We all understand why high inflation and an aggressive Fed is a bad combination for the stock market (SPY). However, this bad-tasting tonic also raises serious concerns that could lead to much greater economic devastation and investment losses. 40-year investment veteran Steve Reitmeister describes this potential “black swan” event in his timely commentary below.
(Enjoy this updated version of my weekly commentary from the Reitmeister Total Return Newsletter).
Investors appear to be in a rut ahead of quarterly earnings season results and whether there are growing concerns about an impending recession. Early signs say yes, with earnings estimates for the first quarter of 23 coming in negative, indeed pointing to growing concerns.
This is another one of 101 different reasons to stay bearish and not give this recent stock market (SPY) bounce each merit. Sooner or later we will find our way to lower lows, as is warranted by the declining economic outlook.
The focus of today’s commentary will be on a topic that doesn’t get much press on popular media outlets like CNBC and Bloomberg. Still, one that deserves to be on our radar as it is a black swan type event that becomes all the more possible as interest rates rise.
I’ll explain in this week’s Reitmeister Total Return commentary.
Today we are going to take a little detour from the standard discussion of “here’s what happened…this is what comes next”.
That’s because you know I’m bearish and painted that picture week after week in great detail in my Reitmeister Total Return and POWR Value commentary (see archive here).
Over time, we’ve looked at everything from how low stocks will go… to how best to take advantage on the way down. Heck, we even have a game plan of when to fish to get back on board the next bull market.
And in the case of this most recent bear market rally, it’s no more impressive than last week’s two-day rally that hissed or any other bear market rally. We even talked about this being a likely place for a bounce with this comment from 9/27/22:
“3,636 = June lows. Rarely will you see a correction or bear market that ends without retesting the lows. So that’s probably the next fulcrum as we explore the true depths of this bear market.
It can be hard for stocks to get below this level without seeing some of that pain the Fed was talking about. Like the labor market that is finally showing some weakness.
So if we rush down and pain isn’t on the menu yet, this will be enough support, maybe with another juicy jump. Not 18% insanity as we say in July/August. Maybe more like +5-10% pending the next economic signals.”
Let that serve as enough of the typical market commentary to make better use of this time to discuss a possible dark side of this bear market. And how it can be potentially more sinister than your typical weak economic cycle leading to a typical bear market.
The key phrase in the above paragraph is “potential dark sidebecause it very well may not happen. Unfortunately, it can happen and therefore the best we have on the radar just in case.
Okay enough introduction. Let’s get into it…
Do you find it interesting that government bonds, even short-term, pay only about 4% when inflation is twice as high?
Well, this perverse result is happening because this is the most manipulated market in the world, with the Fed owning TRILLIONS of bonds as part of their Quantitative Easing (QE) initiatives going back into the Great Recession and then accelerating further during the Covid crisis.
It is clear that prices in government bonds are not really driven by supply/demand. Because if they were, the rates would be much, much higher.
In addition to the Fed’s rate hike, investors should also be aware of the $90 billion a month of QT (Quantitative Tightening) taking place to lower the Fed’s balance sheet. The point is that as more of these bonds are put back on the market, demand will increase while supply is still low because they are underpaying investors what they earn.
This is a long way of saying that shorting government bonds offers far more benefits as interest rates should stay higher. And why we’re back for a second helping of our favorite bond shorting ETF (Ticker reserved for Reitmeister Total Return members), which worked out well for us earlier in the year.
As if this higher rate story wasn’t bad enough, check out this clip from a recent Bloomberg article »The most powerful buyers of Treasury bills are all paying off at once”. The title actually says it all, but here are some more details to appreciate.
“Everywhere you look, the biggest players in the $23.7 trillion US Treasuries market are pulling out.
From Japanese pensions and life insurers to foreign governments and US commercial banks, where they once queued to get their hands on US government debt, most have now left. And then there’s the Federal Reserve, which a few weeks ago accelerated its plan to take Treasuries off its balance sheet to $60 billion a month.
If one or two of these usually steadfast sources of demand were to disappear, the impact, while noticeable, would probably be little cause for concern. But for all of them, pullback is an undeniable source of concern, especially due to the unprecedented volatility, deteriorating liquidity and weak auctions of recent months.
The result, according to market observers, is that even as Treasuries have fallen the most since at least the early 1970s, there is still more pain ahead until new, consistent sources of demand emerge. It’s also bad news for U.S. taxpayers, who will eventually foot the bill for higher borrowing costs.”
So if you have more sellers of government bonds… you have fewer buyers. Add that to the quantitative tightening equation and it again tilts toward greater supply than demand… which tilts toward higher rates in the future.
This has left some other investors concerned about a much bigger debt crisis in the making, with the recent UK pension issues being the first warning shot. I encourage you to take the time to think about what John Mauldin has to say about this in his most recent weekly commentary: Pension Zandhoop.
The summary version is that for a long time there has been great instability in the financial arenas due to the obscene amount of government debt from around the world. The interest rate cuts we had from the early 1980s to 2021 have obscured these problems, as it was much easier for governments to repay this debt at lower interest rates.
Now we have the opposite. Interest rates are rising, making it much more expensive for borrowing countries to repay. Second, you have a weak return for large bond investors, since higher interest rates = losses in value on bonds.
Much of that pain occurs in huge pension funds (such as in the UK). Once this instability takes root, it could be like a Tsunami growing in height and wiping out financial markets around the world.
Yes, we’ve heard of this monster before. And it will NOT continue to happen as we continue to find ways to sweep these issues under the rug.
The net result over time is that it feels like the “boy who cried wolfscreenplay. But just like that cautionary tale… eventually there was a wolf.
This means that at some point the amount of debt will be unsustainable. And yes, that’s much more likely in a high-rate environment.
No… I’m not setting off an alarm right now. However, we investors should realize that the chances of this black swan event happening have increased and we may not be dealing with your ordinary recession and bear market.
This means that IF inflation and bond yields don’t move south around the world, it creates instability that could turn into a more global event. Think back to the Greek debt crisis ten years ago. The US stock market went into a defensive shell awaiting the outcome. And that was only a small country like Greece.
Now imagine we are talking about the UK…France…Italy…Japan…or even cracks in the foundation of the US debt markets. Yes, that would be very bad for the US economy and stock market (understatement of the year).
Again, I am neither a fear monger nor prone to conspiracy theories. Just an investor realizing that there is too much debt in the world and higher rates does NOT help the situation.
So let’s just keep an eye on this to make sure it doesn’t get out of hand. Because if so, then we want to keep our bearish portfolio strategies in place for much longer than previously planned.
In the meantime, we’ll just gawk through this latest bear market rally, expecting lower lows along the way… and thus higher highs for our portfolio built to benefit from this outcome.
What to do?
Discover my special portfolio of 9 easy trades to help you generate profits as the market descends further into bear market territory.
This plan has worked wonders since it kicked off in mid-August, delivering solid gains to investors as the S&P 500 (SPY) plummeted.
If you have successfully navigated the investment waters in 2022, don’t hesitate to ignore it.
However, if the bearish argument shared above makes you curious about what happens next… consider my updated “Bear Market Game Planwhich details the 9 unique positions in my timely and profitable portfolio.
I wish you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Right”)
CEO, Stock News Network and Editor, Reitmeister Total return
SPY shares were up $2.52 (+0.68%) in after-hours trading on Tuesday. Year-to-date, the SPY is down -20.96%, versus a % increase in the benchmark S&P 500 index over the same period.
Steve is better known to the StockNews public as “Reity”. Not only is he the CEO of the company, but he also shares his 40 years of investment experience in the Reitmeister Total Return Portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock selection.