This Financial 'Turtle Race' Is Worth Watching

Tech stocks sell off – again... Bonds are down, too... A pair of turtles racing down a sidewalk... What the bond market is saying today... This financial 'turtle race' is worth watching... A counterintuitive tailwind for stocks...

This probably isn't the start to 2022 that many were hoping for...

The Omicron wave aside (and that's a pretty hard one to simply set out of the way), we're talking about the stock market... as is our main business here.

In particular, shares of many technology and growth stocks have been down the first 10 days of the year, reflected by the tech-heavy Nasdaq Composite Index, which is already down about 6% for the year...

The names that grab headlines often are among the losers, so this sell-off has been an attention-grabber...

Today, for instance, Facebook parent company Meta Platforms (FB) and Amazon (AMZN) were down by more than 2% before recovering some losses.

With all the down days and volatility lately, you might be among those wondering what the heck is going on and if this is the start of a bigger, longer drop...

I (Corey McLaughlin) will explore these questions in today's Digest, in part by examining an old, reliable indicator and seeing what history shows about similar scenarios... In short, there is evidence that suggests long-term investors should remain bullish in stocks – for now.

First off, this sell-off relates to the 'hawkish' narrative we talked about last week...

That is, the nearing reality of the Federal Reserve raising its benchmark overnight interest rate... So, we said, get ready for a "hawkish" market ride in 2022.

The central bank has indicated it could raise rates as soon as March, but as we wrote last week, some investors are concerned about the Fed being more aggressive...

For example, Wall Street firm Goldman Sachs predicted today that there might be four rate hikes in 2022 instead of the three the central bank hinted at in December... Plus, many are talking about the possibility that the Fed's other "tightening" measures, like trimming its balance sheet, may happen sooner than previously expected.

The uncertainty, stemming from the minutes of the Fed's December meeting and continued inflation concerns ‒ another key number comes out Wednesday ‒ has spooked enough stock owners into selling shares of companies that these policy changes are likely to hit the hardest.

When the Fed raises rates, it filters through the economy to things like mortgages and other loans. This means a few things, not limited to...

1. It's more "expensive" to borrow money, which theoretically can take a greater bite out of corporate profits from those companies that tend to borrow more than others... Whether this is true is another story and depends on other indirect factors.

2. Higher rates encourage people and corporations to hold on to more money or borrow less than they would have if rates were lower.

Whatever the reasons, tech shares are down to start 2022... That's a fact.

It's similar to the panicky behavior that we've seen over the last year or so every time the Fed indicates that the rock-bottom interest policy will eventually end... and that the massive bond-buying operation, which has artificially suppressed interest rates, will slow.

Recently, bonds are selling off, too...

Like growth stocks, bonds – which trade inversely to yields – are also down, nearly 10% from their recent highs of the last months of 2021.

The iShares 20+ Year Treasury Bond Fund (TLT), for example, is off almost 8% since its recent high in December. This is significant when you consider Treasury bonds make up a significant portion of the conventional 60/40 stock-bond portfolio mix that many folks follow.

On the surface, this first-level thinking makes intuitive sense...

Higher rates make business a little bit more difficult for companies relying on debt... and they also make the fixed interest payments of bonds less attractive than they would be if higher rates will exist at a future date.

For folks investing on a certain timeline and with certain quarterly goals to hit – like Wall Street institutional investors – this line of thinking might be the right move for them. But fortunately, as individual investors, we're free to buy and sell as we please...

So let's take a closer look beyond the headlines...

I have written before that most people hear the word "bond market"... and then ignore whatever comes next and move on with their lives. I was once one of them. If you've made it this far, congratulations.

But, even if you don't fully or partially understand the bond market, it is important.

At the very least, it's wise to pay attention to bond prices and yields in the market because it shows a lot about what's going on with the plumbing of the economy... if things are strengthening or weakening.

As our colleague Dr. David "Doc" Eifrig put it in the recent issue of Stansberry Portfolio Solutions, released to subscribers last week...

We are optimistic and will stay invested in the stock market. But we do see one rumble under the surface that tells us caution in bonds is warranted: the yield curve.

We've written before about the "yield curve." This is a trustworthy indicator that many of our editors consider when making judgments about the markets.

But it doesn't usually get much attention since it's about as entertaining as watching a pair of turtles race down a concrete sidewalk...

In plain English, the yield curve is the difference between short-term and long-term interest rates in the bond market...

You can measure this curve in a variety of ways... but the most common is the difference or "spread" between the 10-year U.S. Treasury notes and the two-year U.S. Treasury notes.

Most times, long-term rates are higher to compensate investors for the trouble of tying up their money for a longer period of time. This is healthy... and logically, it makes sense. There's more uncertainty in the long term.

But when that relationship flip-flops, and you can get a higher rate on shorter-term bonds than longer-term ones, the yield curve is said to have "inverted." It doesn't happen often... But when it does, it warns that trouble is ahead for the U.S. economy.

Because it means enough people are betting that bond risk in the short term is greater than the long term... and that can lead to some wild outcomes for the economy and stocks.

This is why this "turtle race" – to continue the analogy, rates tend to move slowly but surely each day – is worth watching...

An inverted yield curve has preceded the last eight recessions, going back 60 years...

Most people will forever chalk up the last brief recession in 2020 to the pandemic – and it no doubt was the trigger – but the truth is there were warning signals flashing from enough investors months before anyone had even heard of COVID-19.

The yield curve inverted in August 2019 for the first time since the 2008 to 2009 financial crisis.

And as we wrote then, it signaled that the "bear market countdown" to the next recession was officially on... though history indicates that bull markets have continued well over a year after the curve first inverts.

In other words, pandemic or not, the yield curve in 2019 was saying that the economy was due for a recession – and it happened when COVID-19 struck.

