Transcript:
Tom Vaughan:
I’d like to start off the show each week with a summary of what I saw happening in the market. And I’m also going to answer a question right now, too, that I’ve been getting from clients and some of the strategy sessions that I have, which is essentially:
The market is down, we have gotten defensive and reduced our stock market exposure over the last five weeks. And really, you know, the question is, you know, why are we doing that the market is down, isn’t it time to kind of hang in there and let things you know, develop. And, of course, now we’ve had a great week this week in terms of the upturn. As far as that goes, I’ll show you some of the things that I’m seeing.
And historically what that means, and what’s happened in the past when these things have happened. And kind of why we’re having caution here and kind of share with you some of those pieces. So, of course, we start with, you know, the market itself. And we look at what’s happened so far this year. So you can see, obviously, we’ve had this downturn, blue line is the 200 day moving average, it’s also coming down. But if you look at this last week, here, we had a nice run up, except for today. Alright, so snap, reported earnings last night, they’re getting really, really, really hard. And it seems to have affected the market overall. What has happened in these earnings periods? For 2020 2021, we’ve seen earnings be a catalyst to the upside, mainly because the endless have chronically underestimated, how much impact all of the stimulus would have, and how much that would impact earnings to the upside. Well, what we’ve seen last quarter, and what we might be seeing this quarter is that the analysts are actually overestimating what’s happening. And so as these companies come in, they start missing their numbers. And we can see the stock market kind of come down. That’s certainly what happened with snap. And that makes, you know, the stock market worry about what might be happening with Google or meta, because they’re both in that kind of an online advertising space, for example. So we also had some interesting things to the upside here. There’s a couple of gaps that were established on the way down in the middle of June there that you can see, the market has a really high propensity to refill gaps. So we refilled the lower one same time ago. And today, we basically refilled almost exactly the gap that happened earlier, in middle of June. So, you know, lots of resistance above here, I still think we have a little bit of room to run upward.
Wouldn’t be surprised next week is a is kind of a big week with all the big tech companies reporting, plus the Federal Reserve will be doing their meetings and coming out and telling us you know what they’re going to do with the interest rates, I wouldn’t be surprised to see that that’s a positive catalyst. Yet, we’re still being defensive, right? And so let me talk about why. Alright, so first of all, the leading economic indicator was reported for June, yesterday on Thursday. And so that’s the blue line here, these big gray bars that you see, those are the recessions that have happened, you know, this is going back to 2000. And you can see the most current blue line there is certainly peaked at drop point 8% In June is now 2% off of its top. And this indicator is a basket of 10 different indicators has been very successful at predicting future recessions. So when it peaks, you got to be careful, because a recession combined with a bad stock market can really create some problems. The gray line there is the actual current, what called coincident economic indicators. And what these are showing is kind of what the economy is doing now. And so this is where it gets confusing for the clients, right?
Hey, the markets coming up this week. Plus, we starting to see you know, the economy still doing okay, you can see it, it’s going up and the gray line there, right. But if you look closely at this, the blue line peaks before the gray line does, and that’s why they’re called leading economic indicators. And a lot of people get lost in all of these different news reports as to which ones are leading and which ones are current and even which ones are lagging. So current and lagging aren’t that critical for the stock market. It’s always looking forward. So but one of the key things is if you go back, long term back to 1960. And you take a look at the S&P 500. And you look for periods of time where the S&P 500 is below the 200 day moving average, which is that blue line, right? And the blue line 200 day moving average is moving down and the leading economic indicator is peaked. That’s a very rare occurrence. And when it has happened, we’ve had some very big downturn. So this is the main reason that we started to get conservative in the middle of June because this was reported for May in the middle of June. And it certainly showed some peaking. And it was you know even further emphasize this month when it dropped point 8% and which is a lot for this particular indicator.
