Most industries have already crashed. Some of these crashes started happening as far back as February 2021. And when it comes down to it, almost all the industries in the market have already crashed 20% or more within the past year.
For example, the biotech industry crashed 47%. And retail stocks crashed 25%.
That’s not all, either –
The software industry crashed 23%. Health care services and health care equipment stocks both crashed more than 20%. And transportation stocks crashed 20%.
Even defense-related companies and oil and gas stocks – which are both up a lot recently – crashed into a bear market within the past year. Oil and gas stocks fell as much as 32%, while defense stocks were down 21% at one point.
The tech crash is particularly interesting.
So-called “innovative technology” stocks crashed as much as almost 40%. Just look at what happened to the SPDR FactSet Innovative Technology Fund (XITK) in late November.
Now, just a few months later, it’s a much different story. The S&P 500 tumbled into a correction. And since then, we’ve seen heightened volatility and erratic movements in the market.
Meanwhile, hundreds of stocks in the weakest industry groups have been suffering big crashes for more than a year. The only difference is that now the losses are becoming widespread enough to get the attention of the mainstream media.
Again, the overall market had dropped as much as 13% earlier this month before bouncing back over the past few weeks. It’s still about 2% below its all-time high.
But if you were to zoom in, you would see that more than 60% of the industries have plummeted between 20% and 50% since February 2021.
A rolling crash doesn’t happen in an instant. It can be much worse. It spreads across the market over time. It sends specific industries crashing before spilling over into the next.
The last rolling crash happened in late 2018.
That year, investors were worried about war with China. And talks of a big interest-rate hike led many folks to believe the end was near. Sound familiar?
Stocks were still chugging higher overall back then. But the rising index failed to warn investors that something serious was bubbling under the surface.
You see, the average stock in the index was down 18%. So it’s not surprising that the market soon tumbled into a downturn.
The 2018 rolling crash spread from the banking industry to automakers to raw materials to the semiconductor industry.
And it all culminated in a big, market-wide plunge. The S&P 500 nearly entered bear market territory on Christmas Eve.
Another rolling crash happened in 2015. A “flash crash” occurred in Chinese stocks. Then, the price of oil plunged.
And when you zoom into the industry level, you can see how the rolling crash spread from industry to industry in just less than a year.
The mining industry collapsed 58%. The crash then rolled into the entire oil and gas industry, which plunged 55%.
Then, it rolled into a 47% crash in the biotech industry, a 40% crash in the pharmaceuticals industry and a 30% crash in the health care industry.
In the end, the S&P 500 itself only dropped 15%. But the months leading up to that were still a terrifying, painful time for investors. Many folks were blindsided by massive losses.
That’s the exact experience most investors have felt since the start of this year, too.
And a similar phenomenon happened in 2011. Back then, the markets quickly plunged after Standard & Poor’s downgraded the credit rating of the U.S. from the coveted “AAA” level.
I’ve seen this period called “the bear market nobody talks about”.
Overall, the S&P 500 crashed 19%. But before and after the broad market fell, a far more devastating rolling crash spread across specific industries.
The banking and insurance industries both crashed more than 30%. Meanwhile, industries like transportation, biotech, and retail didn’t peak until as much as five months later. And then, they crashed 20% to 30%.
It’s crazy to think about but even an investor in his or her early 30s, who is still just testing the waters, has already lived through four rolling crashes.
US Economy
- The market continues to drive up rate expectations. Eight 25 bps hikes are now fully priced in
- Of course, there aren’t eight additional FOMC meetings this year, which means we will get a few 50 bps hikes along the way.
- At this point, the market expectation for the end of 2022 is well above the FOMC’s dot plot.
- The 2-year Treasury yield is headed for 2.5%.
- The 30yr – 5yr portion of the Treasury curve has inverted this morning for the first time since 2006.
- The 10yr – 2yr inversion is a few basis points away.
- The updated U. Michigan consumer sentiment figures were worse than the earlier report.
- A sharp divergence between the U. Michigan’s and the Conference Board’s sentiment indicators tends to lead to economic downturns.
- To put it another way, the U. Michigan weakness could indicate softer labor market dynamics ahead.
- Mortgage rates continue to surge to 4.7% with Treasury yields, which signals tougher times ahead for homebuilders, as affordability deteriorates
- The spike in mortgage rates to 5% could have broader implications for the economy.
