

Does the Yield Curve Matter?

Bear Rally Over? Yield Curve and VIX Turn Higher

It has been a long and winding road in this bear market. Yes, I still believe a bear markert is underway until new highs are made. I haven't been tactically bearish on the market over the preceding months, onyl taking some small swings when setups looked good. Until those old highs are taken out, my bear market call from November 2021 remains intact.

First, the classic bubble chart pattern hasn't been violated:

A double-top is a valid expression of the "return to normal" phase. Bullish sentiment and speculative behavior return to near peak levels, propelling the major indexes or stocks into double-tops. Anecdotal, but cryptocurrency speculators believe a new bull market is underway. Bitcoin BTC has a pattern that is consistent with the classic top though:

Tesla, Google, Amazon and Meta all sport the classic pattern with no hint of an imminent double-top. The paradox stocks are Apple and Microsoft. Both have achieved new all-time highs. Their massive weight in the S&P 500 technology sector (nearing 50 percent at times) propelled that sector to a new all-time high in July. If I'm correct in my assessment, this will turn into an overthrow of a double-top pattern and not an extension of the bull market.

Industrials also achieved new all-time highs this year. Energy and materials made new highs in the second-quarter of 2022 and remain within striking distance of new highs.

I'll digress here and give the bullish argument over the longer-term. Assume for a moment the U.S. was primed for a recession around the time the coronavirus hit. The government then wrecked the economy and then flooded it with far too much stimulus. Even though there's no official recession in 2023, the U.S. government is running deficits on par with the fallout from 2008:

There's nothing bullish about that chart long-term. Growing deficits will increase inflationary pressure. Falling deficits could trigger deflationary pressure. Since stocks are priced for perfection, deviation out of the Goldilocks Zone will trigger price declines in all sectors at least for a time, barring an explosive move higher in energy as we saw in early 2022.

I don't want to belabor the valuation topic, but here is the price-to-earnings ratio divided by the growth rate (PEG) and the spread between investment grade corporate bonds and the Federal funds rate.

Going back the to the bull thesis: what if the government front-loaded stimulus and the bear market/recession doesn't materialize? In that case, either an extension of the bull unfolds or the transition occurs without the bear move. Both EFA and EEM, the developed and emerging market ETFs, bottomed in October 2022, with EEM having a little overthrow this year:

To wrap up the bull case: the government flooded the economy with stimulus, triggering a temporary inflation surge. Inflation settles back into the Goldilocks Zone, as does GDP growth, sub-2 percent for both. In the short-term bull scenario, stocks enjoy an extension with tech and other speculative assets resuming leadership. In the longer-term scenario, the transition to new leadership such as industrials, energy, commodities and foreign markets takes place without a major bear.

Back to the bear scenario, one of the strongest signals for a recession has been the inverted yield curve. It doesn't indicate an imminent recession, rather it signals the pre-recesesionary stage. The actual recession comes when the yield curve steepens. Going back the past four decades, this has always occurred when the Federal Reserve slashed rates. Right now, the yield curve is steepening because long-term bond yields are rising faster than short-term yields. It is a small move at the moment, but the spread has made a higher low, indicating the final low might be in.

The 10-year treasury yield has a bullish formation that may or may not complete. If it completes, then higher long-term rates will sink financial asset valuation and could indicate a stagflationary recession. The 30-year mortgage would be on its way towards 10 percent, a level that would almost assuredly kill home prices too. On the flip side, a traditional steepening via Fed rate cuts would be another bear market and recession like we've seen in 2000 and 2008.

The decline in the VIX has been a hallmark of this bull market. The VIX has fallen below the level reached at the November 2021 peak, indicating fear is gone. Here's the VIX overlaid with the 2s10s spread:

VIX isn't a great indicator in that it tends to be coincident with the 2s10s, but a rising VIX indicates rising fear, likely because there's bearish action in parts of the market ahead of the full-blown bear. Here's a look at when the VIX bottomed ahed of prior bearish periods:

There will be bearish trades emerging very soon if the yield curve has finished inverting and moved into steepening. Ditto if the VIX follows it higher. With September and October coming up, the calendar supports a market top scenario here. New highs on the major indexes will invalidate the bear scenario, as will a falling VIX. If the 2s10s inverts further or moves sideways, it will indicate no imminent economic pressure. If the 10-year yield fails a breakout for instance, the yield curve might invert further while the broader stock market interprets the falling yield as disinflationary and therefore bullish.

