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Market Analysis: The Coming RecessionIn this post, I will present a market analysis with a focus on recession metrics and indicators. Right now, many of them are sending a recession warning. Home Prices - U.S. home prices are surging higher at the fastest quarterly rate of change on record. (See chart below) This extreme rate of change in home prices is occurring as U.S. 30-year fixed mortgage rates also explode higher at nearly the fastest quarterly rate of change on record. (See chart below) Additionally, we see in the chart below that 30-year fixed mortgage rates have potentially broken out into a new uptrend on the longer timeframes. The best way to detect trend reversals is by using the Ichimoku Cloud. When the price closes above or below the cloud (the shaded area) it is considered to have "pierced" the cloud. Once the cloud is pierced to the upside, resistance becomes support. In this case, assuming the piercing sustains, we can see a sustained period of higher interest rates on 30-year fixed mortgages. Exploding home prices and exploding mortgage rates occurring simultaneously is unsustainable. Examine the yearly chart of U.S. home prices below and notice the similarities between 2005 and 2022. Notice that the Stochastic RSI is extended to the upside, and that home price extends above the upper Bollinger Band. Looking at this chart one could reasonably conclude that in the coming years home prices are likely to revert to the mean (orange line), as they did during the Great Recession. Many analysts try to contradict what this chart is suggesting by claiming that we are in much better shape now than during the sub-prime mortgage crisis prior to the Great Recession. But are we really? With spiraling inflation, every mortgage holder suddenly becomes relatively more sub-prime. We also did not see mortgage rates explode then as quickly as they are now. Unemployment - Analysts point out that the current low unemployment is a reason to believe a recession can be averted. But under the surface, that's beginning to change in a hurry. Below is a chart of most leading unemployment data published by the Federal Reserve: Seasonally Adjusted Initial Claims (Weekly). In this chart, we see that in about a period of the past 4 months, the amount of new unemployment claims has risen by around 100,000 or about a 50% increase. Compare this to the chart from the 2007-2008, when the U.S. economy was beginning to enter a recession (the shaded area represents where the recession began): In the period leading up to the Great Recession, we saw a rise of about 50,000 new unemployment claims or about a 15% increase over a similar 4-month period. Therefore, the rate of increase of initial unemployment claims (both in real numbers as a percentage) is higher now than when we entered the Great Recession. Perhaps more worrisome is the difference in how accommodative the Federal Reserve was in response to rising unemployment. Here is how the Fed Funds Rate changed as unemployment began to rise in late 2007 into 2008: As unemployment was rising, the Federal Reserve began to cut interest rates. Compare this to the current situation in the below chart which shows the Federal Reserve raising interest while unemployment is rising. This change in context is reflective of both the fact that the Federal Reserve is behind the curve with containing inflation and the fact that the Federal Reserve is prioritizing the current problem (inflation) at the expense of the future problem (unemployment). We are experiencing a macroeconomic situation whereby rapidly rising initial unemployment claims are being paired with rapidly rising interest rates. This combination is unlikely to end with any other outcome than a recession. For more details on unemployment data see here: www.dol.gov To interact with the initial unemployment claims data on a weekly basis you can go here: fred.stlouisfed.org Yield Curve Inversion - The 10-year minus the 2-year Treasury yield is used to detect an impending recession. When the 2-year yield rises above the 10-year yield that creates a yield curve inversion, which can often indicate that a recession is coming. Right now the yield curve inversion is very steep. In fact, just recently, the yield curve inversion actually steepened to a level that was even worse than what we saw before the Great Recession. Perhaps most alarming are the rates of change in interest rates. Look at the 10-year yield Rate of Change on a 3-month basis: Here's the 2-year yield rate of change: The federal reserve uses the 10-year minus the 3-month as a more reliable indicator for detecting an impending recession than the 10-year minus the 2-year. However, the rate of change for the 10-year yield has been so parabolic to the upside that the 3-month yield has been struggling to invert relative to it. However, that may soon change. Here's the 10-year minus the 3-month yield chart: Volatility - As you know, volatility is measured by the VIX. The yearly Stochastic RSI for the VIX is trending upward, signally the potential for greater volatility now and throughout the years ahead. This part is a little confusing, but try to follow if you can: Volatility of volatility is measured by the VVIX and is considered a leading indicator of the VIX. Currently, the VVIX is so suppressed to downside that the K value of the Stochastic RSI oscilator has reached zero for only the second time ever. (The first and only other time this has happened was in 2008). While this may be more coincidental than predictive, it nonetheless suggests that volatility of volatility has nowhere to go but up. See below. Margin - Margin has already unwinded both in real numbers and as a