- Pending home sales were softer than expected last month, which points to weaker existing home sales this month.
- Tight inventories could keep home prices from declining.
- And homes are still selling quickly.
- The spike in diesel prices is putting pressure on freight transportation companies.
- Chicago hog futures are up sharply.
- Fertilizer prices continue to surge.
- US cotton futures hit a multi-year high.
- Finally, we have food price gains since the start of the pandemic, by category.
- Global IPO activity has slowed sharply this quarter.
- Year-to-date share buyback activity hit a new record.
- Here is the S&P 500 return attribution over the past decade.
- The market is punishing US companies that, according to Goldman, “rely on international supply chains or have a high international manufacturing footprint.” Investors want to see more onshoring.
- Higher bond yields typically mean lower stock valuations.
- The Dallas Fed’s regional manufacturing index eased this month.
- City-center rents have returned to their pre-COVID trend. Suburban rents are surging.
- Consumer spending was softer than expected in February as inflation eats into disposable incomes. Real consumption declined
Debt
$30 Trillion….That’s the total federal debt right now, and every American should have it in mind when hearing about the government’s two-months-overdue $5.8 trillion budget, which is 31% higher than the 2019 federal budget. In 2009, the federal debt stood at about $12 trillion and it was $20 trillion eight year later. Our budget calls for $73 trillion in spending over the next 10 years, which would put debt in 2032 at an estimated $45 trillion.
Inflation functions as a massive regressive tax that hits low-income people hardest because they have the least disposable income and the highest percentage of budgets dedicated to items that are more expensive. Put another way, your paycheck is devalued.
In the midst of this rampant government-spending-induced inflation, our government proposes jacking up government spending and imposing the largest nominal tax hike in history.
Which brings us to revenue. Washington is rolling in money. Federal receipts in FY2021 were 18% higher than in 2020. They’re up 26% so far this year. Revenue of $4.53 trillion this year would have meant a surplus in 2019. And yet our government still manages to run big deficits and demand higher taxes.
As for the “fair share”, the top 1% already pays 70% of the taxes on 50% of the income. Also, keep in mind that the original income tax in 1913 was supposed to target only the wealthy, and look where we are now.
Tax rates will be going higher which is why we want to make sure clients are doing Roth conversions and funding their IULs.
Inverted Yield Curve
“I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come.” (and subprime is contained.)
—Ben Bernanke, March 2006
It’s always interesting when the yield curve inverts. Almost immediately, we see suggestions it is wrong this time. To wit:
“The Federal Reserve has its fingerprints all over the curve. The central bank is raising interest rates, which has the relatively direct impact of lifting shorter-term rates. To a lesser degree, the Fed may also have an impact on longer-term rates because it snatched up a lot (over $3 trillion!) of U.S. Treasuries since the beginning of the pandemic.” – Yahoo Finance
An inverted yield curve is unusual and has occurred just six times since the 1970s. A recession has followed each signal. The last four times the yield spread between 10-year and two-year Treasurys crossed below 0%, stocks dropped an average of 40% soon after. It’s getting awfully close to 0%… and then an inversion.
As of Fiday’s close, the spread was 0.06%.
As of today’s close, we’ve actually seen “inversions” in the 5-3 year Treasury spread, the 7-3, 10-5, 10-3, 10-2, 30-20, 30-5, and maybe most notably to me, the 30-3, meaning you could get a better yield on a three-year Treasury (2.58%) than a 30-year note (2.44%).
That’s not “normal,” and shows that the “smart money” in the bond market is as uncertain about the next three years as the next 30… Woah.
The only Treasury-yield relationships that aren’t that close to inverting are those that include one-year notes or shorter, like the three-month/10-year spread… and that’s because the Federal Reserve has much more influence over short-term rates than longer-term rates.
The Fed is hiking rates and pulling back on stimulus efforts – which would slow an economy in any circumstances, but now inflation is at decades-long highs, the Fed’s balance sheet is twice as large (near $9 trillion) and U.S. debt-to-GDP is well above 100%.
When an inversion does occur, it’s important to note that the time delay between an inversion and a recession tends to be anywhere between 12 and 24 months. Six months has been the shortest and 24 months has been the longest. We can only know after two negative quarters of GDP growth. Q1 2022 will report positive growth. Therefore, at best the official start date will be the end of Q3.
