Market Review &
Update
I previously stated that with the market already trading 2-standard
deviations above the 50-dma, further upside
could be limited. Such was the case as markets struggled all week
to hold gains in a very narrow range. (Horizontal
dashed lines.)

Currently, the money flow signals remain positive, but “sell
signals” did trigger as of the close on Friday. While
the money flow itself remains strongly positive, the “sell
signals” continue to suggest downward pressure on prices currently. However,
given the more extreme overbought and bullish conditions, there is a risk of
a deeper correction over the next few weeks.
Importantly, as discussed last week, while we will certainly warn you of
when our indicators turn lower, the problem remains two-fold:
-
The indicators don’t distinguish
between a 5% correction and a 20% drawdown; and,
-
Secondly, the corrections often occur so quickly you don’t have much
time to decide just how defensive you need to be.
In other words, it is often advantageous to pare risk by “leaving
the party a little early.”
Are Rates About
To Cause A Problem
The question we need to answer is why the market has been struggling as of
late. As we touched on last week, investors may be starting to factor in the
twin threats of higher inflation and interest rates. To wit:
“With an economy pushing $85
trillion in debt, the entire premise of the ‘consumption function,’ as
well as ‘valuation justification’ for the stock market, is based on
low-interest rates. However, that is rapidly ending as the rise in rates
is now approaching a “danger zone” for the markets.”
As discussed in our #Macroview
report yesterday, interest rates are rapidly
approaching the 1.5% to 2.0% barrier, where higher payments will collide
with disposable income. Historically, such has not ended well for markets.

The rise in interest rates is much more problematic than most suspect. Higher
interest payments reduce capital expenditures, threatens refinancing, and
spreads through the economy like a virus.
As noted by Laura
Cooper yesterday:
“The writing may soon be on the wall
for the buy-everything-but-bonds rally, with focus on inflation fears
and subsequent Fed tightening. Yet it’s rising real yields that might
prove to be the ultimate stumbling block for the risk rally.”
Little Margin
For Error
Higher rates also quickly undermine one of the critical “bullish
supports” of the last decade:
“In a heavily indebted economy,
increases in rates are problematic for markets whose valuation premise
relies on low rates.”

“Each time rates have ‘spiked’ in
the past; it has generally preceded a mild to a severe market
correction.
As is often stated, ‘a crisis
happens slowly, then all at once.’
So, how did the Federal Reserve get
themselves into this trap?
‘Slowly,
and then all at once.’”
When combined with higher inflationary pressures due to stimulus injections,
such becomes problematic. Higher borrowing costs and inflation compresses
corporate profit margins and reduces real consumption as wages fail to
increase commensurately.

While the Fed
continues to suggest they will let “inflation
run hot” for a while, the problem is that the real economy won’t. The
impacts of higher payments and costs will derail consumptive spending very
quickly, given the real economy is still massively dependent on “life
support.”
Equally
problematic is when the stock market suddenly realizes that higher rates
have derailed a primary thesis of overpaying for value.

Risk Appetite
Is Extreme
It seems as if with each passing week, we have continued to point out levels
of exuberance either rarely or never, seen historically. This past week
continues to see increasing levels of exuberance on many fronts.
One that I will discuss more in Monday’s blog is the fact that “no
one is bearish.” Of course, that may be reason enough to be
concerned.

As Bob Farrell once noted:
“When all experts agree, something
else tends to happen.”
We must consider two issues.
The first is that current levels of speculation have increased the risk of a
more extreme reversion. As
physics’s fundamental laws suggest, a rubber-band stretched to its limit
will experience a move of equal intensity in the opposite direction.
The second problem is the demise of the T.I.N.A. (There
Is No Alternative) trade.
“The
problem today is that the relationship between the 10 year US note yield
and the S&P dividend yield has reversed. With risk-free rates
of return rising, the 10 year US note now does provide an alternative –
especially with the S&P dividend yield plummeting.” – Doug Kass

When “risk” becomes realized, there
is now a “safe” alternative.
The shift will likely not be subtle.
The views expressed
by Lance Roberts and not necessarily those of RetireEarlyLifestyle.com