Week of November 20, 2022
Today, we will begin by recapping the events of this week, which reflected significant volatility and more pain to come. We’ll discuss the yield curve and what it means for you as the investor going forward.
Then we’ll discuss what investors should be doing as the market evolves.
Let’s dig in.
The Fed’s Next Move
Don’t let the markets fool you…while the Consumer Price Index (CPI) update for October was better than expected and stocks soared, danger may still lurk.
Of course, inflation numbers were better than expected, but they still weren’t good.
You see, the Federal Reserve’s target inflation rate is 2%…and inflation as it currently stands is still at 7.7% year over year.
One of the key elements you may have missed in the news is that no one is talking about the overall CPI…
When you look at the prices of certain assets individually, you see how dire the situation really is.
For example, oil prices increased about 20% over the past 30 days and are up about 70% since last year.
Shelter costs were up about 7% in the same period.
While last month’s inflation report shows that we’re headed in the right direction, it’s still not enough good news.
Now where do we go from here?
Well…if the CPI rises more than expected next month, we could be looking at a major drop in the market…
If consumer sentiment declines and demand for goods goes down, watch out…
But more importantly than that, one thing that won’t change is the Fed’s intervention.
Look, unless there is a dramatic decrease in inflation, the Fed has no choice but to continue to increase interest rates until it achieves its target inflation rate of 2%.
The next CPI release is scheduled for December 13, and the Fed’s next meeting is the very next day.
So will we see another interest rate increase?
It’s very likely.
Short of massive deflation next month, the Fed’s next step is pretty obvious.
The Fed will raise rates again in December.
Now if you’ve been paying any attention at all this year, you know rate increases are not good news for stocks…and it means the volatility will continue.
The Yield Curve
Many are discussing why the yield curve keeps growing negative…even with the rate hikes.
While it may seem like the market doesn’t care what we’re thinking…the truth is that the market is baking in a few years of new expectations.
The yields of Treasury bills, notes, and bonds have been bent out of shape, meaning shorter-term yields have been higher than longer-term yields…
This is what is referred to as an inverted yield curve.
What the market is saying when the yield curve inverts is that there is more risk in the near-term future than in the long-term.
With high inflation and interest rates increasing, investors have determined that they want a higher yield for short-term Treasury securities.
A good benchmark to follow is the spread between the 10-year and 2-year Treasuries…which has been growing more and more negative.
On Thursday, that spread hit a new low at (0.68)% due to the fact that expected inflation and interest rates have kept short-term yields high at the same time 10-year yields have dipped.
For now, the market is betting on better times later rather than sooner, leading to a widening of the 10-2 spread…
This spread hasn’t been this negative and trending downward since the time period leading up to the recession of 1981 and 1982…
At the time, the 1981 and 1982 recession was the worst economic downturn since the Great Depression.
Unemployment hit 11%, and rates stayed high to fight high inflation…
History has a way of repeating itself it seems…
But there is some good news though. While the bond market is signaling a recession ahead, the worst time period for stocks may have already passed.
Adjusted for inflation, the S&P 500 lost 33% from 1980 to July 1982…
But it finished with a 15% return in 1982 and had positive annual returns for the next seven years…
Now…past performance has no bearing on future results…but this does give some signs of hope.
We don’t know how far stocks will slide going forward, but there is data that suggests that the worst of the losses have already occurred.
Additional data also shows that when the yield curve inverts, stocks have typically peaked after the inversion.
So, does this mean that stocks won’t bottom until the yield curve starts to revert? Potentially.
But given the inverted yield curve right now, the market is expecting higher inflation and interest rates for the next two years than they’ve been for the past two years.
It’s not all so bad…
Given the challenging market conditions, it may feel like it’s impossible to make money right now.
But if you adjust your expectations to the market, you can still make money…
High-quality businesses that generate high free cash flow will keep benefiting shareholders over the long-run.
Some sectors of the economy will surge more than others, like insurance and healthcare, due to inflation and higher interest rates.
By finding and owning stocks of companies that provide in-demand services, you will be able to compound your wealth.
This is why the research team at VJ equities is rolling up its sleeves to find the hidden treasures in the market that will outperform.
This is an opportunity for us (and you) to put distance between us and the competition.
Instead of speculating on tech stocks in a 0% rate environment, we are putting in the hard work to find high quality businesses.
After all, anyone can do the former and call themselves a stock market genius.
But it’s in tough times like these when you find out who has true investing skills.
As Warren Buffet once said, “Only when the tide goes out do you discover who’s been swimming naked.”
With our strong investment research skills, we focus on finding the stocks that are uncorrelated with the market…stocks that rise even when the market, the indices, and other stocks go down.
We are hard at work uncovering the next big stock plays for you, which we believe, based on our research, will be poised for significant moves.
We will return later this week with more information.