At least under some circumstances, we should be aware of potentially important timers.
I have heard many here profess that market timing is impossible and often results in poorly executed trades and lost opportunity…certainly in a huge bull market, that could have this appearance that trading in and out merely churns taxes and misses major moves in stocks while sitting on the sidelines…though technicians will dispute this.
But much like life, there are different shades of gray and different forms of market timing that may be much more dependable and predictable IMO…no different than various forms of fundamental analysis that might be more dependable such as free cash flow vs revenue growth.
I have been tracking one such timing trigger that you may find interesting and it appears to be fairly reliable as we enter another year of a long bull market. We have previously detailed why this market still appears to have legs whether the continued broad company revenue increases, corporate tax reform and repatriation of overseas dollars, more middle class velocity of money, reasonable inflation adjusted S&P PE ratio, reduction of corporate “overregulation”, etc. Without a doubt, the tax reform bill has been huge and provided enormous confidence in our growing economy…yes it all looks good.
But…the past many years of stock market gains have been largely fueled by truly unprecedented Fed activity reducing the funds rate to 0…and keeping it there for years!! This has been uncharted territory for the Fed and our economy…thus far, we are thriving. As you know, last year, that has reversed and the Fed began increasing rates…now double what it was just this past year.
Let’s look what happens when the Fed begins a series of rate increases:
You can see from the tables that when a series of Fed rate increases occur, there is near uniform drop in market value that varied from 5.3-13%. Keep in mind that the stocks followed here would likely drop significantly more (in some cases twice as much). But this is pretty consistent in near every series of increases as listed. Some of you may argue, so what, the stocks eventually recovered…true but there is a circumstances when the losses can be rather draconian.
Stay with me because this does get more interesting. The Fed has announced that in 2018, they will raise rates 3-4 times…their inflation goal being 2% or less. Short term rates are around 1.4% and longer term (20 year) double that:
If the Fed continues its path of raising rates, 3-4 more times, we could be very close to what is called an inverted yield curve. Take a look at this animation and run it from 2009 forward:
Do you see what that curve is doing???..going from steep to flat.
Now what do we know about inverted yield curves as regards the economy, recessions and the impact on stock markets. Let’s look back at this earlier link and look at that overlay between Fed Funds rates and the S&P here:
Both those MAJOR pullbacks that occurred in 2000 and 2008…were preceded by ???..you guessed it…an inverted yield curve. In both cases the Fed increased to above 5% which we are way away from BUT, the longer term yield was also higher at that’s time…the curves however were inverted!
This recent article has many years of data confirming that inverted yield curves are bad for stocks going back to the 1970’s:
Every time since the mid-1970s that long rates have fallen below short rates, the S&P 500 has experienced a double-digit drawdown.
The challenge has been the “lag time” between inversions and the eventual drop in the market…the drop always occurs but can lag the first inversion by as much as 1 1/2 years on average.
So this leads me to conclude the following:
The 2018 planned series of increased Fed rates are likely to pressure the market to some smaller degree (as shown in the beginning of this post). That in itself isn’t a reason to make a major investment strategy shift.
If the Fed increases to an inverted yield curve (and we have already significantly flattened) which we might just get with their suggested 4 increases this year, the rapid rise in this market with higher end PE’s, Schiller, Buffet indicator, Tobin Q…would suggest a shorter lag period hit to this market that may be more consistent with 2000. That inverted yield has NOT yet occurred but merits watching.
There is no panic right now or indication to pull back from the market but it seems prudent with the Fed’s announced intentions and the already flattening curve…that we keep a watchful eye in the coming months.
If you made it this far, you are a market timer…where you acknowledge it or not