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Last Week Will Leave a Mark

CAMS Weekly View from the Corner – Week ending 3/10/2023

March 13, 2023

In attempting to succinctly lay out the economic/market challenges of last week we have to emphasize this edition will not come close to capturing the wealth of significant data points, testimony quotes, trading messaging through multiple markets and downstream concerns emanating from them all. We have chosen a very small sample of forward leaning observations, measures and excerpts offering each one could be its own edition in light of their importance to what may be unfolding as well as what they may be offering from a forward view perspective. We suspect near-term editions will cover several other items of interest from this past week as well as delving further into the items covered below. Dude, what is up With Small’s and Mid’s? Relative to market messaging, concerning developments appeared by Monday afternoon. By the close we were left with a very suspicious feel if not outright concern as to why small and middle sized company indexes notably outperformed to the negative. They stuck out like the proverbial sore thumb. Why? We had no immediate answer but we placed it on the “take note” observation board because “it means something” as we often add on said board under the banner of market participants offering a forward message. In particular the significance is those areas thus far in 2023 had been notable leaders of the pack within the market landscape. This elicited the old market adage: “When the generals leave the battlefield the soldiers will not be far behind.” Fast forwarding, by the end of the week these leadership areas were decimated. As a general description these were in the double digit percentage return range for 2023 only to then fall very rapidly to the point of barely holding a positive return for the year. That means something by-the-way as we look forward from here. Volatility Kicks In A couple of weeks ago we shared within an edition how the down trend in the well known Volatility Index had ended. “The VIX” or “The Fear Gauge” as it is often referred to was offering behavior that suggested market participants were getting a little less sanguine of their economic/market outlook. Simultaneously, the Volatility Index kicked up reflecting less smooth conditions may be approaching. This led to an explosive increase in the VIX as the previous two weeks have unfolded.

Click For Larger View:  https://schrts.co/bNyDjDRE

The above chart is taken from our edition of a couple of weeks ago whereby we focused on the blue down trend line being taken out to the upside.  We have amended the chart with the additional red arrow highlighting the notable increase in this Volatility Index since then and with this an increasingly challenging backdrop for the stock market has developed. Similar to the small’s and mid’s behavior this too means something.  From here, at a minimum, general volatility in the market(s) landscape can be expected. The Bond Market As bond market participants become more concerned that inflation/interest rate risk will impact the forward health of the general economy they sell High Yield bonds in droves being they already represent higher risk on the credit quality front.  This is why they are often referred to in slang as “junk” bonds.  If/when recession outlooks develop it adds additional concerns relative to their ability to service their interest payments and even remain as a going concern to use accounting language.  Historically we have seen High Yield bonds go down dramatically in comparison to Treasuries when bond market participants become more and more concerned about recession risk.  It is their way of signaling recession risk is building.  Interestingly, this relationship has offered no recession concern at all over the previous year while narratives have been bandied about that recession is imminent “……if we are not already in one….” as is often expanded upon as an additional qualifier.

Click For a Larger View:  https://schrts.co/BhSBMxAz

The above chart is a well worn chart in historical editions.  It has been nearly a year now since we have shared it simply because it has not been giving any “recession is imminent” messaging.  The chart is a view of High Yield bonds relative to the performance of 7-10 Year Treasury bonds.  When the above line trends lower we can view this as one message coming from the bond market that it is increasing its concerns for the forward health of the general economy.  When it falls rapidly it is an overwhelming statement that the economy is barreling toward recession if not already in one. Our first two blue circles highlighted times when this relationship was leaning towards only to then crater into a recession message.  The far right blue circle with question mark was the last time we shared it as we asked curiously was it beginning to lean into such messaging.  As we can see it righted itself only to move upward offering no recession concerns. Updating to last week and looking to the far right corner we see this relationship fell hard south.  Importantly, in the grand scheme of things this relationship is anything but troubling to date but it can move fast which is why we are sharing it today. With the above small and middle size company abrupt hard trend change coupled with tremendous change in character of the Volatility Index we are now even more interested in watching bond market messaging which the above is one of many tools to do so.  Keeping it simple, if the far right corner line continues to trend down recession risk is building as viewed through the eyes of bond market participants.  If this occurs the stock market can be expected to chime in with its own downside pressures. The Chairman Doesn’t Relent Fed Chairman Powell testified before two different Committees on successive days in Congress last week.  Counter to X general narratives offering the Fed is all but done, i.e. the Fed pivot as is often referenced (to keep it short and to the point) the Chairman remained steadfast in his messaging.  Think the usual suspects in said messaging – 2% inflation target, more rate hikes, rates staying higher for longer, inflation remains far north of the 2% target and they will not finish “…until the job is done…” as he often shares. To underline the general sense of Chairman Powell’s testimonies below is a short excerpt from one of his appearances. 

“Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.” https://www.federalreserve.gov/newsevents/testimony/powell20230307a.htm

Per the above topics in this edition (to include many topics not covered) coupled with the Chairman’s steadfast views on price inflation/interest rate policies we fully expect more volatility to unfold throughout markets in coming weeks.  It is murky out there in the econ/inflation landscape and as a result market participants can be expected to reflect this uncertainty with volatile trading behavior. I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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