Chart of The Day

2022 Should Be An Outlier

Got this scatter plot from Brian Kasal at Four Star Wealth. He earned his MBA at Chicago Booth too. We were chatting about the market, and he pulled out this chart. 2022 is the only year with negative bond and stock yields. It’s rare to have positive stocks and negative bonds, and a little less rare to have negative stocks and positive bond returns.

When you layer on Ben’s stats at A Wealth of Common Sense about how often you have a negative year in stocks followed by another negative year in stocks, you’d have to bet that this year will be positive for stocks.

The fly in the ointment is that if it is a bear market in stocks this year, it’s probably going to be worse this year than it was last year. Also, for what it’s worth if the market goes up by the same amount it went down last year, you aren’t even. You are still behind.

All over I see the phrase, “if we go into recession” all the time. The simple fact is, we are in a recession. We have been in a recession. Six consecutive months of negative GDP growth is the classic way to define a recession and we are there despite what you might hear. Last quarter wasn’t really any better.

I don’t see a massive gain in the stock market this year. But, I don’t see a loss either. My guess is that it will be somewhere between 1%-5% higher. Sort of like 2015’s market.

I remember that August 2015 drop really well. A company I was invested in had signed a term sheet for a big number and a week before the close, the VC leading the deal backed out. I was ready to offer every single share I had to the new investors and walk away happy. Alas, it was not to be.

The chart above squares with my theory that the S+P 500 will trade down to 3200 before it can really enter back into a bull market.

I took a short gander at CME’s Eurodollar market and Fed Funds Market. After listening to the economists from Chicago Booth at the Economic forecast make a few predictions, I wanted to see what Mr. Market was saying.

The Booth people thought that the Fed Fund interest rate would go to 5.5% but not higher than 5.75%. It’s 4.5% now and was .25% a year ago. Pretty aggressive raise in a year and a pretty aggressive prediction to go another 1%-1.25%. When Volcker and the Fed engaged in their interest rate hikes to fight inflation back in the late 1970s, they started from around 8%. Short-term rates hit 21%.

I thought up a trade idea if you agree with the Chicago Booth Professors and don’t believe that inflation will be tamed by the end of 2024. Buy the Dec 2023 Eurodollars and Sell the Dec 2024 Eurodollars. It’s called a “year spread” and I used to trade them. They are whippy and risky. If inflation isn’t tamed, that spread should narrow. It’s around 87 ticks right now. If it trades par, it’s $2175 per contract. I have seen these spreads go 100 points or more negatively given the right economic environment.

When I looked at Fed Funds, Dec 24 is trading at 97.00 and Dec 23 is trading at 95.445. That means they are predicting a 3% (1-.9700) Fed Funds rate for Dec 24, and 4.5% on Dec 23. For kicks, I looked at the West Texas Intermediate crude market and it’s predicting lower oil prices in December 2024. Hmm, do you think you can underestimate the ability of someone to screw that up?

Using the CME’s handy predictor tool, the interest rate market isn’t seeing a high probability of Fed Funds going much higher than 5.25%. A slight disagreement with the Chicago Booth economists. If you look at historical Fed Funds rates, you could generalize that the rate is usually somewhere between 4%-6%. Since 2000, the rate has been abnormally low and that’s pumped up the volume on a lot of asset prices and helped to cause inflation.

But, the real cause of inflation is ever-increasing government spending. There is little the Fed can do about that.