Insights & Advice

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Markets are too frothy

Speculation is not quite rampant but it’s getting there. Volume is trailing off and the short covering that has boosted this market higher is fizzling. These are signs that beg for a nice sharp pull back that is overdue.

As I have been suggesting (hoping) over the last two weeks, negotiators from Russia and Ukraine are making progress. Investors are beginning to hear more positive statements from both sides. A combination of factors are pressuring negotiators to cut a deal that would be acceptable to both heads of state.  I expect that to happen soon.

Remember that we are now approaching planting season in Ukraine. The spring thaw will also make mobility difficult for the invading forces. The Russian army seems to be pulling back in some areas but bolstering its forces in others. I suspect that has more to do with the Russians’ strategic intent to capture and hold areas that contain Ukraine’s most valuable energy resources.

The stock markets’ “fear” trades have already begun to dissipate as evidenced by the slide in oil prices. The red-hot price rise in wheat and fertilizer stocks are selling off, and gold is faltering as well. But notice that all this good news on the geopolitical front during the past week has not moved the overall averages up by much. That is a tell-tale sign to me that the good news may have already been discounted and it may be time to take some profits on some of the gains we have enjoyed recently.

Of course, the flattening of the yield curve, which inverted for a brief time on Tuesday and Thursday, March 29-31, had the bears jumping up and down. A flurry of bearish commentators lined up to solemnly predict the curve will invert further and a recession is right around the corner when it does. What is an inverted yield curve, you might ask, and why is it so important?

According to Investopedia, “An inverted yield curve occurs when short-term debt instruments have higher yields than long-term instruments of the same credit risk.” An inversion is the first sign that the long-term growth prospects of the economy are in trouble and have preceded every U.S. recession in the past 50 years. Typically, a recession has followed in the two years after an inversion of this measure.

However, before you leap into the lifeboat, remember the same thing happened in August 2019. I warned readers at the time not to jump ship because I believed the condition was temporary. It was, and I think this time around the same thing may happen. If, over time, all the short-term, versus long-term, debt instruments—one-month, three-month, one-year, two-year, five-year, versus ten-year, twenty- and thirty-year—were to invert, well then that would be a horse of a different color. We are not there yet.

But my optimism concerning the longer-term prospects of the economy doesn’t necessarily translate into the short-term prospects for the stock market. I believe that the financial markets are still not out of the woods. This relief rally off the lows is a bear market bounce in my opinion. It has further to go, but a day or two of pullback next week would be helpful. I expect next week we will work off some more of this froth.

Sometime in late April or May 2022, we may see a return to the bottom once again. Why do I believe that when the latest data show unemployment dropped to 3.6%? A combination of persistent inflation, a slowing economy, expected tepid corporate earnings, and an even more hawkish Fed will simply be too much for the markets to take on board.

 

 

 

 

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