Financial Stress Like in 2020 and 2008

I covered BXMT a few times last year. It was one of my "crash" targets. It is rolling into crash territory now. Some resistance around, conservatively, $16.50 per share. Below that it can free fall. If that happens, we'll be in a full-blown financial crisis of some degree.

The other side of the market is the Nasdaq. The NQ continues holding up. It needs to break 12000 and not look back for a full-blown bear move to get underway.

The Nasdaq's reslience, really the whole market's, speaks to the still extremely bullish sentiment within the market and the trillions of inflated liquidity sloshing around. The behavior of banks, commodities and so on are now hinting that this money will be deflated and sent to money heaven. Investors can hedge risk of bailouts and supercharged inflation with assets such as gold. Until there is some major pain however, I do not expect the Federal Reserve will go into full bailout mode because it will risk, with signficant probabiity, even higher readings the inflation indexes. If inflation goes up and rates with it, more banks fail. If inflation goes up and the Fed does what they did for SVB Financial, inflation goes higher still and takes down the whole economy. They're trapped and so are all the bulls that aren't hedged.

Silicon Valley Spanked Shares

I posted a bunch of times on the formerly named Silicon Valley Bancshares. It collapsed this morning. I wasn't in the trade at the time, haven't messed with SIVB in awhile, but I expected it would evenutally makes its way lower because it is at the crossroads of technology and banking. Fitting that today's plunge comes hours after Silvergate (SI) announced it would liquidate, a stock I said could fall 80 percent a year ago. SBNY was another target that has recently come in for a pummeling.

SVB Financial stock plummets toward biggest one-day selloff in 23 years after stock offering, large losses on securities sales I'm going to keep digging in a post more over at the Substack later.

Most Recessions Start a Year After Steepening

Most recessions start at least a year after the yield curve starts reversing higher. There already was recession in Q1 and Q2. Maybe there isn't now, or maybe inflation is being undercounted. Either way, not a good outlook.

I posted some trades over on the Substack.

Interest Rates Still Far Too Low

Asset prices are way, way too high. Most of the inflation went into asset prices, not consumer prices.

When Do 100 bps Hikes Enter the Conversation

The past couple of decades have seen increasingly activist central banks intervene in markets. The Federal Reserve helped blow a housing bubble, then an everything bubble that it is now trying to unwind. Previously, they mostly followed the market. A couple of articles worth reading are De-mystifying RBA Setting of Interest Rates by Steve Keen and Here's How to Know When the Fed Might Raise Interest Rates by Vadim Pokhlebkin.

The 3-month Treasury bill rate is a proxy for the Fed funds rate. From the chart below, you can see the Fed funds rate used to fluctuate around the 3-month treasury rate. In the 2000 and 2008 recessions, and again in 2020, the market dropped interest rates faster than the Federal Reserve.

Something different is happening now. The market is raising interest rates faster than the Federal Reserve. If you notice the green line, the market takes rates up in between meetings and the Fed then catches-up by closing the gap to near zero. Notice the gaps widening? Remember Powell saying 75 bps was off the table? Then it wasn’t. The Federal Reserve is following the market and not vice versa. If the market believed the Federal Reserve and was following it, then the gap between the market rates and Fed funds rate would adhere to Fed policy and jawboning, and not the other way around.

The spread between the market and the Federal Reserve is still widening. The 3-month treasury yield is almost 125 basis points ahead of the Fed funds rate heading into this meeting 114 bps according to FRED). This is a wider gap than existed in June when they switched to 75 basis point rate hikes.

The current gap might not enough for a 100 bps rate hike because it would leave less than a quarter point gap. However, a 75 bps hike will leave the gap at around 39 bps. Notice that will be lower than the gap than at all previous rate hikes. The Fed should hike 100 bps if this chart factors into their decision making. The chart is saying the Fed is not only losing its battle, but that it is in a worse position today than it was at the start of its rate hiking.

With the market currently 50/50 on a 50 bps vs 75 bps hike in December, the Fed can push those odds with a hawkish statement, but they’ll still be behind again in December unless the market slows its pace.

In conclusion, the Federal Reserve is chasing the market higher and, key point, the market is accelerating its rate hikes. The Fed’s 75 bps pace falling behind the market’s pace. The speculators on Fed policy are undecided between 50 bps and 75 bps for December. If the bond market doesn’t slow down or worse, continues accelerating, 100 bps hikes might be on the table.