Stocks, which can move in tandem with recessionary trends (but also don't have to – the stock market is not the economy), plummeted 30% at the same time, then rebounded to record highs, which brings us to today...

The good news is that today the 'yield curve' is not inverted...

A recession does not look imminent. Nor does a major bear market, despite the sell-off that started 2022.

But... and there's always a but...

The yield curve is "flattening"... and that's not a good sign, particularly for bondholders.

As Doc wrote in the January issue of Stansberry Portfolio Solutions last week, toward the end of 2021, short-term rates were rising faster than long-term rates...

This is called a "bear flattener." It suggests that inflation will take hold... hence the lack of attention to longer-term bonds. And it suggests the U.S. Federal Reserve will hike rates... leading to higher short-term rates.

The other three scenarios for the yield curve are long-term rates rising faster than short-term ("bear steepener," meaning the curve is steepening), short-term rates decreasing faster than long-term rates ("bull steepener"), or long-term rates falling faster than short-term rates ("bull flattener").

Doc also shared this chart that shows the yield curve since the start of 2017...

The bottom half of the above chart plots the interest rates separately. This allows us to see that the yield curve has flattened, but only because of a rise in the short-term rates (and not because of a fall in long-term rates).

Now, today, some of the headline news is that the 10-year rate has moved sharply higher to near 1.8%... That has widened the "spread" with the two-year rate (around 0.88%) a little bit, but the overall trend of this indicator since March 2021 is down.

This is all to say, if you're concerned about bond prices going down, you have every right to be. Because rates are rising... with short-term rates rising higher over the last 10 months than long-term ones.

The Fed is also lowering the amount of assets it has been purchasing each month and is getting closer to removing its buying support of bonds... though it may still be over a year away from that.

In other words, the advice that Doc has shared over the last year about how bonds could actually lose folks money – should they drop in price enough that the income payments don't cover the losses – looks like it's playing out.

We'll keep you posted on the race, but in the meantime...

What does this mean for stocks?...

If you are a long-term investor, you simply want to know what this all means for stocks over the next year or more...

Contrary to what you might think, history has said that what's happening now is a good thing. As Doc noted, according to research from investment management company Merrill Lynch that covered 1976 to 2018...

During bear flatteners, the market has tended to return 17.4% per year, compared with 12.4% over the course of the period studied. This tells us that the phenomenon in which stocks rise because there's no other place to go will continue.

In fact, in no other interest rate environment have stocks performed better than in a "bear flattener." The others have returned 13.7% ("bear steepener"), 10.9% ("bull flattener"), and 6.9% ("bull steepener").

It's counterintuitive...

Yes, what we're saying is counterintuitive... Because of rising rates, stocks – even if they are already expensive – can actually become more attractive as bonds become less desirable.

What's more, in the past three decades, there have been four Fed rate-hike cycles... And on average, tech stocks are among the best-performing sectors during those cycles, according to brokerage and advisory firm Strategas Securities.

In other words, some of the very stocks that have been selling off lately might be the ones that perform the best while the Fed is hiking rates however many times this year and next year...

If anything, history shows that it's when the Fed stops raising rates altogether that the bottom often falls out of the market.

For subscribers to our colleague Dr. Steve Sjuggerud's True Wealth Systems newsletter, he wrote more about this in his latest issue, published last Thursday... And we'll share more on this point in the near future.

The long and the short of it is... we're not seeing the signs of a "screaming buy" market like we did in the March 2020 bottom and the next several months after... when you could pick a stock ticker at random and be pretty sure it was going up...

Today, about 40% of all stocks in the Nasdaq have fallen at least 50% from their 52-week highs. Some folks are even writing comparison stories reminiscing about the dot-com bubble popping.

But, importantly, we're not there yet...

As our newest senior analyst Matt McCall wrote in his Daily Insight note on Friday...

We aren't even close to the same situation...

Valuations are nowhere near as high as they were in 2000. Companies are much better capitalized today and sitting on solid cash levels. The yield on the 10-year Treasury is 1.75% – and at the start of 2000, it was all the way up at 6.5%.

In other words, hang on. Pullbacks happen... And so do rebounds, when everyone is scared.

Be smart about your portfolio allocations and risk management, use proper position sizing and diversification... but also be careful not to let your emotions ‒ or fear-inducing headlines ‒ convince you to sell all of your stocks either.

A Market Shake-Up Is Coming

In the latest episode of the Stansberry Investor Hour podcast, our colleague Dan Ferris caught up with Ten Stock Trader editor Greg Diamond to talk about what we've seen early on in 2022 and what could come next for stocks.

Importantly, Greg warns that a huge wave of volatility is coming in the next few months.

Click here to listen to this podcast right now... And to hear more about the approaching market shake-up that Greg is anticipating, be sure to check out a free, special webinar from him this Thursday, January 13.

You can find out more and sign up for Greg's event here.

New 52-week highs (as of 1/7/22): Bunge (BG), Berkshire Hathaway (BRK-B), Dollar General (DG), Flowers Foods (FLO), General Dynamics (GD), SPDR S&P Regional Banking Fund (KRE), Invesco High Yield Equity Dividend Achievers Fund (PEY), Sprouts Farmers Market (SFM), Travelers (TRV), and W.R. Berkley (WRB).

In today's mailbag, praise for Dan Ferris' latest Friday Digest... What's on your mind? As always, e-mail your comments and questions to us at feedback@stansberryresearch.com.

"[Dan's] Digest on Friday, January 7, ["Everybody Knows... Nobody Thinks"] surpasses almost all of his previous articles. Dan is a brilliant wordsmith. Thanks for another enjoyable article." – Paid-up subscriber Sue M.

All the best,

Corey McLaughlin
Baltimore, Maryland
January 10, 2022