From the Desk of Willie Delwiche.

Time for A New Driver

Priced in their own currencies, more than half of the countries in the world are trading above their 200-day averages. The US is not among them. 

Why It Matters: The US has been in an uptrend versus the rest of the world for 235 weeks in a row, the longest continuous stretch of US leadership in the past 50 years. More broadly, the past decade has taught US investors that global diversification means lower returns and higher risk. But that trend is long in the tooth. If the dollar continues to fade, the opportunity for new leadership will become more apparent. Emerging Market central banks led the way into the tightening cycle and they could lead the way out of it. Remove currency factors and improving global rally participation can more readily be seen. And right now the US is not in the driver’s seat.

From the Desk of Willie Delwiche.

Rules Need Application To Be Useful

Market legend Marty Zweig was known for his investing rules. The first among them addressed the importance of staying in harmony with the underlying trend in the market. Good rules are great guides - we ignore them to our own peril. 

Why It Matters: Rules need to be more than trite and convenient sayings. But given that we each have our own temperament and time frames, our individual applications will likely vary. For me, recognizing that the trend is my friend and not fighting the tape means respecting the direction of the long-term trend in the S&P 500 and the advance/decline line based on net new highs for the NYSE + NASDAQ. All of the net gains for the S&P 500 over the past two decades have come when at least one of those is rising. Right now, as has been the case almost continuously since February, they are both falling. That is not a tape I want to fight.   

From the Desk of Willie Delwiche.

A Market of Stocks > A Stock Market

The Chart: The S&P 500 fell 0.7% on Wednesday, despite a majority of the stocks in the index advancing on the day. Thursday was similar, with the index falling 0.6% but again more stocks were up than down.

By The Numbers: Going back to 1998, there have been 276 single day instances of the index declining on days when more stocks were up than down. That is less than 5% of the time. We’ve seen it for two days in a row only 25 times. 2022 is the first year since 2017 that we have had two in a row more than once in a single year. We’ve only seen three for three (three consecutive index-level declines accompanied by more stocks rising than falling) three times since 1998, with the most recent coming more than twenty years ago.

Why It Matters: Cap-weighted indexes are heavily influenced by the direction of the largest components. But rallies are stronger when more stocks are rising than falling, when more stocks are making new...

From the Desk of Willie Delwiche.

2022 Sovereign Stress > 2008 Corporate Stress

The Chart: 

The long-term Treasury Bond ETF (TLT) is currently in a drawdown of more than 40%. This exceeds the 35% drawdown that high yield bonds (HYG) experienced in 2008 during the financial crisis.

Why It Matters: 

High yield bond yields are rising but spreads are not widening. That’s because sovereign yields are rising just as fast. That is a big difference between 2022 and 2008. It’s not just peripheral countries. We are seeing stress in the UK and we are seeing stress in Japan. We are also seeing it in the US, where yields are rising at their fastest pace in 40 years, yield curves are inverting and some Treasuries are trading at 50 cents on the dollar. It’s a risk off environment, but one in which risk off assets are leading the way lower.

From the Desk of Willie Delwiche.

Labor Pressure Eases - Is Inflation Next?

The Chart: 

On the labor front, job openings turned lower in August and the Atlanta Fed’s Wage Growth Tracker for September seems to have followed suit. On the inflation front, the year change in the median CPI reached another new high (its 7th in a row) in September.

Why It Matters: 

Despite a bevy of other explanations, surging inflation has had more to do with imbalances in the labor market than anything else. A drop in job openings (while not a sign of strength) is a more preferable way to restore labor market balance than increased layoffs and unemployment. With wage growth now slowing, the hope is that inflation could soon peak. The challenge is that once the inflation genie is loose it can be hard to get under control - even if the initial causes are mitigated. In that regard, this month’s jump in inflation expectations reported with the University of Michigan Consumer Sentiment Survey is unwelcome news for the Fed...

From the Desk of Willie Delwiche.

Apple Floats, Small-Caps Skid

The Chart: 

Many areas of the stock market have undercut their June lows. The largest company (Apple) and an ETF of small-cap stocks (IWM) stand out as exceptions. When we look over 3+ years (rather than just 3+ months) we see that small stocks are back to pre-COVID levels, while Apple has been consolidating its gains.

Why It Matters: 

The post-COVID speculative bubble in small-caps has been unwound. For Apple, the work seems hardly to have begun. Apple’s resiliency could become a liability if stocks take another leg lower and investors look again for safe havens to sell. As it stands now, Apple  is larger than 5 entire sectors in the S&P 500. Bear markets don’t usually leave anything unscathed.