Crash: Real Interest Rates and Gold

The real 10-year interest rate is inverted on this chart. This is a calcualted figure from a model, so I'm more interest in the trend than in specific levels.

Frequency: Monthly

The Federal Reserve Bank of Cleveland estimates the expected rate of inflation over the next 30 years along with the inflation risk premium, the real risk premium, and the real interest rate.

Their estimates are calculated with a model that uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations.

Putting the Bear Market in Perspective

Look at the ratio of SPY to TLT, and SPY to ZN the 10-year treasury futures.

Will Hussman Finally Be Proven Correct?

I see many many bullish articles coming out now, calling for a meltup into next year, calling for a new bull market after the first half of next year. One of John Hussman's models called for negative 2 percent annualized returns (the chart below) and currently sits at 0 percent expected return. A negative 2 percent run from 4800 comes to 3767 in 2034. Zero percent from where it sits today. Considering stocks rise in most years and there will be 20 percent and 30 percent return years following the bear market low...there's still a lot of downside if he's right. In the short-term, bullishness is possible, but value mostly lies outside the United States.

Estimating Downside Market Risk

Is Powell Playing a Deeper Game?

Is Jerome Powell playing a far deeper game than most realize?

Someone asked about this article where Tom Luongo theorizes the Fed is playing a different game than most realize. Right off the top, I think it is very helpful to come up with these types of theories as thought experiments because they help crystallize interlocking parts of the market. Whether you end up agreeing with it or not, it can be helpful. The trouble with these theories is when they lean too much on conspiratorial thinking and not plain facts. You want to work back from the facts and then ask: how might the power players like to use this situation?

I've given examples before. One, Xi Jinping in China could have allowed a deflationary crash in the economy as a means of eliminating political opponents in the aftermath, since the public is always looking for scapegoats. He can also use a deflationary crash as an excuse for devaluing the Chinese yuan. He can also use the U.S. trade war as an excuse. A perfect retaliation for Biden's move on semiconductors would be letting the yuan drop, something that is inevitable anyway if the dollar continues rising with U.S. interest rates. If WW3 has started, retaliatory tariffs from the U.S. merely pushes along a tit-for-tat economic separation.

Conversely, we can play that same game with the U.S., which is where Luongo goes. The article is worth reading and the DiMartino Booth interview linked within is worth watching. Most of what follows is my riff on his article, as this article doesn't explain his position with much depth so I don't want to attribute things he may not believe.

When They Call For the Bailiff You Know You’re Winning

I haven't read Luongo all along, but my read of it is he's arguing the Fed is fighting against the Great Reset. He sees Truss getting knocked out as an anti-Brexit (can confirm reading all the people who think Britain will now return to the EU) and anti-Federal Reserve move. The Anglos are independent and aligned. He also notes which countries' banks are on the Fed's new commercial repo list: Anglos (he doesn't put it that way) and Japan.

Perhaps this is happening, perhaps not. Socialists love cheap money and any restrictive policy on credit will upset them. Since neosocialists (neoliberals, globalist, whatever) control most of the world's governments, they do not want tight credit policies and high interest rates. As commercial speculators, the Anglos are more comfortable with unleashing the wrecking ball of inflation to screw up their enemies and frenemies for fun and profit.

Another question is whether the U.S. will also exit as reserve currency. I've maintained for what seems like a decade now, that the dollar dies in deflation. All these foreign countries want to inflation. They don't like that the Fed is actually fighting inflation. The $100 trillion question is whether global capital would prefer to sit in socialist serial inflator countries or stay in the United States. The Empire Strikes Back if you know what I mean. It can all be boiled down to China and neverending belief that the yuan will become a reserve currency. Short of winning WW3 against the United States, China is still many decades away. Their capital account is closed! It's shocking that people still think China is in some kind of strong position here. A competitor to the U.S. dollar that is not gold is the Argentine peso in waiting. If gold, then the U.S. will depreciate more slowly versus gold.

