The Pause that Depresses - Sell Equities/Buy Bonds

Rarely does the market ring a bell to signal a selling opportunity, but it did yesterday. Fed Chair Jerome Powell announced the Fed would stop its interest rate hikes and consider slowing its balance sheet reductions.Equity investors, trained over the past 10 years to buy on Fed easing, gorged on any and all equities, sending the S&P 500 Index up 1.58 percent. They won’t taste as good coming back up.Bond investors, a less flamboyant type with a sensitive ear for risk, quietly gathered their things and left the party, which they know is over. They bought bonds across the curve and sent the yield on the 2-year Treasury note down 2.51 percent.The rally in stocks yesterday was a head fake that should be sold.

Long Series of Rate Hikes + Pause = Recession and Market Decline

For the past 20 years, every time the Fed has paused after a long period of rate hikes, the economy has stalled into a recession and the market has fallen.

Chart 1: Fed Funds Rate versus S&P 500 Index

In the chart above, the white line is the Fed Funds rate and the green line is the log of the S&P 500 Index price. When rates (the white line) go flat after rising for a few years, the S&P 500 (the green line) goes down.I predict the yield curve will steepen, but not from long-term rates going higher, short-term rates will fall. Which is why the two-year U.S. Treasury is so appealing.

Chart 2: Log of 2-Year U.S. Treasury Yields and Relative Strength

In the bottom pane of the chart above, you will see that over the past 30 years, the relative strength of the 2-Year Treasury yield has never been as overbought (above the red line) for as long a period as the past two years. This is now reversing.Very simply, investors should sell equities and buy the two-year U.S. Treasury.

Stock Market Vigilantes?

The narrative has become that there are now "stock market vigilantes" that will sell the market if the Fed doesn't do their bidding. This trope is a tale told by an exhausted stock market, full of hope and yearning, signifying nothing. The Fed is looking at the economy, not the stock market, no matter what fanciful stories the market tells itself.Jerome Powell spoke yesterday about economic "crosswinds".[1]  Crosswinds is Fedspeak for headwinds and soon the economy will be in irons.Why am I certain?  Simple:

• Every economic indicator I know is pointing down;
• Both economic growth and inflation are declining. If you listen to Ray Dalio (probably the best asset allocator ever) these are the key tells of how the markets will perform.  When both growth and inflation decline, stocks decline and bonds rally;
• Every major economy in the world is slowing;
• Every heavily cyclical industry is down sharply, including chemicals, housing, and autos, and;
• We are coming out of a record nine straight quarters of earnings growth. This is a post-war record.  (I'm referring, of course, to the War of the Roses.) The comparables for the next four quarters will be absolutely brutal as corporate America has to overcome the sugar high of the tax breaks.

All this equates to a high probability of declines for risk assets.NOTE: this is not individual investment advice.  You should consult with your advisor as to your individual facts and circumstances and make decisions accordingly.