The Recession 'Countdown' Is Now Underway
Investors are in love with stocks again... This critical sector is in freefall... 'Inversion' is here... The recession 'countdown' is now underway...
The average 'investor' will never learn...
Just three months ago, as U.S. markets were plumbing their Christmas Eve lows, many folks were getting worried.
As regular Digest readers know, most measures of investor sentiment didn't reach the all-out "panic" levels we've typically seen at major market bottoms in the past. However, we did note that some indicators had reached extremes that suggested at least a short-term rally was likely.
One example is CNN Money's so-called "Fear & Greed Index," which fell well into "extreme fear" territory in late December. Another is the Daily Sentiment Index ("DSI") – a highly reliable measure of short-term market sentiment – which plunged to just 4% bulls on December 24. (For reference, any reading of less than 10% is considered extremely bearish... and therefore an extremely bullish short-term signal for the market.)
Now, let us be clear... Depending on your personal circumstances and risk tolerance, these extremes alone weren't necessarily a valid reason to commit significant amounts of new money to stocks.
However, it was certainly a terrible time to be selling stocks and getting more bearish on the market, like many folks apparently were.
What a difference a few months make...
After a nearly nonstop rally of roughly 20% in the benchmark S&P 500 Index, investors are anything but worried these days. Instead, they're once again clamoring to buy.
Today, several measures of sentiment are showing opposite extremes...
The Fear & Greed Index has been well into "greed" territory for several weeks. And the DSI just hit a rare 90% bulls this week. This is the single highest reading in this indicator since January 2018... just before stocks plunged nearly 10% in five days during February's "volatility panic."
In other words, traders are even more bullish on stocks than they were at last September's all-time highs, even though the market remains well below those levels.
But investor sentiment isn't the only troubling sign today...
Regular readers may also recall our colleagues Ben Morris and Drew McConnell highlighted the performance of financial stocks for their DailyWealth Trader subscribers back in early December.
In short, at that time, the S&P 500 remained above both its February and October 2018 lows. However, Ben and Drew noted that financials were struggling mightily, and warned that they could ultimately drag the market lower as well. As we shared in the December 12 Digest, which originally appeared in their DailyWealth Trader issue that day...
Financial businesses play key roles in the economy. And with a 13% weighting in the S&P 500, they're critical to the health of the stock market, too...
More than any other sector of the market, financial businesses have their hands in the flow of money. Banks hold it, invest it, and lend it. Credit-card companies help you spend it. Brokerages help you invest it. And insurance companies pool and manage financial risk.
The flow of money is the economy. So the performance of the financial sector is closely tied to the performance of the overall economy.
Over the past month, shares of financial companies have fallen 10%... more than any other sector. They hit a fresh 52-week low yesterday and are now trading 19% off their January highs...
If the bull market is going to get back on solid footing, financials will likely need to participate. So keep an eye on this important sector.
Of course, we know now that they were exactly right...
Financials continued lower... and the S&P 500 followed, plunging more than 10% over the next two weeks.
Likewise, after bottoming with the market on December 24, this sector has been leading the way higher. Bank stocks – as tracked by the KBW Bank Index – surged as much as 26% over the past three months.
But this week, something changed...
As you can see in the following chart, banks are suddenly in freefall. They've plunged more than 10% over the past four days, and have already given up more two-thirds of their gains for the year so far...
This is concerning. As Ben and Drew explained back in December, it could be an early warning signal for the broad market.
So, what's been troubling the banks?
We suspect it has to do with another important indicator we've been following: the U.S. Treasury yield curve.
As we've discussed many times in the Digest, the yield curve has been one of the most reliable "early warning" signals for stocks and the economy for decades.
In short, whenever the yield curve has "inverted" – that is, whenever short-term interest rates have exceeded long-term rates – bear markets and recessions have inevitably followed anywhere from six to 24 months later.
In addition, because the business of banking is based on borrowing money at short maturities and lending at longer maturities, inversion is terrible for most financial companies.
Last fall, several 'spreads' across the yield curve began to invert for the first time since 2007...
As we reviewed most recently in the December 6 Digest (emphasis added)...
The most widely followed measure of the yield curve – the difference between the yield on 10-year U.S. Treasury notes and two-year U.S. Treasury notes, known as the "2-10" spread – has fallen to just 0.115.
While this spread remains above zero for now, it's dangerously close to inverting. And two less-followed spreads – the "2-5" spread and the "3-5" spread – have already inverted, which suggests it's just a matter of time before the 2-10 does as well.
