Recent Stock Rally Not Likely To Last

Stocks and bonds have had a rough year in 2022.

Readers might remember, we forecast this as a “risk off” year quite some time ago, meaning a high probability of a dual bear market in both stocks and bonds.  From the beginning of the year, stocks had lost about 26%, putting us officially into “bear” market territory.

However, around the middle of October stocks began to rally and have retraced about 18% and taking the market back to major resistance at the 200-day moving average.  It has been a good two-month rally.  So good, in fact, many people are now changing their minds about what is ahead.

The market seems to sense that the Federal Reserve now sees progress on the inflation front.  The consensus view is that while perhaps two smaller hikes are ahead, the FED will soon pause, and then pivot back towards lower rates.  Hence the market is rallying ahead of expected interest rate cuts.  Expectations are the FED will pull off the “soft landing” for the economy.

While this view seems to have the market’s attention, we would suggest that the rally we have seen is likely simply a rally within an ongoing bear market that is not yet complete.  Students of market cycles suggest that bear market rallies are normal and that rallies should not be mistaken for a new bull trend.

If we are correct, there is a strong historical tendency for the market to be strong between Thanksgiving and Christmas, and after that period, early next year, the market will most likely resume its downward trend.

Here are some of the reasons this is likely:

Interest rates are already inducing a housing recession and homes are the single largest source of wealth for most consumers.

The savings rate is plummeting, suggesting all the Covid cash is running out.

The yield curve is inverted, that is short-term rates are above longer-term rates.  While no indicator is perfect, “the inverted yield curve” has been the most reliable indicator of a coming recession.

Stocks are not yet priced in the cheap range, and not yet priced for what is likely a poor earnings season stemming from recessionary conditions.

The Leading Economic Indicators have been down for now 8 months in a row.

The election results were enough to move the country to political gridlock but did not allow for Republicans to repeal the worst aspects of Biden’s economic policy.  The coming months will be full of investigations and partisan bickering but Democrats control the executive branch and the bureaucracy.  The Republicans have a very narrow margin in the House, and the Senate is deadlocked.

All it takes is just a few weak-kneed Republicans to keep Democrat policies in power.  History suggests there are plenty of such Republicans.

History shows that by the time the FED is willing to cut rates, it was prompted by severe economic weakness, and that weakness is not good for stocks. History shows that AFTER the FED starts to cut rates, the bear market goes into another downward phase.

A recession is likely in both Europe and China.

A slowdown means less revenue, and when that occurs in a condition of massive overindebtedness, it means credit default problems. There has been a wild use of debt and leverage in the previous business cycle by both government and the private sector, and a slowdown will reveal that many entities will not be able to service their bloated debt.  The fantastic break in cryptocurrencies, SPACS,  and NFTs, are likely just the tip of a credit mess iceberg.  The Chinese real estate bust and the problems with international financial institutions like Credit Suisse are also signs of a coming credit crisis.

Bottom line, what does this mean for our readers?

It suggests taking advantage of the current strong rally to sell into the strength, getting the portfolio less exposed to stocks, and more exposed to cash, and hence preparing for another leg down in markets next year.

Modest positions in long-dated bonds could be a decent trade to exploit interest rate cuts next spring.

Some gold could prove helpful if debt defaults become serious and widespread.  Gold likely will do well if the FED gets cold feet and pivots back to easy money policies too soon to strangle inflation.

Extra cash is always helpful and helps stabilize the portfolio.

When the time comes to purchase stocks, you won’t want to.  We need much greater pessimism than we presently have, to build a durable bottom.

We don’t like bringing you this sober news but protecting our readership from financial harm requires us to humbly offer these opinions.

These are, of course, general macro-market views.  Your own particular situation is unique.  Be sure to consult soon with your financial advisor.