The Heat Is On

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“The heat is on, on the street
Inside your head, on every beat
And the beat's so loud, deep inside
The pressure's high, just to stay alive
'Cause the heat is on”

The Heat is On by the Eagles

Another wild ride on Wall Street, with negative economic numbers and possible hostile situations around the globe.

From a California heat wave and out of control fires in Laguna Beach and Los Angeles (not very far from the the upcoming Super Bowl no less), to “hot” inflation numbers this past Thursday, much higher than many economists had expected (but not our Mish who has been saying it would run this hot all along), to geopolitical turmoil in Ukraine, to Iran getting a nuclear weapon to assassinations in Syria, it has certainly been a HOT week.

Speaking of California, due to the “heat wave”, coupled with a prolonged drought, their produce prices have been among the fastest rising products contributing mightily to the inflation rate (along with housing products like lumbar, meat, pork and chicken prices and certainly oil related products including gasoline at the pump for all Americans). These are the products that we all consume every day. We point this out because while many prices are rising due to global supply chain disruptions, this is not one of those. There is clearly no way to escape it. See CA produce prices below:

Truly, the heat is on.

Other factors have exacerbated the slew of hot, negative events this past week. Probably none more detrimental to your money then a number of Fed Governors speaking out on Thursday after the higher-than-expected CPI number came out (7.5% YOY). The Governors openly declared it was time for aggressive action. James Bullard of the St. Louis Fed spoke out pontificating that aggressive action was needed soon. Rumor and conjecture from the media translated this to mean that the Fed was going to call an emergency meeting as soon as this coming week to hike interest rates by no less than 50 bps. This sent interest rates soaring and stock prices plummeting.

Then on Friday the US Government stated that they had classified intelligence (without sharing the proof with anyone) that Russia had created a false video showing hostile and aggressive action had commenced by the Ukrainians and that they were “going in.”  Whether this is true, or not, this predicated aggressive rhetoric from Washington that all Americans in Ukraine needed to be out within 24-48 hours. This compounded the “heat” and sent stock prices down hard for the second day in a row.

What gives?

Probably some over-reaction and a heavily negative narrative playing out as the main street media loves the drama to attract viewers. Yet there is no denying that the recent climb of interest rates to over 2% on the 10 year Treasuries as well as a straight moon shot on shorter-term 2 year treasuries to approximately 1%, broadcasted that the market was already pricing in aggressive action. Individual investors as well as Institutions holding stocks began to calculate the effect higher interest rates would  have on growth related stocks (including the spec tech highflyers) and sold down these multiples quickly. Plenty of heat for one week (actually two days).

This was compounded by large commercial banks letting their customers know that their lending rates were going to rise sending big borrowers to panic pulling their lines of credit. Also, mortgage rates for homes rose steadily this past week which took the sizzle out of publicly traded Reits and the homebuilders. More heat.

What Investors Can Do to Fight the Heat

First off, if you monitor our signals and the rotation of investment themes in a number of our investment models, you would have noticed a few ideas and themes that have emerged (especially if you are a subscriber to Mish’s Market Minute):

• We are sitting in an abundance of cash in some of our strategies. Right now, cash is not earning anything, but it sure helps us find shelter in these volatile times. Investing in cash (or a cash substitute) requires patience, but keeping your powder dry is often the best antidote to fighting the tape
• We are playing the rise in interest rates by investing in an interest rate inverse ETF.
• Commodities have emerged as a good bet in these times. We have invested in a number of commodity ETFs in the past 3 months and most, if not all, have done well. They were the bright spot this past week as oil, gold, silver, and agricultural ETFs rallied and ended the week on a high note.
• Industrial metals and mining are also acting positively and have emerged as an  important inflation hedge.
• We further suggest Incorporating value-oriented inflation fighting stocks such as chemical companies, a few of the DIY retailers, global shipping companies, energy and energy service themes.
• Consider deep value stocks (consumer staples) that have held up well and even some of the financial service companies that will benefit from higher interest rates.

On another note, here is a metric that might amuse you…two of the biggest market crashes took place only 56 days after hitting new all-time highs (however they both happened late summer) so we are less than two weeks away based on this stat. However, with only two examples this observation is not exactly mathematically significant, but we share it nonetheless.

In addition, here are some takeaways from our Big View that may provide a more thorough understanding of the inter-market relationships and important indicators we are constantly monitoring:

Risk-On

• Interest Rates (IEF) rose quickly, and could be potentially overdone and in the process of mean-reverting, and easing a bit (+)

Risk-Off

• Equities gave up hard-fought gains, with all 4 key US Market indices breaking hard and closing under their 200-day moving averages, potentially looking to retest recent lows
• Despite the IWM being down almost -10% YTD, it was actually up 1.5% on the week. However, IWM is showing zero accumulation days over the past 2 weeks and continues to be the only key index in a bear phase
• Energy (XLE) +2.1%, Materials (XLB) +1.1%, and commodities in general were the only sectors up on the week
• Speculative Sectors like Technology (XLK) -3% and Semiconductors (SMH) -2.7% led the decline
• Commodities led by precious metals like Gold (GLD) +2.9% and Silver (SLV) +5% soared this week, likely thanks to increased tension in the Ukraine as well as global inflationary pressures
• The McClellan Oscillator for SPY slipped into negative territory, with potentially more downside action building
• The McClellan Oscillator for QQQ peaked at overbought levels late this week, and finished Friday by leading the market down
• Risk Gauges improved rapidly through this Thursday, however, gave up gains by Friday’s close that now have all key indices back in Risk-off territory and with negative TSI values
• Volatility ($VIX.X) held its long-term 200-day moving average and closed the week in a bullish phase, a Risk-off indication
• Value Stocks (VTV) continue to outperform Growth (VUG), but even VTV lost its Bullish market phase on Friday with the rest of the market
• Gold (GLD) and OIL (USO) roared to their highest levels since November, and GLD has broken out of a long-term wedge while USO continues its upwards trajectory. These are direct results of global inflation and increasing geopolitical stress

Neutral Metrics

• Regional Banks (KRE) is the only member of Mish’s Modern Family to hold up on the week, and is still maintaining a Bullish market phase thanks to the increase in rates
• Emerging Markets (EEM) is holding its gains on a relative basis compared to the SPY, not surprising because of EEM’s sensitivity to commodities
• The top performing Country ETFs this week were Canada (EWC), Peru (EPU), and Mexico (EWW), again thanks to their high rate of exposure to commodities

Crypto

• If you are planning to watch the Super Bowl this weekend, keep an eye out for everything Crypto. Several major exchanges including eToro, FTX, and Crypto.com are expected to run ads during the event, with countless other commercials expected to mention cryptocurrencies, NFTs, or the metaverse
• In comparison to the stock market, cryptocurrencies held up exceptionally well this week, with BTC up +3.8% on a rolling 7-day basis as of Saturday morning
• Altcoins are showing a bit of volatility, while Bitcoin remains our best crypto market benchmark. BTC retested support at its 50-day moving average late Friday night, but looks to be maintaining that level as of Saturday morning, with the 10-day moving average also about to cross back above the 50 thanks to 2 weeks of positive price action