Unfortunately, after a brief pause to begin the year, the yield curve has been flattening rapidly again...
And as of this week, more than 50% of spreads across the curve – ranging from the short-term federal funds rate through 30-year Treasurys – have now inverted...
Even more concerning, the median spread has now also turned negative for the first time since 2007...
To be clear, the most-followed "2-10" spread has still not yet officially inverted – it's near 0.1 as we write.
But history suggests the "tipping point" has been reached. The clock is ticking.
Again, typically these signals have provided many months of advance warning...
For example, the last time the yield curve inverted, in 2006, the boom continued for nearly two more years.
But that hasn't always been the case. During the dot-com boom, the bust began almost immediately.
There's no way to be certain just how much time we have left...
But at least one other signal suggests it may not be as long as we'd hope.
The following chart compares the NFIB Small Business Cost of Labor Index with U.S. gross domestic product ("GDP")...
You're probably not familiar with this index. In simple terms, it shows which share of small-business owners rank rising labor costs as their single most important problem.
As you can see, this chart shows us two important things...
First, going back to at least 1972, this NFIB index has also been a strong predictor of recession. Every time it has risen to eight or above, the U.S. economy has fallen into recession 12 to 18 months later.
Second, this index has now been above the crucial level of eight since March 2018... 12 months ago. According to this indicator, the U.S. economy could be in recession inside of six months.
As always, this is not a recommendation to sell all your stocks...
This 10-year bull market has been incredibly resilient, and we could still see a "Melt Up" before it's all said and done.
In fact, it's possible the remarkable rally we've seen so far this year is the beginning of this final "blow off" move.
However, we'll remind you that even under the most bullish Melt Up scenario, we'll likely experience several sharp corrections along the way. And right now, several signals suggest the market is ripe for at least a short-term pullback.
In addition, we now have a confirmed recession "countdown" for the first time in over a decade.
Caution is warranted.
Stay long, but continue to hold plenty of cash. Reserve new money only for your highest conviction ideas... Consider "hedging" with a few short sales or long put options, if you haven't already done so. And be sure to keep a close eye on your trailing stops, just in case.
New 52-week highs (as of 3/21/19): Automatic Data Processing (ADP), Cabot Oil & Gas (COG), General Mills (GIS), Ionis Pharmaceuticals (IONS), Intuitive Surgical (ISRG), KLA-Tencor (KLAC), Kinder Morgan (KMI), iShares iBoxx Investment Grade Corporate Bond Fund (LQD), Microsoft (MSFT), Nestlé (NSRGY), Procter & Gamble (PG), Starbucks (SBUX), Vanguard Real Estate Fund (VNQ), and Wheaton Precious Metals (WPM).
Another subscriber shares his experience with "Wall Street research." What's on your mind? Let us know at feedback@stansberryresearch.com.
"THANK YOU to Tom Carroll for the brutally honest Digest: 'The Best Way to Read Wall Street Research.' You have literally hit the proverbial nail on the head with every single word; specifically with #3 – 'aligning with investment-banking' – even more so, that most management teams won't meet with an analyst or his clients if they don't have a buy recommendation on the name!
"Individual retail investors have no idea what this even means!!! 95% of financial advisors (or more) don't understand this concept – they don't even know what 'nickel business' is or that institutions get paid for providing access to management teams. Without a buy recommendation – the client (xyz hedge-fund) will simply call any one of his other 10 brokers whose analyst has a 'buy' recommendation on the name.
"Investment banks can lose over 5 revenue streams on a simple downgrade from hold to sell... it's why companies like NIHD (NI holdings) were 'select list' companies – from $44 to bankrupt without a downgrade (but we fired the analyst – SMH).
"Tom – while our paths never crossed – we are alum of the same firm... I was institutional focused on financials. I've been reading these guys at Stansberry for over a decade. I left on my own accord for countless reasons (reading independent research like Stansberry and formulating opinions other than the one you're told to have doesn't align with firm values) – you couldn't have made a better choice in joining Stansberry. Thank you for your honesty and openness. I can't wait for your webinar and I'm looking forward to reading your work as an Alliance member. I've made some personal investments in some private placement CBD start-ups. It's an interesting time for this industry though your insight is something that I have been waiting for! Welcome aboard." – Paid-up Stansberry Alliance member Mitchel K.
Regards,
Justin Brill Baltimore, Maryland March 22, 2019