If you look long term, you can see going back to 1960, the gray bars are recessions. And you can see it’s pretty consistent at peeking out before those recessions since why, like it doesn’t always work, it probably won’t always work, it could be that we set a bottom back in June. But when you look at all of the different pieces that are going into what’s happening, it is, in my opinion, a time to be conservative, we still have exposure to the stock market, we will still go up if the market goes up like we did this week, we will still go down as the market goes down. But just not as much on either side, because we have a lot of T bills now that we’ve purchased TBL ETFs. And we also have some inverse, you know, S&P 500 inverse, that goes the opposite direction, in order to kind of insulate our clients from some of the volatility that might be coming our way as far as that goes. So here’s some of the things that I’m looking at. First of all, here’s the good news. In a way, the fans, I look at this, but consumers are purchasing. So this is manufacturing’s new orders for consumer goods. It’s up in June, that’s good. consumer retail sales up in June. That’s good. But there’s a couple of problems with this, that we have to watch out for number one, one of the reasons that retail sales is up is because things cost more, this is purely just $1 amount, it shows how much is being spent, if we take out the rate of inflation, what they call real retail sales, and it’s actually coming down. And so what’s happening there is essentially, you know, let’s say last June, you know, we compare the retail sales this June, it’s up 8%. That’s pretty good. But if inflation is up nine, actually the real retail sales drop 1%.
So part of what’s happening here in terms of that number is it’s being driven by this, you know, inflationary environment that we’re in, things just cost more. But one of the real issues is, the consumer can save us from a recession, if they keep spending and keep spending and keep pushing. And because the Federal Reserve will have that room, then to lower, you know, to slow down the economy. With this rate increases, the problem is two thirds of the economy is consumer spending, they’re going to be fighting each as consumer is going to come in with all this pent up demand, want to travel, want to spend money, go to restaurants go to movies, do these things we haven’t been able to do. And the Federal Reserve is going to be on the other side really, really fighting this inflationary environment. And what’s going to happen, you’re going to have a battle. And that’s what’s happening now, between the consumer and the Federal Reserve, the Federal Reserve will win that battle in the end, because they’ll keep pushing and pushing and pushing. And then when the consumer capitulates the, you could get a much bigger downturn, because the consumer pushed off, there is one path where they capitulate just enough, and the rates are raised just enough, and we get what’s called a soft landing. And we end up with a market that does pretty well in that environment. So we’ll see what happens here. But that’s the battle that is intensifying. And that’s one of the things I’m concerned with. And then if you look at what consumers think about their current situation, their expectation, so this is a survey, University of Michigan survey that’s done that shows, you know, basically ask the question, what do you think of your finances in the next six months? And it’s down at nearly a record low going back to 1960? Actually 1950s.
And so, you know, they’re spending, right credit issuance is going up, right, credit card issuance is going up. People are, you know, there’s a lot of pent up demand, and we expected this, but it’s creating this giant inflation. And there’s creating situations like what happened to Ukraine, obviously, where gas prices are very high. And so people are looking at that inflationary environment and feeling negative, right. This particular index is in the leading economic indexes the 10, because it is seen as a future gauge of future economic activity. Okay, current retail sales is not in the leading economic indicators. manufacturing orders are because that’s earlier in the process, which will show I’ll show you that in a moment. But this survey has predictive power. So the consumer is saying I feel negative eventually that starts to possibly affect their spending. Right. So we have to watch out for that again, because it’s a big component. Then if we look at the what’s called the yield curve, right, so, you know, normally the yield curve is you know, your three month t bills pay a lot less than your two years which pay less than your five which pay less than your tan, etc. And you get this yield curve. Right now, that two year is paying more than the 10 year they call that an inverted U yield curve. And so you can see the difference graphed out on this graph here. And when it gets below zero like it did before 2000. And before 2008, that was a precursor warning to recession. And so this has been one of the more accurate predictors of recession. As far as that goes, although, I think the more accurate predictor, according to the study that the New York Fed did is really the three month, right. So think about that. You could make more at periods of time, and this happened back in 2000, before 2008 downturn before the 2000 downturn, the three month t bill was paying more than the 10 year so you could invest money into a treasury and make more money in 90 days than you could by letting them hold on to it for 10 years. Why does that happen? That because the bond market is a very good predictor of future economic weakness. And so they see in 10 years or in that longer period of time, that the economy might be doing poorly. So that has not crossed that’s not negative right now.
