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Market review 22.05.01
Making sense of this market
Last week we saw lots of new breakdowns. This week, there were even more.
We’ve closed the month of April and it was a highly eventful one. On the monthly charts, we’re simultaneously seeing the S&P 500 breakdown while the US dollar index is breaking out.
Checkout the ETF returns for April (from worst to best):
In this post, we’ll look at what’s behind these moves.
Making sense of this market
#1. Inflation (both actual & expected) is high. As a result, bond yields are rising.
#2. To keep up, earnings yields must rise too. Thus, stocks fall.
#3. High-duration growth stocks (eg. tech) fall harder than value stocks during rising bond yields. Why? Because future cash flows get discounted more heavily and so growth matters less and current dividends matter more. It’s also because value stocks are dominated by banks & oil names which benefit from higher interest rates & inflation (commodity prices).
#4. Defensive sectors (XLP, XLU) hold up better as there is a flight to safety.
#5. Gold falls since it's tied to real bonds (which hold up better than nominal bonds thanks to inflation).
Why is gold tied to real bonds? Because when inflation is rising faster than interest rates, people pull savings out of money market funds and put in into gold (and vice versa).
#6. US Dollar is working since US bond yields are climbing to higher levels than global ones. Japan is even refusing to raise rates in this environment! This is why the Yen has been one of the hardest-hit currencies.
#7. Bitcoin is getting hit as it’s highly tied with stocks.
Aside: While I’m on the topic of Bitcoin, a random thought I had…
Read more here.
#8. As inflation is high, crude oil keeps working. On the weekly chart, we see oil in an uptrend and currently on multi-month support. Meanwhile commercial hedgers (smart $) have their highest net exposure in years.
This market can seem very erratic on the surface. But by looking at the intermarket relations above, I hope things makes a little more sense.
The Ritholtz team is an entertaining bunch. They had Jurrien Timmer on their show this week and I thought it was insightful. Checkout the podcast here:
Fundamentals tell you what & why, technicals tell you when & how much
Technicals will alert you of trend change before narrative changes
Don’t draw diagonal lines on charts. Don’t use log-scale for yields
Sees bond yields range-bound for next several years rather than in a new secular uptrend
PE ratios are inversely correlated with inflation & interest rates (We looked at this earlier).
Given where 2-yr treasury yields are, sees forward PE dropping to 15 (it’s 18 currently). This doesn’t mean a 16% price drop – since earnings are expected to increase 11% over the next year.
While I thought Jurrien made some very realistic comments about the future, always take predictions with a grain of salt:
That’s all for this week! If you found this post useful, please give it a like and share. Thanks for reading.
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.