Are We at Risk for Another Leg Down Before a New Bull Market Begins?: Market Commentary from Cabana’s CEO – June 30, 2022

2 months ago

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Last week’s rally appears to have failed and we are now headed back toward recent lows on all the major indices. We discussed several days ago the typical two steps, one step process in both bull and bear markets, and what we are seeing is more of the same two steps down followed by one step up bear market bounce. As such, any rally for now should be viewed with skepticism and simply a temporary rally within a larger confirmed downtrend (in my opinion). A confirmed downtrend is defined as a series of lower lows and lower highs in a stock or index. That is certainly the case right now. 

The good news is that we are beginning to see the next and perhaps final phase in the cyclical bottoming process. A couple of weeks ago I provided a chart (here), which showed the major asset rotation process as bull markets end and bear markets begin. I suggested that this bear market would end only after commodity prices began to fall. Commodities are typically the last asset class standing at the end of a bull market. It is their outperformance that typically leads to inflation and higher rates, which pressures riskier assets like stocks and safer (but interest rate sensitive) assets like bonds. This has been the case for the past seven months. As of this morning we have seen a more than 20% drop in the energy sector (XLE) in three short weeks. Copper is also at lows not seen since the first quarter of 2021. This breakdown in commodities is likely necessary to reduce the upward inflationary pressures that are driving the historic jump in interest rates. As inflation abates, bond prices should begin to rise, which coincides with a bottoming in stock prices and lays the groundwork for the next bull market in stocks to begin. 

The bad news is this pullback in commodities suggests we are headed for economic weakness over the short to medium term and I believe there is a strong likelihood the Federal Reserve will continue to aggressively raise rates until it is confident inflation is under control. What this means is that we are at risk for another leg down in stocks before this is all over. In my view, it is this last leg down in bear markets that is most dangerous. We provided a commentary and graphical analysis of this stage of bear markets on June 7. This was penned by another manager but is very good in my opinion. I suggest reading it again as we may be about to witness this final stage play out. 

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June 22, 2022

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