But the trend is drastic, right? I mean, that’s, that’s March, it is coming down, it looks like it’s heading towards I mean, if you look back on this chart, just for this time period, the only times it’s had that type of downturn that fast, it has eventually turned into a negative, right. So, you know, we’ll see how this plays out. But again, the direction is, is worrisome, as far as that goes. And we look at, you know, US manufacturing new orders and total down, right, you can see that, right. So manufacturing, this is one of the leading economic indicators for a reason, right. So we’ll focus on things that are leading the economy. And these will also be things that will lead the stock market, theoretically, as far as that goes to. So here’s average weekly hours worked in manufacturing peaked out in March coming down, here’s building permits. So building is, you know, residential building, and what have you. And that’s what this is new residential units, is huge industry massive. And we’re starting to see, you know, that peaked out in January. So again, that’s a leading indicator, it’s not, you know, houses that sold, those were built a long time ago, basically, it is new permits for new homes, which is starting to fall, obviously, mortgage rates are up to 5.8%. They’re at 3%, you know, just beginning of this year, that’s going to slow down housing, that’s going to take that entire industry of mortgage brokers and realtors and contractors, you know, and all the different people that feed into that interior designers and put a crimp potentially in their, you know, overall revenues, which eventually will flip through the rest of the economy. This is actually a lagging indicator. And that’s the claims for unemployment insurance, I just show it to you because it is up 50% from its low, you can see that little dip there in April, and it’s come up, and so still quite low. And the the market for employment is still quite good. Still a lot of job openings, but it’s starting to deteriorate. Again, that is a lagging indicator, employment lags.
The economy lags the, you know, the stock market, that’s for sure. But nonetheless, something interesting. And the last piece I’ll show you is just gas prices. And this is there’s some good news in here. First of all, you can see it peaked at $5. Nationally, not here in San Jose. But nationally, and it’s at $4.50. Nationally, that’s a big drop, actually. And here we are in the summer, which is kind of a peak driving month and gas price coming down. That’s cool. If you look at the wholesale futures right now, it’s predicting a $4 gas by the end of the summer for national. So again, that’s a good thing. But the problem is, if you look at that chart, in totality, it’s still up a lot. And there’s a huge, you know, draw against the economy, because gas and diesel, for example, are used in so many production capabilities, transportation. And of course, as consumers, you know, if we’re spending more money at the gas station, we’re not spending as much money in other areas. So this is a good thing. It’s but it’s very, very important to watch this, especially because of what’s happening in Russia, Ukraine, where they can kind of weaponize the energy, which they’ve started to do with natural gas. This is gasoline difference, different substance, but they started to really weaponize natural gases, Nord ones, you know, pipeline, they’ve only got about 40% of the flow coming through and kind of pinching, you know, Europe in that regards. And so anyway, this is probably one of the most important things to watch as far as that goes.
So, in summary, I love the fact that the market is coming up here. I’d love to be you know, back in the market wholeheartedly if it continued to come up and continue to really gain and break through some of these barriers. We are heading towards some very Big resistance, I wouldn’t be surprised to see us get up higher next week, hit that resistance. But it’d be a little bit surprised to see us break through that with all of these other negatives that are happening out there, it is possible. So you have to watch for this, you can have a thought for where things are going to go. But you have to be able to be flexible in that thought process. But at the moment, when I look at that leading economic indicator being peeking out, and I look at you know what happens like the average downturn since World War Two for the stock market is 15%. But the average downturn with a recession since World War Two for the stock market is negative 36%. You know, we’re down about 17%. Right now, that’s a big jump down to get to the average if it should happen. And these things happen exactly like this, where it’s this, I call it a rolling downturn, you know, it kind of all goes up and like we saw in late March, and it comes back down and it rolls up, it looks good. And so 2008 and 2000 are the last two rolling downturns we had, which were negative 45 and negative 57. This is not a V downturn, like we saw in 2020, big downturn, very quick recovery. And what we saw in 2018, again, big downturn, quickly, very quick recovery, both of those had the Federal Reserve lowering rates to create that had Congress putting out stimulus, we’re not going to see any stimulus right now because of the inflation. And we are going to see the Federal Reserve continue to raise rates dramatically, trying to fight the inflationary issue, even if it means causing a big recession, and additional pain to the stock market.
So again, it’s just a time to be careful, I wouldn’t be worried about things, we’ve already taken care of that for our clients. And we’ve lowered the exposure, we’ll lower it farther if we have a lot of downturn coming at us, and really try to protect the asset base. And then it gives us power to come back in. At some point, if it does come down, you know, we got these T bill ETFs. We can come back in and be buying things that have had a lower place and really take advantage of this. If it does happen. So we’ll see what happens. I’m just showing you kind of historically what’s happened and what’s happening right now in the leading indicators, not the lagging or current indicators. But those are the things that I look at that, you know, let me feel that we’re on the right path. Okay.