From the desk of Willie Delwiche.

Stocks & Bonds Make It Three In A Row

The Chart: 

In the past we've had bonds down for 3 consecutive quarters and we've had stocks down for 3 (or more) consecutive quarters. Since at least 1976, we have never before had stocks & bonds both down in 3 consecutive quarters.

Why It Matters: 

The lack of safe harbors in 2022 has taken a financial and emotional toll on investors. After the storm passes, some may want to re-evaluate their investment opportunity set and perceived risk tolerance.   

From the desk of Willie Delwiche.

2022 Is Not 2008 - It Just Looks Like It

The Chart: 

In the past quarter century, only 2002 & 2008 have been more volatile than 2022. None have seen less strength beneath the surface than 2022. Other than this year, the only year to see more volatility than strength was 2008.

Why It Matters: 

Every year is its own experience, but we can see similarities in market environments over time. The current environment is consistent with past periods of persistent weakness.  

From the desk of Willie Delwiche.

This week’s upside surprise in inflation is raising the stakes for next week’s FOMC meeting. While the 10-year T-Note yield is still just below its June peak, yields at the shorter-end of the curve are breaking out to the upside. Leading the way is the 1-year Treasury yield, which crossed above 4.0% this week for the first time in 15 years. Even more pronounced is the pace of its ascent. One year ago, the yield on 1-year Treasuries was just 7 basis points (0.07%). That makes for the largest year-over-year change in yields since the early 1980’s. Investors are unaccustomed to yields moving this high and this fast and that is disrupting both financial markets and the economy. Continued upward momentum in yields could leave the macro situation vulnerable to further deterioration and increase downside risks to equities. Stocks do the best in periods of sustained strength and low volatility, neither of which is present at the moment. 

From the desk of Willie Delwiche.

Inflation data has overtaken jobs data as the economic indicator that seems to generate the most interest every month and next week’s CPI report will be no different. But seeing inflation just from a post-COVID perspective misses the point. It’s not about prices for used cars or gasoline or shipping containers. Those might be in the headlines but they aren’t the news. The match was struck when the Fed was cutting rates in H2 2019 with wage growth and median CPI inflation at their highest levels in a decade and more job openings than unemployed workers for the first time ever. That reality got lost during the COVID shut-down & re-opening. All the stimulus that followed was fuel for the fire. The Fed made a policy error in 2019. The Fed compounded that error by mis-reading the situation and remaining complacent through 2021. All that being said, we may very well be nearing peak inflation. Inflation needs to stop going up before it can start going down. But it having stopped going up doesn’t mean that it has started going down in a meaningful way.

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From the desk of Willie Delwiche.

The late-July breadth thrust provides a breadth thrust regime that lasts for a year (or more if we get additional breadth thrusts between now and mid-2023). In such an environment, near-term oversold conditions tend not to persist and, in fact, reverse quite quickly. One way of measuring this is to look at the percentage of world markets trading above their 50-day average. Anything above 70% is pretty good participation, whether we are in a bullish breadth thrust regime or not. Below 40% is a different story. Without a breadth thrust as support, the S&P 500 struggles to make headway when the percentage of world markets above their 50-day average collapses. But within breadth thrust regimes, it signals an oversold condition that leads to strength. 

The percentage of world markets above their 50-day average was at 90% in mid-August and is now down to just 25%. The recent breadth thrust suggests that rather than a red light arguing for caution, the signal now is a greenlight encouraging exposure.  

From the desk of Willie Delwiche.

Fighting inflation is job number one for the Fed right now. Jerome Powell made that crystal clear in his remarks from Jackson Hole on Friday. He discussed the deleterious effects of inflation and the risks that come with prematurely claiming victory (and loosening policy). This could lead to more persistence in raising rates, more tolerance of economic weakness, and more willingness to keep rates high for an extended period of time. In this environment, inflation data will be scrutinized more than ever. While inflation expectations get a lot of focus, they are much more closely related to where inflation has been than where it is going. There is an 85% correlation between 5-year CPI inflation and current 5-year inflation expectations. That drops to just 26% when inflation expectations are moved ahead 5 years (so that the inflation data and expectations data are covering the same time period).  If inflation stays high, expectations will become further unanchored. Alternative measures of inflation (like the median CPI from the Cleveland Fed and the trimmed-mean PCE from the Dallas Fed) show that the central tendency for inflation...