Weekly Market Update March 10, 2023
Dow Jones Industrial 31,909.83 -4.44.%, S&P 500 3,861.52
-4.55%, Nasdaq Composite 11,138.89 -1.76%, US Ten Year 3.685%, West Texas Intermediate $76.45
The February stock market rally gave us reason to believe that we finally had come out of 2022 pattern of stocks market rallies, where each rally’s peak was lower than the previous one. That was not to be, the S&P 500 dropping below the 3,900 level, which for a while appeared to be a new support level. A horrible week for stocks was capped off by the failure of the once-high flying Silicon Valley Bank in California, as higher interest rates lowered the value of many of its holdings which it was forced to sell at these lower prices cover obligations to depositors. It was an old-fashioned “bank run,” as the fire sale of its securities caused their prices to fall further.
This stock market action should have been no surprise. Fed Chairman Powell has been very clear about his intention to raise short-term interest rates to fight the highest inflation in over forty years. It has become almost comical to see stock investors grasp at any Fed official utterance that might be considered “dovish,” and dive into stocks, only to see equities soon give it all back and more.
It has long been accepted by many (although not all) that an inverted interest rate curve, where short-term rates are higher than long-term rates, eventually leads to a recession. The yield curve below is from January 2021, where rates were near zero in the short term not much higher longer term. Stocks had a tremendous run in 2021 and rose to all-time highs. This was the time of TINA, or “There is No alternative,” when cash and bonds paid virtually nothing, and stocks were the only game in town. This positively sloped term structure of interest rates is the usual shape of the curve, where borrowers pay more to compensate for the uncertainty of inflation and interest rates.
The second yield curve below is as of this morning. The high point of the curve is the six-month yield of 5.3% and is 1.4% higher than the ten-year yield of 3.9%.
The steepness of this inversion is very concerning. The chart below shows previous inversions in red: Every time this has happened a recession occurred shortly thereafter.
This chart below is merely the previous one over a shorter time frame, to better show the yield curve inversions and the recessions that soon followed when three-month rates were higher than ten-year rates. As some may recall, the 2001 recession was the overheated “dot com” economy becoming the “dot bomb” sell-off, the 2007-2009 recession was from the financial crisis, and the very short 2020 slowdown was the Covid recession. Each of these was preceded by shorter rates being higher than longer rates. The current inversion is greater than those three previous ones. As of March 3, the NY Fed assigns a 57% probability that the US will be in a recession in Q1 2024.
This is why we have been urging investors to keep their powder dry, by investing in money market funds and short-term fixed income securities. CME futures predict a fifty-fifty split between a 25 basis point and 50 basis point jump in Fed Funds coming out of the FOMC meeting later this month, so conditions will likely worsen. But remember, stocks will begin to recover before the recession ends, when the central bank begins lowering rates to reignite the economy.
Have a Great Weekend