Volatility Continues Despite Ending Last Week on a Positive Note: Market Commentary from Cabana’s CEO – March 10, 2023

1 year ago

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Last week we discussed the apparent failure of the S&P 500 (SPX) to hold its’ early February breakout above resistance at 4100. The reversal to lower prices came as investors realized that inflation remains an ongoing problem and rates would likely need to rise further (and perhaps faster) than expected. This same reality continues to plague any sustained rally attempt. Despite ending last week on a positive note, the S&P 500 has again fallen below 4000 and its’ 50-day moving average. As of this writing (Thursday, March 9, 2023) it is searching for support at its 200-day moving average and the 3900 level (see below).  

I suggested last week that we need to hold these levels or risk a retest of the 3800 level and potentially the October low at 3500. Tomorrow, we get the February employment report and another upside surprise like we got with the January report could put additional downward pressure on stocks and lift rates higher (see addendum below for an update).  

The yield inversion (short term rates are higher than long term rates) has reached extremes not seen since 1981. The difference was more than 100 basis points earlier this week! This is strong evidence of a sharp economic slowdown coming. It is this potential “slowdown” that is being discounted by investors in hopes of determining how much prices will need to drop to account for reduced corporate earnings. This mathematical process is called “multiple contraction” and gives us some idea of whether stocks are cheap or expensive. A simple measure of this is the price to earnings ratio (P/E). Right now, the S&P 500 is trading at about 19 times forward earnings or at a P/E of 19. If earnings drop 20%, then price would need to drop by that same amount just to maintain the same relative equilibrium. So, the question is how much they are going to drop as a result of rising interest rates. If you can figure that out it would go a long way toward at least knowing how much you are paying for stocks. It doesn’t mean you would agree to pay that price, but at least you would know. I am oversimplifying of course, but that is the idea and what I see going on as this stock and bond marking thrashes around. So far, we have seen this discounting process make earnings lower and lower. This is why the market has continued to make new lows and the breakout mentioned above failed. 

So… Why can’t all this get figured out and we move forward? Because it takes a long time for the effects of rising rates to make it through the economy – and even when it does the effects are different for different businesses. It’s complicated stuff and part science part fortune teller. I don’t claim to be good at either, so at Cabana, we just strive to follow the big picture by incorporating the basics of interest rates, earnings and price into CARA and she attempts to tell us where we ought to be once she has aggregated that information. Right now, she says we should be very cautious. We are in a Bearish Scene within our system. 

We remain in Safety Valve Level 2 allocations as portfolios are outside of target drawdown. 

Addendum: We did get a relatively hot employment number this morning. More than 300k jobs were created in February and stocks are feeling the pressure of higher interest rates down the line. The S&P 500 has dropped below its 200-day moving average. If it cannot regain that important level quickly, I expect more selling in the days ahead. 


January 17, 2024

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