percentage by a magnitude that is consistent with, and usually only occurs during, a recession. See chart below. Credit to Yardeni Research, Inc. You can view their full report here: www.yardeni.com Stock Market - Several bellwethers in the stock market are showing that, while we may have a robust rebound from extremely oversold levels in the short term, the longer timeframes look quite bearish, especially for the interest rate-sensitive tech and growth sectors. For more details, here is my analysis on the QQQ/SPY relative performance: Tech and growth are not alone in the bearish context. Indeed, the bull run from the end of the Great Recession to the current period has been characterized by increasing prices but decreasing volume. This is generally bearish, and may reflect that quantitative easing was a large cause of the bull run. Now, quantitative easing is ending in the face of spiraling inflation. Other Metrics - There are many other metrics that are used to detect recessions (e.g. GDP, PMI, M2V). Some may even look toward shifts in demographic trends, rising geopolitical tensions, declining globalization and climate change as recessionary factors. While I cannot discuss every possible metric, one last metric worth considering is the corporate bond market. In 2020, during the COVID-19 shutdown, in order to stabilize markets, the Federal Reserve rushed in to save corporate bonds from crashing fearing that high borrowing costs for corporations could cause liquidity issues. Corporate liquidity issues can cause a whole host of issues from bankruptcies to layoffs. Currently, however, corporate bond prices have fallen to nearly that of the COVID low when the Federal Reserve rushed in to buy, yet the Federal Reserve is only just beginning quantitative tightening and just now beginning to roll bonds off its balance sheet. Finally, I will leave you with this note: The time-tested winning strategy is to continue contributing as much as possible to your retirement fund. If the stock market crashes, do not stop or lower your contributions or try to pull money out because you think the world will end. Rather, continue to contribute as much as you can afford no matter what to a retirement mutual fund with diversified holdings. Contributions during market downturns will buy you more shares of your retirement mutual fund relative to the number of shares your contributions bought prior to the market crash. When price rebounds (and it will) you would have been glad to stick to this investment strategy.
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ECONOMICS:USSFHP
by SpyMasterTrades
121
However you slice it, real estate doesn’t look good.While it might not be the subprime/GFC “SELL” kind of situation, the real estate sector is undoubtedly facing headwinds. With the most recent Fed’s preferred inflation measure, the Personal Consumption Expenditure (PCE) printing higher than consensus, maybe it’s about time we take the Fed’s hawkish commentary more seriously. To review, let us look at interest rate expectations from a month ago vs today. Market expectations are now pricing in three 25bps hikes instead of one, and more importantly no more rate cuts in the second half of 2023. This rise in rates expectation has notably resulted in sideways action for equities, while the dollar strengthens. What a difference a month makes! Mostly importantly, it’s not hard to see how higher rates will translate into higher mortgage rates. This is bad news for home buyers as borrowing becomes more and more unaffordable. In fact, higher mortgage rates have continued to weigh on the minds of Fed officials as underscored by the following statements in the latest Fed minutes, including “Participants agreed that activity in the housing market had continued to weaken, largely reflecting the increase in mortgage rates over the past year.” and “Participants agreed that cumulative policy firming to date had reduced demand in the most interest-rate-sensitive sectors of the economy, particularly housing.” Existing home sales are now at a 12-year low, surpassing the 2020 lows. Only 2 other periods post-GFC, saw a lower print, and it’s worth noting that mortgage rates during those periods were at the same level or lower. Home prices have also started to turn over, ending a 12-year run higher. Lower prices could indicate tepid demand in the housing market, which we will watch closely over the next few prints. And forward-looking indicators all seem to point towards contraction. With US Building permits and NAHB Housing Market Index slightly off the covid low, while the MBA Purchase Index close to the 7-year low. It does seem like however, we slice it, real estate looks pretty ugly now. One way to express the bearish view on real estate could be to use the CME E-Mini Real Estate Select Sector Futures which tracks the S&P Real Estate Select Sector Index. Looking at the sector futures alongside the 30-year Mortgage rates shows us the effect of the rising rates on the real estate sector. On the technical front, we see the sector future breaking the short-term support established since October 2022, while the longer-term trend seems to point downwards. Given our view that rates have further to go, negative home prices and sentiment measures across the board, and a technical break lower, we see the potential for the sector future to trade lower. We set our stops at 196, a previous resistance level, and the take-profit level at 163, with each 0.05 increment in the index equal to 12.5 USD. The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com Disclaimer: The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description. Reference: www.cmegroup.com www.federalreserve.gov
CME_MINI:XAR1!Short
by inspirante