February Markets in Play

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When we look at the markets in play, we see that the Euro is showing up. In terms of four of the Crosses the EURNOK, the EURSEK, the EURCAD and EURUSD and we're seeing Swiss strength as well, by USDCHF and CADCHF. One of our favorite themes of the year is the Mexican peso, it's showing up on the list along with the Swiss franc and the euro and the futures and then we're seeing strength in European equities, in the Euro stocks in the DAX and then also in the Russell. We've been seeing strength in the gold Oh, this significantly changed in the last two days. In energies, we've been seeing plural weakness, led by nat gas, we've been also seeing weakness in heating oil and in crude. Then in commodities, we've been seeing strength in soybean meal, and soybeans, and live cattle and we've been seeing weakness in coffee and then we've got some of the sector ETFs that are strong, we have XLI, XLF and XLB, and small caps IWM. 

When we look at the change in the WAM relative strength in February, we can see how strong equities were, equities had a huge up January and we saw weakness in the two-year note, gold and in the five-year note. So, the big shift, though, has been clearly in equities being really strong and in the sector ETFs we've seen big relative strength changes in XLY, XLK, and XLC and this has been because several of the names that have just been getting crushed in 2022, rallied hard, particularly in short, covering rallies in January.

All right, so the macro backdrop hasn't changed materially, but we've kind of hit a really important potential inflection point that we're going to talk about. First of all, if we look at monetary and credit and liquidity, the yield curves are still hugely inverted, more so than any time since 2000 and even more than that, both the three month 10 year down here and the two year 10 year. That has a perfect record since 1959, nine for nine of calling recessions, at least within the 18 months afterwards, but you don't know how long it's going to take. Usually you don't get a sustained rally in stocks until after the yield curve actually comes back and becomes positive, so steep and substantially off of its lows. There's one sort of minor exception, it wasn't a sustainable rally, but it was a significant rally in 1978, which we're going to talk about. In 1978, basically, stocks were able to go undergo a nine-month 25% rally, even while the Fed was raising rates and even while the yield curve remained inverted, and it took a little bit longer than normal for the yield curve to impact recession, it started in 1980.

Still have leading indicators and a number of things also telling us recession, so if you're looking at the macro indicators, they're still quite cautious. Leading indicators are falling year over year more than 1%. They're actually falling at a 7% year over year rate, which is very steep decline. That also has anticipated nine of nine recessions since 1959, with a perfect record and when the year over year rate of change of the LEI is less than zero, the s&p has returned an average of minus 11.2% annually over the period. Also have manufacturing ISM's falling substantially, retail sales falling substantially, all of these things tell us that we're weakening in a lot of the economy and financial conditions and liquidity conditions particularly are still declining, even though the market is declining. Chinese new stimulus may have an impact, but we have to understand that within the United States and most of the developed world, we still have a situation that is likely to tighten policy. That's one of the reasons why when you look at forward earnings indicators, they point really sharply down. 

One of the biggest divergences between present earnings estimates and leading earnings indicators that we've seen in the last 40 years. This tells us probably this quarter, and maybe next quarter or two, at least, we're going to have significant earnings problems. You can see the margin pressure here, because costs are firms are still going good, making new highs while sales have fallen off and that generally leads to margin pressure, somewhere around nine months after it begins and it's been going on for six months. We talked about how there's normally an earnings decline of about 26%, somewhere between 20 to 26%, during recessions, and so that this earning season that we're in is kind of a risky backdrop for the market you want to be careful of and when we get through this one, if it hasn't really led to a big revision in earnings for double digit declines, really want to be careful about the next earnings seasons. 

Now we had a really, somewhat timely, potentially, that we have the report now, because we have really what I would call a potential news inflection point. We've talked about before news, oops, where markets starts to react to a really strongly bullish news event and it starts to react as you'd expect, positively, and then reverses this is somewhat similar. I call it a news inflection point and it's where the market starts to make a move, so markets all started to make moves for breakdowns in interest rates, break downs in the dollar breakouts in stocks, breakouts in junk bonds. Off of the Fed FOMC meeting on Wednesday, which was interpreted as being dovish and so we started to see these breakouts that were plural in various asset classes, and all of them reversed on Friday with a very strong NFP report and as we'll see, stocks didn't reverse nearly as strongly as other asset classes, but nearly all asset classes did. Because we're at a point where we're at really important resistance, we're in that 4100 to 4200 original target, bear rally target, that we had for the s&p and as we'll see, a lot of the major internals are just on the edge of saying, look, you've got to throw in the towel and become more positive but not yet doing that. We think that last week's levels are really important in the markets, if we get follow through down, that could be the start of the of a new leg down in the bear market, but if we break through those levels in stocks, then there's likely going to be a longer intermediate term rally, perhaps not a full bull move to new highs, but we'll talk about that.

This is it, this news inflection point. News inflection points are where you have a shock that hits the market, you get an initial reaction, it's broad in various asset classes and now you're kind of watching to see how much follow through you get and how much that keeps going in all the asset classes to determine whether that inflection point becomes really an intermediate term turning point or whether it's just something temporary and the markets can break through that tells you that they're much stronger than you would think.