Interest rates

Inflation, the US Dollar and Cooling Interest Rates

Last week, figures were released indicating that inflation has started to subside. Thursday morning, the publication of the October CPI was expected at 0.6%. When it was released, the figure was actually 0.4% and the market took off like a rocket. Year-over-year inflation rose to 7.7% from 8.2% in September and investors celebrated a possible (pivotal) slowdown in future Fed interest rates.

Our take: 7.7% for the people is still a very hot number, and don’t count on President Powell and company to slow the pace of interest rate hikes any time soon. They made their opinion (and their warmongering posture) very obvious. They have repeatedly said that they will not stop raising rates until inflation tends towards 2% year-on-year. We don’t think they have any reason to pivot yet.

However, the market had a different take and saw its biggest two-day decline (Thursday-Friday) since 2009. Interest rates saw a significant retracement and rates eased with the new information. We went from a draw of 4 on the 10-year to a draw of 3 at the end of the day on Friday.

The (chart broke its steep trendline last week:

DXY Chart

The Invesco DB US Dollar Index Bullish Fund (NYSE:) had a hell of a fall. See the chart for UUP and (10-year Treasury rate) having quite significant price declines below:

UUP daily chart

UUP daily chart

The “cooling” of the dollar and interest rates was a welcome sign that the economy is indeed “slowing down”.

October’s CPI drop motivated traders to cover shorts and put fresh money to work. It was the fifteenth best daily return in history.

By the end of the week, the was up 8.4% in just two trading days (Thursday and Friday). This is the strongest rise on the Nasdaq since December 2008 . As positive as this news is, it is important to note that just like December 2008, we are still in a bear market. See the chart for the last two months below:

Nasdaq Comp.  Index

Nasdaq Comp. Index

This week saw a real turn of events as the best areas of 2022 underperformed and the hardest hit areas this year saw huge rallies.

Performance table

Performance table

Mish told many readers to “watch the dollar”. She has long argued that when the US dollar breaks its steep slope (see above), the metals could move dramatically.

was up over $100 an ounce last week. climbed even higher on a % price move. Metals boosted these moves due to the US Dollar and interest rates starting to “calm down,” as Mish continues to suggest.

Gold Daily Candles

Gold Daily Candles

The following chart shows the relationship between gold and UUP. One of our favorite technical indicators produced by Decision Point, is the PMO (Price Momentum Oscillator). We are close to getting a significant crossover on this indicator, suggesting that it has momentum and could rally yet. It has been among the top performers currently in Mish’s premium trading portfolio.

GLD: UUP Weekly Chart

GLD: UUP Weekly Chart

Problem in Crypto Land

We also want to point out that last week the FTX cryptocurrency platform imploded (went bankrupt) and caused huge capital losses for investors as well as users of their platform. This could change the blockchain technology sector in the short term with both positive and negative ramifications.

Many have pointed out that this was a “Bear Stearns” type collapse and that it could have long-term effects on the emerging blockchain technology industry. We want to point out that when events like this happen, they tend to create non-paper assets like gold, copper and . This may have also fueled the rally in gold last week.

FTX was a major sponsor of major league sports, also held the naming rights to the Miami Heat arena, and a long-term sponsor of MLB umpires.

Seasonality and the electoral cycle

Last week, we discussed seasonality and the favorable 4-year cycle that bodes well for investors.

The midterm election has passed and some of the following charts may appear. Similar to our article last week, we caution you NOT to “go all out” in implementing these landmark findings. History may not always repeat itself, but it usually rhymes in one way or another.

We likely have a different market environment this year, given continued high inflation and the Fed’s persistence on its hawkish path.

Also, we really don’t have any election findings yet, as several states have yet to decide who they will send to Washington.

S&P 500 Performance Nov.

S&P 500 performance based on a 4-year presidential cycle
S&P 500 performance based on a 4-year presidential cycle
Stock Performance Based on Congressional Composition
Stock Performance Based on Congressional Composition

After reading all of this, you might be inclined to want to get aggressive and put more capital to work. Again, we warn you that BEAR MARKET Rallies are often confused with NEW bull markets. They are not.

We may still have a long way to go. Why? We have not seen the effect of the recently announced layoffs and the expected contraction in revenues, profit margins and the inevitable decline in profits that may occur.

Recently, Goldman Sachs and other Wall Street houses have started to cut their 2023 earnings forecasts. As you all know, the market (S&P 500) is pricing in 12-24 month earnings forecasts. Given Goldman’s (and others’) expectations for earnings of around $220 per share in 2023, it was a bit surprising to see the market’s huge rally last week. This is why it is a bear market that is running short.

Let us give you a rough estimate of what stock market valuations might look like based on Goldman’s near-term earnings per share forecast.

If earnings of $220 to $230 (consensus opinion) is actual earnings per share in 2023 (figures shown are the fair value of the S&P 500), attributing different price-earnings ratios can provide an S&P 500 figure for the evaluation. Remember that in the later part of 2023 the market will start pricing in 2024 earnings.

Earnings to Earnings Ratio

Although we have no idea what dramatic effect rising interest rates will have on the economy and therefore what P/E we should be using. Historically, coming out of an economic downturn (and if we are truly in a recession), P/Es tend to be low to mid-teens. Past recessions have seen these P/E ratios reach 12 or less before starting to recover and rise.

It’s also why the S&P range of Wall Street firms, from Morgan Stanley to Wells Fargo, UBS and others, is between 2800 and 4100 on the S&P 500 index for the start of next year. Much will depend on the level of interest rates and continued earnings growth.

Today, earnings are expected to grow about 5% in 2023. Don’t count on it. We think there will be no earnings growth next year and maybe even a 5-10% contraction.

The same reason Warren Buffet still isn’t buying stocks

The legendary investor is still on the sidelines. He is considered a “value” investor. According to the metrics he and his team of analytical fund managers use, the stocks are not in the “value zone” and “do not presently have good valuation prospects.”

The combined market capitalization of the US equity universe as constructed by the Wilshire 5000 Index stood at $38 trillion as of this week’s close. This equates to 148% of the $25.7 trillion worth of US gross domestic product at the end of the third quarter.

US equity market cap

The ratio is now at levels that prevailed on the eve of the first wave of the pandemic, when hardly anyone would have thought stocks offered real value.

Based on Buffet’s previous comments, he said he liked stocks when the percentage in the chart above was in the 80% zone. As its holding company, Berkshire Hathaway (NYSE:) continues to make acquisitions, the company’s cash at the end of September was $109 billion, down from 105.4 in June. In other words, he and his staff currently find no value in the stock market.

Also, in all the time we spend writing about the decimation of wealth following the 2022 stock market downturn, the price-to-book ratio for the S&P is still VERY high at 3.8x and even more punishing at 5.8x for the Nasdaq 100. With 2-year Treasuries offering a yield of 4.5% and below-average dividends on the S&P of 2%, we still have an expensive market no matter what the exuberant analysts and forecasters could tell you.

US Stock Valuations