As a quick recap, a yield curve inversion happens when short-term interest rates are higher than longer-term rates. That inversion suggests something is wrong economically. As David Kelly from JP
Morgan quoted for the Financial Times:
“An inverted yield curve doesn’t do much to the economy, but it’s a very bad sign. The only reason you’d buy a long-term bond at a lower yield than a short-term one was if you thought yields were going to fall . That usually happens when most people think the Fed has gone or will go, too far.”
Notably, when the 10-year interest rate was lower than the 2-year rate, such has preceded the last eight recessions. Such also occurred when most suggested a recession wasn’t possible due to “full employment,” as shown.
While such seems counter-intuitive, it isn’t.
“The current case for a Fed mistake in terms of the historically low unemployment rate. The economy has to slow somewhat in the not-too-distant future, because at 3.8 per cent unemployment. ‘We’re out of workers. It’s hard to produce more when there is no one to produce it.’ Such might happen just as the US central bank pushes rates to their peak, exaggerating the slowdown to the point of recession.” – The Financial Times
Jim Bianco generously shared his trader’s perspective in a recent must-read Twitter thread . I’ll quote it in full here.
- On the yield curve and how to read it: Bottom line * Curves no longer than 2-years (i.e, 3M/2Y) are steepening A LOT. They are signaling many rate hikes are coming. See the table, 12 hikes are now priced in for the next year. Yes… 12!
- * Curves no shorter than 2-years (i.e., 2Yr/10Yr) are flattening a lot and many are inverting. So, we believe they are signaling the huge number of rate hikes will break something in markets, the economy, and/or the financial plumbing (repo). Details below.
- 2018 Engstrom & Sharpe argued an inverted 10y2y curve did not mean recession. The FOMC was so impressed (or wanted this to be the case) that they invited them to an FOMC meeting to explain it. The curve inverted in 2019 and a year later, recession.
- We don’t know the counterfactual if the pandemic did not happen. That said, we believe there was solid evidence pre-pandemic the economy was beginning to struggle. They are doubling down with an update to their 2018 paper, out Friday.
(Don’t Fear) The Yield Curve, Reprise
- They believe the orange curve matters more; the 3-month yield now versus the swap curve’s estimate where 3M yields will be in 6 quarters? For those without a Bloomberg, the blue line is the standard 2yr/3M curve. It is almost the same thing (and goes back further).
- This orange yield curve above makes sense. When this curve inverts it means things are already broken and a recession has either started or is inevitable. The Fed is in panic mode cutting rates to stop it. So, with it a record wide curve, no worries, right?
- Well as the next chart shows, the curves no shorter than 2-year (red, orange, blue) are inverting while curves no longer than 2-year (green) are going in the opposite direction massively steepening. How do we reconcile this?
- The Fed starts hiking for valid reasons, like inflation. The problem is they don’t know when to stop, overdo it, and break something. Why would the Fed go too far? Because nothing matters but inflation, and they have to get it down, as Nate Silver noted .
- This is why we have been arguing the Fed has no choice. They have to hike until it hurts. And if that causes a recession or bear market, so be it. I believe this is what the short and long yield curves are signaling. No recession now but headed that way with no off-ramp.
I have to agree with Jim’s bottom line: The Fed is going to hike until it hurts. Powell and his crew hope to engineer the fabled “soft landing.” I really doubt they can do it.
What gives me pause, though, is whether Powell really has the Volcker-like stomach needed to stay on this course. Make no mistake, the Fed’s rate hikes and ending its asset purchases will cause a lot of pain, both to financial markets and workers/consumers, and with no guarantee the desired effects will follow.
Market Data
- It’s been quite a quarter for commodities
- While buyers have shown heavy interest over the past two weeks, there still hasn’t been a sustained surge in securities hitting 52-week highs versus those falling to 52-week lows. It’s been 200 days since the last one. There is also a large split in the market, with too many stocks at either extreme.
- Higher bond yields typically mean lower stock valuations.
- KKR expects a significant slowdown in earnings next year, especially if inflation remains elevated.
- Earnings guidance continues to soften.
- Goldman is pessimistic about global growth.
Thought of the week
“I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty-six times I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life.
And that is why I succeed.”
– Michael Jordan
Picture of the Week
All content is the opinion of Brian J. Decker