The U.S. has already lost the trade war. The American worker is on the bottom looking up. He's being crushed by neoliberals in Washington, Wall Street, China, he's being overrun by migrant labor, he's watched his factories and then his neighborhood get packaged up and sold off to foreigners. Any shakeup in the global order has a high probability of helping the average American worker if only because everything has gone against him. That doesn't mean it will. Things can always get worse. Yet even if the dollar collapse scenario plays out, that would close the American consumer economy to the world because exports would be too expensive. Many products now imported would have to be made in the United States. A massive transfer of wealth from capital to labor would ensue. A massive transfer of employment from China and Germany to the USA. To think this through is to answer the question of whether any other nation wants reserve status. The U.S. has it. The Federal Reserve can gut other central banks like fish with rate hikes if that's their prerogative because whatever they say publicly, almost all the other central banks inflate harder than the USA. Only closely aligned nations that pull their security weight will be safe from retaliatory tariffs if currency devaluations start popping off.

Social mood is also negative and falling. The one out for a rising dollar would be Plaza Accord 2.0, but I've explained why this is impossible before. Social mood means nations will not cooperate. China has said it'll never go along with it. It's a dead story with the current geopolitical situation.

Where Can U.S. Policy Go?

America First was policy until around 1945. Critics of American foreign policy will point out that didn't exactly end, but it's also true that the much of the country was supporting what in hindsight is the American empire because they were confronting global communism. Many people were appalled with U.S. actions against Serbia and Russia in the 1990s. The nationalist, anti-communist mask dropped from the globalist traitors within the U.S. government. USG has been openly and brazenly imperialistic in its foreign policy since then, as well as going to war with domestic opposition. Journalists are in prison. Books are banned. Social media accounts are censored and shutdown. A return to the 1920s, when the United States was still a mostly neutral global commercial power, seems impossible because of this war. It seems like there's no support for it because the political constituency for it is being openly crushed. Whether Powell is consciously or unconsciously driving policy in that direction, I cannot say, but he sure could go a long way to giving outsiders a chance at power.

None of this is to say things can't go poorly. The U.S. government can print up treasury bills. Another election like 2020 could unleash double-digit CPIs. I'd expect the Federal Reserve would be all but captured at that point, with any idea of inflation-fighting rate hikes going out the window. The general intelligence of the ruling class is going downhill at high speed with Kool-Aid drinkers replacing the mercenaries who instituted identity politics. Competent people implementing evil policies are retiring and the rising generation actually believe in the evil ideas such as white privilege. To say nothing of their near total ignorance of math, economics and physics. The wheels can certainly fall off if the value of the U.S. dollar collapses after socialist economic policies are passed.

Conversely, whether he cares or not, Powell dropping a deflationary bomb (disinflationary if you like) on credit markets is going to damage the outlook for socialism. People say the U.S. is bankrupt at 5 percent or 7 percent interest, but this isn't true. They say that because they take it as a given that U.S. economic growth will slow and that the government will never cut welfare and warfare spending. high interest rates will be expensive for the imperialist USA and could push it into a fiscal crisis, but it'll be a different story for a nationalist government. The debt will become a budgetary weapon that some have always dreamed it could be. The U.S. government is far too large and spends way too much money. If high interest rates instead force a political shift to economic nationalism that tears the welfare-warfare state down, then the U.S. not only won't go bust, but it'll enjoy high inflation via a rapidly growing economy with wage inflation assuming tariffs and nationalist development are part of the package.

Many predicted the U.S. dollar would crash when China started dumping treasuries, and instead the opposite happened because China was dumping to defend the yuan. The new common wisdom predicts high interest rates and an eventually lower U.S. dollar will wreck the U.S. Instead, it could power a rebirth of the U.S. domestic economy, rising wages, high nominal GDP growth and shrink the government's footprint in the economy. It depends in part on whether its done intentionally. It depends on who is in power. Is it a flailing incompetent government or a Machiavellian one that uses great turmoil to reshape the future? Will the Machiavellians be globalists or nationalists? Never let a crisis go to waste as they say. Whether Powell is kicking off that domino I doubt it, but it doesn't mean he isn't kicking it over accidentally.

Going back to Luongo's piece, one of the most important points is that the Federal Reserve will not pivot. I've said I could see them pausing and stock market bulls treating it a pivot, but looking at stocks and crude oil lately, I'm not sure they can pause anymore. The market is still extremely bullish, sentiment indicators be damned. For investors, that's the main point. The Fed will disappoint financial markets and global central banks alike until something really major breaks. Everything else is downstream of that.

Random Thoughts

It is said that rate hikes do not help high oil prices. Do rate cuts?

