Powell reveals the gameplan … Luke Lango’s forecast for 2022 … keep these two indicators on your radar

 

Our February 11th Digest noted that the probability of the Fed raising rates by 50 basis points at its March meeting stood at 58%.

What’s the probability today?

About zero.

Yesterday, Federal Reserve Chairman Jerome Powell all but put this matter to rest in remarks made before House and Senate committees.

He said he was “inclined to propose and support a 25-basis-point rate hike” at the Fed’s policy meeting in a couple weeks.

Here’s more from Powell:

The implications for the U.S. economy are highly uncertain, and we will be monitoring the situation closely.

The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain.

Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways.

We will need to be nimble in responding to incoming data and the evolving outlook.

***Our hypergrowth specialist, Luke Lango, has been tracking the Fed’s shifting stance on rates for months

That’s because the type of stock that Luke finds most attractive – innovative, tech-based growth stocks – are heavily influenced by interest rates.

This recent slow-down in rate-hike expectations is unfolding as Luke has been suggesting it would for weeks.

From Luke’s Early Stage Investor Daily Notes:

The indirect economic impact [of the Russian invasion], meanwhile, is its effect on Fed policy. And the consensus is that it will force a dovish reassessment by the Fed — a bullish development for our growth stocks…

For all of 2022, market expectations have shifted toward five or fewer rate hikes for the full year, with the three-rate-hike outcome gaining a lot of traction.

In other words, the market is starting to come to grips with the fact that the Fed is going to move a lot slower on rate hikes throughout 2022 than initially expected.

This is causing a repricing of risk assets. And that repricing is benefitting [tech-based growth] stocks, hence their outperformance amid the recent turbulence.

More importantly, we believe this repricing sets the stage for growth stocks to begin their long-overdue comeback rally as soon as tensions in Europe start to ease, even if just a little bit.

The reality is that the earnings momentum of our stocks is not at all impacted by the developments in Ukraine, and their valuations are positively impacted by the sharp drop in Treasury yields.

So fundamentally speaking, they should be up a lot right now.

***Speaking of the drop in Treasury yields, let’s check in on the status of the 10-year Treasury

Below, you can see the 10-year Treasury yield climbing to nearly 2.05% back in mid-February. That was its highest point since 2019.

But with Russia’s invasion into Ukraine, global investors have fled to the relative safety of U.S. bonds, gobbling them up, which drives down yields.

The 10-year yield fell as low as about 1.70% last week, but has pushed higher since. As I write Thursday morning, it stands at 1.87%.

As Luke pointed out, this lower yield has been a tailwind for tech-related growth stocks in recent trading sessions (despite the Nasdaq selling off as I write).

But the question is how long this tailwind of lower yields will remain.

As noted earlier, the drop has been due to the flight to safety based on geopolitical conflict. But if global leaders are able to broker a ceasefire, this overhang is removed.

In that case, risk-averse investors would breathe easier and be more confident in rotating out of bonds, back into riskier assets. That would put upward pressure on the 10-year Treasury yield, and by extension downward pressure on rate-sensitive tech stocks.

At the moment, however, Russian President Vladimir Putin is showing zero genuine willingness to deescalate. This is likely to keep any dramatic move north from the 10-year Treasury yield in check – barring unexpected commentary from the Fed.

Meanwhile, as we’re talking rates, let’s check in on the 10-2 spread.

***This early warning recession gauge continues to creep in the wrong direction

In normal times, the longer you tie up your money in a bond (say, the 10-year Treasury), the higher the yield you would demand for it.

The yield you’d want would certainly be higher than what you’d expect from a short-term bond (like the two-year Treasury). After all, locking up your money for just two years gives an investor far more financial flexibility than locking up that money for 10 years.

Given this, in healthy market conditions, we usually see a “lower-left” to “upper-right” yield curve. That would translate into a wide, healthy “10-2 spread.”

The opposite of this is a flattening yield curve, which means a narrower 10-2 spread. This reflects fears of an ailing economy. And an inverted yield curve has a perfect record of predicting a recession for the last half-century.

As you’ll see below, the 10-2 spread had its most recent peak in 2021, topping out at roughly 1.60.

Since then, it’s been moving steadily lower. And here in 2022, the declines have accelerated (circled below).

As I write, the spread has narrowed to just 0.33.

This isn’t a reason to get overly defensive at the moment. The 10-2 spread has narrowed then expanded many times over the years.

However, it’s something to keep your eye on. The closer we get to “0,” the greater the risk to the stock market.

***One final indicator to watch

Investors who perform technical analysis spend a great deal of time analyzing historical market data, charts patterns, and a slew of indicators.

A preferred stock indicator is a simple moving average (SMA).

As its name suggests, a SMA is a line showing the average reading of some number of the prior days’ worth of market prices.

Typically, a medium-term SMA uses the prior 50 days of market data. And a longer-term SMA uses 200 days.

These SMAs can be important psychological lines-in-the-sand for investors that help identify price trends for a stock (or an entire market). And that can impact investors’ investment decisions.

For example, if a price falls below the 200-day SMA, traders usually interpret this as a bearish long-term trend change. To avoid potential losses, some traders will sell, which can intensify the move south, leading to even bigger price declines.

The opposite is true as well. A push north through a 200-day SMA is often seen as a bullish long-term indicator. This can attract more buyers, which leads to bigger price gains.

As you’re about to see, we’re nearing a situation in which the 50-day SMA falls through the 200-day SMA.

So, what’s the significance?

Well, over the last 10 years, every time the 50-day SMA has fallen through the 200-day SMA, the S&P has seen a substantial pullback.

Actually, there’s one exception – the 2020 bear market, which happened so fast (while the recovery was equally fast) that these moving averages didn’t cross until the stock market damage was already in the rearview mirror.

Below, I’ve circled each 50/200-day downward cross over the past 10 years, not including 2020.

Again, this is not a reason to sell today. After all, if you look again at the chart above, you’ll see many times in which the 50-day SMA flirted with crossing the 200-day SMA yet didn’t, and instead, rallied. But this is something we’ll be monitoring for you here in the Digest.

By the way, we’d be remiss not to point out the long-term lower-left to upper-right slope of the stock market.

This is a great reminder that despite wars, recessions, and worrisome news of all types, stocks are the best long-term game in town.

If you’re feeling nervous today, remind yourself that the stock market has always recovered and gone on to make new highs. It has a perfect track record.

Have a good evening,

Jeff Remsburg