After the worst first half of the year for the S&P500 since 1970, it is not surprising that the overall bearish sentiment is at very elevated levels right now. This is something that can be seen in various data points. For example, asset manager positioning in ALL equity futures (% OI) is currently at 2.08%. To put that into some context, this was 5.07% in March 2020, 3.11% in 2016 and 2.85% at the end of 2011, making the current matric a new record low over the past decade. There are also signs of capitulation in the broad equities market, with the percentage of companies trading below cash and short term investments reaching nearly 12%. Again, for some context, this number only briefly exceeded 10% at the bottoms in 2002 and 2008. Lastly, the corporate insider buy/sell ratio is indicating that insiders are once again on the buy side. On a historical basis, they have usually been on the right side of the trade. Does this all mean the bottom is in? No it does not, but in my view we are close to one when looking at these data points, especially if we see reversal in monetary policy by the FED soon.
Now I know some of you may be wondering what this has to do with the FED pivoting, as they have shown that they are not really bothered by the broad equities market correcting in the manner that it has done. After all, what they are concerned about is getting inflation down to more sustainable levels. Allow me to put a pin in that ‘fight against inflation’ for a moment and concentrate on something that monetary policy does care about, which is the economy. Let’s start off with everyone’s favorite subject, taxes. We are seeing tax receipts come in lower on the back of these rate hikes and an economy that is slamming the proverbial brakes. This was also covered by Bloomberg recently, who noted that June’s estimated payments, which are closely tied to capital-gains realizations, were 31% lower than the same period last year. With tax receipts going down and likely continuing the slide if we don’t see a turnaround in monetary policy, budget deficits are poised to go up and US entitlement spending is poised to consume approximately 90% of these US tax receipts, which is wholly unsustainable.
Another reason why the FED is on the cusp of either breaking the economy or breaking their rate hike policy, with my view being that the latter is far more likely, is that the treasury market is slowly breaking. With debt to GDP at around 130% in the US, a major rise in yields and the breaking of the treasury market is a sure fire way to put a bullet in the financial system, something that I believe is not on the cards. They can rectify this by pausing their rate hikes, cutting inflation loose to inflate debt to GDP down towards the high double digit level, start a new QE program to halt the cracks in the economy and implement yield curve control as the final piece of the pivot puzzle.
In my view, seeing the speed at which this is unfolding, I believe that we will see a pivot by the FED and the beginning of the aforementioned monetary policy roadmap before the end of Q3. What they would need to start this however, is something to justify it. Call it an excuse or rather a justification for changing said monetary policy. This would likely have to come in the form of lower inflation numbers, as that has been the most important driver vis a vis the current rate hiking cycle. I think that this is exactly what they are poised to receive very soon, so let’s take the pin out of this subject and address it. Why do I think that after we just had the highest inflation print in some years? Because inflation metrics that are looking ahead, such as 1-year inflation swaps and port data are pointing to slowing inflation and that will give the FED the excuse it needs to get back to said renewed QE. Various commodities are also down over the past few weeks and months, with two examples being copper (down from $4.82 to $3.41) and oil (down from $113.39 to $98.43). With inflation slowing down, QE is the most likely path going forward to support the economy, even if it means cutting the inflation loose and letting it go up for the coming 12-24 months to bring down debt to GDP as I mentioned earlier. Before that happens however, we are still looking at a strong US Dollar, as well as continued volatility and downside risk across the markets between now and the decision to stop hiking, which I again think will come before the end of this quarter.
What will benefit from this taking place? Asset classes across the board, with the broad equities market resuming an upward trajectory and commodities (such as copper) and energy (such as uranium and oil) performing exceptionally well as those embark on the second leg of their respective bull markets. One asset class that I want to touch upon briefly in particular, gold and silver, is poised to outperform in a QE and YCC environment after being in a correction for nearly 2 years now. Sentiment is scraping the bottom of the barrel for this asset class and from a TA point of view they are at historical support levels. There are various ways to play this, whether it be via an index tracking the actual metal, royalty companies or the miners themselves, but that is of course all dependent upon your own portfolio goals and risk tolerance.
I hope that this post has proven to be informative and the coming months will likely be as volatile as they will be eventful. Best of luck out there for all of you and I hope you have a good and healthy rest of your day people!
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