You can't print oil. Aye, and what does currency printing do in this context?

Home prices climbed 42 percent since the pandemic according to Case-Schiller. Home affordability is at all-time lows. Assuming lockdowns damaged the econmoy, why should's prices fall 30 percent back to the pre-covid level?

For 12 years, the Federal Reserve suppressed interest rates and thereby indirectly funneled hundreds of trillions in capital into unsustainable projects and investments. Higher interest rates are the solution, no?

Why shouldn't the strongest companies and countries set their interest rates higher so as to attract scarce capital?

Short-term: if the U.S. dollar is peaking, where do commodity prices go? Inflation? Interest rates? Long-term: same questions, but also what if the dollar hasn't peaked for good yet?

Lows Beget Lows; Yuan Deval to 8.28 on Deck

I talked about what could be next for markets this weekend. I posted charts on transportation companies, an airline, high yield and chemicals. There is a clear case for a bounce on these charts because they're at major support. If I have to condense the market into one chart, I pick BTC. My long-term support line breaks around $17,800.

The other charts to watch are currencies as I laid out in the "what's next" post. Almost all currency charts are either in "free fall" territory or coming up on major support and resistance. USDCNY is one day (at current volatility) away from breaking out. The target is around 8.10, but I'd wager the market tests the old peg area of 8.28 on a break. A 15 percent rally for USD from here, about 14 percent deval for yuan.

If this sounds crazy to you, consider this: yuan has mostly risen with the USD durign the bull market. Here's the returns for USD vs EUR,JPY, KRW and CNY since September 2018:

A yuan "deval" is not so much a devaluation as catching up with the decline in export currencies. I'm not predicting this will happen now, though I think it is highly likely for this cycle. If the dollar keeps running though, that is where the yuan is headed.

Finally, long-term government bonds continue their slide.

The 10-year bond futures contract has reversed all gains since 2008.

In conclusion, the market is poised for a bounce or a collapse and that's it. Until there are concerted reversals in currencies, bonds and stocks, then do not expect a sustained rally. Rallies will terminate within hours or days until this happens.

Market Top: Stock Bond Ratio Charts

One Chart Every Investor Should Internalize

Prior to 2008, the low for the Fed funds rate was around 0 percent aka the CPI and the high in the prior 20 years was about 5 percent. If we put a 0 to 5 percent range on forward inflation rate of...let's be generous and say 2 percent...then the "normal" interest rate for next year is somewhere between 2 and 7 percent. The nominal interest rate of 0 percent is probably gone. The two pandemic years ruined it because the Fed will not risk a repeat. Interest rates can go down, but not much. It'll take actual deflation to get rates down to 0 percent and even then, the Fed might stop cutting around 2 percent and see what happens. There won't be any QE either.

Taleb said similar things in a recent interview.

When the Bubble Stopped

I saw a chart of monetary data that topped out in February 2021 that made me think, "Duh!" It was so obvious that I didn't record it, but now I can't remember it. So here's an attempt at finding it again. I'll post charts that broke in February or March 2021.

Here's the yoy change in the Fed's balance sheet versus BTC.

Here is ARKK and the 10yr2yr yield ratio. The yield spread peaked about a month later.

Forward Real Rate Says Powell Could Be the Ultra Volcker

What is the real interest rate moving forward? This chart shows the Fed funds rate minus the CPI, a hindsight look at real rates.

The CPI for Q3 will annualize to about 1 percent if prices don't continue dropping. I suspect they might and that CPI might be near 0 percent by October as a result. The Federal Reserve should hike to 3.50 percent in September and signal 4.00 percent for November. Looking forward, the real interest rate could be positive 4 percent or higher by the end of the year. 

Now go back to Q2 when inflation was running at 10 percent annualized in the quarter and the Fed funds rate was averaging about 0.50 percent. If you accept the above assumptions are reasonable, then it's quite possible the real rate of interest (defined by Fed funds minus CPI) will have swung from about negative 10 percent to positive 4 percent. Volcker took rates from minus 4 percent to positive 10 percent. The CPI also rose straight through this period. There wasn't a peak and reversal in prices as is happening now, technically Powell's swing in real rates won't seem as impressive as Volcker's looking at the 12-month CPI, but the reversal in real rates from Q2 to Q4 will be even more dramatic when one considers the economy could see a double-digit down swing down in the CPI. Impressive.

Adios Inflation