After the stock market crash of 2008, there were several 20% declines in the stock market that brought with it central bank action to stop the decline and make the market go back up again. One happened in 2015 when the stock market corrected for a 20% decline that ended in the first quarter of 2016. To stem that selling, central banks around the world joined together to launch new QE programs and the bull market resumed. In 2018, the Federal Reserve went on a rate hiking cycle and then stopped and “pivoted” after the stock market fell 20%. Many of the bull gurus you have seen this year were predicting a similar Fed pivot in memory of that event. They have been wrong, of course, but in 2020 the Federal Reserve took interest rates to zero.
The yield on the two year Treasury bond is closely tied to the Fed funds rates and vice versa.
As you can see in the chart, when the Federal Reserve took the fed funds zero they pushed the yields on the 2-year bond close to zero. Now the 2-year bond yield has been rising for a year. It’s gone up almost as fast as it went down. When people talk about volatile markets they are speaking of how quickly something moves, and we have seen volatile swings in interest rates in the past two years.
The time period that I circled on the chart represents a period of financial nirvana for stock market bulls. Zero rates helped to created a bubble and drove millions of people into trading for the first time, in an environment that they thought was normal in the markets as it was the only one they had experienced before. So, they believed that buying meme stocks and crypto coins was a way to get rich, even though they only were experiencing a rare moment of time for the markets. It wasn’t that they were dumb, it was that they were new to the game with no personal experience of it.
The internals of the stock market, as represented by the percentage of stocks above their 200-day moving average, began to turn down at the moment that the two year bond began to tick up in June of 2021.
Bull market peaks are historically preceded by peaks in the internals of the market, so when this happened last year it was a huge warning sign for us.
What I want to point out today is that we have seen periods of financial volatility in the markets since the 2007-2009 bear market, but they didn’t really impact the economy, excluding the 2020 shutdowns, however the economy was impacted by shutdowns then and not moves in the financial markets.
Now we have just begun a period in which volatility in the markets is going to generate volatility in the real economy. Real estate prices, for instance, had a quick and temporary decline in the spring of 2020 right as the shutdowns began, but then quickly went to new highs, and beyond, with huge gains across the country, just like the stock market, as interest rates went to zero. Now the Case-Schiller real estate index made a peak a few months ago and is down 6% from that high.
Manufacturing is doing something similar, as you can see from the Chicago PMI.
Chicago PMI has now fallen into contractionary territory for first time since June 2020, 45.7 vs. 51.8 est. & 52.2 prior … new orders fell at faster pace and are contracting; prices paid still expanding but at slower pace; inventories expanding at slower pace pic.twitter.com/vegjtFg9xj— Liz Ann Sonders (@LizAnnSonders) September 30, 2022
You can see how the PMI had one of its biggest plunges ever in 2020 and then went to a high and is plunging back down.
That’s economic volatility. And now we are seeing the two combine together in England.
So many stock market gurus are still looking for Federal Reserve pivots and basically a “return to normal” to create markets like we have in the past, but it’s not going to happen.
This is still a tough time at the moment with everything, with basically nowhere to hide.
Gold did manage to show some more positive relative strength against the stock market last week, so that is a sign that it is likely to turn up and go into a new bull run before this bear market in the stock market ends.
Gold commercial producers and hedges closed out more of their short positions last week and are now net short around 60,000 contracts. They may end up close to net short zero or even net long by the end of the year. Such things only happen about every ten years and end up being incredible investment buy points when they do, as commercials are typically net short all the time, using gold to hedge production.