📈 The 2-YR Treasury Tells All

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Every month I try to share with you all a general update on my views of the market — as well as attempt to make a few lofty predictions. These aren’t intended to scare you or cause panic — but instead to update you on market developments and my specific thoughts about them.

Below are examples from throughout 2022 —

• We’re in a Bear Market (January)

• Please Be Patient (February)

• How Low Can We Go? (March)

• Don’t Fight the Fed (April)

• Who Wants to Be a Millionaire? (May)

• The Fed, Bottom Signals, and Timelines (May)

• Investor Appetite: Hungry (June)

• We’re Officially in a Recession (July)

• Unemployment, Inflation, and the Economy (July)

• Why Did Stocks Rally if We’re in a Recession? (August)

• Hold on to your Pants.. (August)

• “A Sustained Period of Below-Trend Growth” (August)

• Building a Dividend Growth Portfolio from Scratch (November)

In this post, we’ll be covering:

• Macro Update — The Fed, treasuries, and earnings

• Valuations — P/E predictions

• Charts — Technical analysis and trends

⚡️ Macro Update

Let’s walk through… the comments Jerome Powell made that shocked the markets, a pattern we’ve noticed with 2-year treasuries, and the current condition of the labor market. 

The Federal Reserve

The Federal Reserve concluded their November FOMC meeting by raising interest rates by +75 basis points. This was very much expected — so much so, the markets quickly reacted in a positive way.

However, only after Jerome was asked the following by Christopher Rugaber did the market begin to realize what was really happening..

Jerome responded with..

Then the CNBC and WSJ headlines came marching in —

Here’s the deal — despite overly-optimistic WSJ articles, a Fed “pivot” isn’t coming anytime soon. Jerome Powell made his stance very clear — there is no pause, and certainly no pivot, on the horizon.

Could Jerome slow down the rate increases?

Sure — maybe we’ll slow to 50 bps, or even 25 bps — but the idea that the Fed is going to begin cutting interest rates in the near future is outlandish and simply not true.

And remember — the Federal Reserve lowering their speed of rate hikes is not them pivoting their monetary policy from “tight” to “loose.”

To better visualize the impact of what the Fed did last week, look no further than the yield on 2-year treasuries. They quickly climbed another +25 bps to ~4.75% after the announcement and subsequent Q&A.

The chart above depicts the 2-year treasury yield throughout the last few decades. The chart below takes that data (and then some) and overlays “market bottoms” to help display an important pattern.

Considering the yield just rose by +25 bps last week — I’m going to reiterate my prediction that a bottom is not yet in for the stock market. I’m still a firm believer that we have another -15% to -25% left to fall.

I still believe we’ll see the S&P 500 move much closer to ~3,000.

Unemployment

According to the most recent JOLTS Report, the United States labor market remains healthy — with over 10.7 million job openings up for grabs. Mind you, this report released last week reflects September data — so there’s a bit of a lag.

Unemployment remains low at 3.7%, with the ADP October Job report telling us wages increased +7.7% YoY.

Thinking back to the Federal Reserve and their goals for a moment — it’s two fold: 1) price stability and 2) maximum employment. Today, prices remain wildly unstable as inflation continues to run rampant. However, despite this reality — the labor market has remained unusually strong.

We’ve begun to see more and more headlines in November pointing toward layoffs and restructuring (Meta, Chime, Opendoor, Stripe, Lyft, and many others). In my humble opinion — I believe we’ll begin to see the unemployment rate begin to tick up closer to 5% in 2023.

Remember, as I shared in this video, there were four other times in modern history when inflation spiked above 8% — and before inflation came back down to historical norms, we’ve needed to experience both a recession and a spike in the unemployment rate (6%).

Above is a chart that displays the unemployment rate the United States was experiencing when the Fed hiked rates for the last time before they began to pivot toward looser monetary policy.

Again, the recent weakness in the labor market won’t show up in the JOLTS Report (or other job reports) for a few more months — but it will eventually. And until then, it’s very premature to think about any sort of pivot by the Fed.

Earnings

We’ve seen 95% of earnings results for Q3 reported thus far — and we’ve heard a lot of the same stories shared by the companies’ management teams.

• We’re in a challenging macro economic environment

• Foreign exchange headwinds

• Lower-than-expected margins

• Lower-than-expected Q4 and 2023 guidance

The reason I’m sharing this quick section about company earnings is because I believe the sell-side analysts on Wall Street have yet to accurately include the earning compression coming our way in 2023 into their public projections. 

The above chart displays next 12 months (NTM) earnings growth year-over-year dating back to the mid-80s in blue, and the year-over-year ISM Manufacturing growth throughout the same period of time in green.

As shared in our recent Week in Review post, the ISM Manufacturing and Services indices are two of the most important economic indicators available. Generally speaking, when the ISM Manufacturing Index is below 50, our economy is shrinking. When it’s above 50, our economy is growing.

Take note that, like in 2008, the sell-side analysts on Wall Street share their earnings projections with sort of a lag. It took a nosedive from the ISM Manufacturing Index to change these analysts’ earnings expectations in 2008. The obvious catalyst might have to take place for things to change in 2023.

⚡️ Valuation Updates

It’s fun to use historical patterns to try and “mark the bottom” of the market — so let’s keep guessing.

Price / Earnings

As you all might remember from this post (The Fed, Bottom Signals, and Timelines) we shared with you all how P/E multiples have compressed during the last few recessions.

Recessions and their compressions: P/E ratios

• 2000 Dot Com Bust: 26X to 14X

• 2008 Great Recession: 18.5X to 9X

• 2018 Rate Shock: 18.5X to 13.5X

• 2020 Covid Crash: 19X to 13X

• 2022 Covid Bubble: 23X to ~16.5X today

I believe the S&P 500’s 2023 P/E multiple lands somewhere between 13X and 14X at capitulation.

I found this awesome P/E matrix on Twitter (Marlin Capital) that clearly shows where the S&P 500 might end up depending on P/E multiples — assuming changes in earnings growth. If our 13-14X prediction came true, we could expect the S&P 500 to land somewhere around $2,800.

Again, I have no idea what the market will do. However, I do not believe a Fed pivot is in the cards, nor do I believe Wall Street is accurately predicting earnings for 2023. With that being said, I’m prepared for another -15% to -25% drop.

Technical Analysis

I’m no TA expert, I leave that for Katie Stockton. However, I’ve found a few interesting charts I want to share with you all to put the recent price action we’ve seen in perspective.

200-Week EMA

This long-standing moving average has shown to act as “support” for the S&P 500 — we’ve bounced off of this many times. However, when we fall below it — all hell breaks loose.

We’ve broken below this twice in the last two decades — the Dot Com Bubble, and the Great Finance Crisis. We briefly dipped below it in 2020, and are now flirting with it. It currently sits at ~3,670.

If the S&P 500 makes a clean break below this, watch out!

The Golden Cross

If and when we move below the 200-day EMA, be on the look out for a “Golden Cross” to form. This is essentially when the short-term, medium-term, and long-term trends are all pointing up in unison.

Historically speaking, this has been a signal that the downtrend has ended and we’re off to the races.

Above is a screenshot from TradingView that shows this cross taking place in late-2004 and again in late-2011 — two instances where the market had definitely found a bottom and it was “safe” to begin investing again.

Don’t worry — I’ll definitely let you all know when this happens.

Did I miss something? Are you keeping your eyes on something not mentioned here? Please let me know in the comments below — or simply reply to this email.

Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.