Jeffrey Saut: “Inversion?”

by Jeffrey Saut, Chief Investment Strategist, Saut Strategy

“We are going to be buyers of things over time. And if you’re going to be buyers of groceries over time, you like grocery prices to go down. If you’re going to be buying cars over time, you like car prices to go down. We buy businesses. We buy pieces of businesses: stocks. And we’re going to be much better off if we can buy those things at an attractive price than if we can’t.”

We have used our version of the above Warren Buffett quote for years and used it on CNBC yesterday afternoon. Our modified version goes like this, “Stocks become riskier when they go up sharply and more valuable when they go down sharply!” And boy did that happen in spades yesterday. I wish I could say I predicted it, but when our short-term model flashed a cautionary signal three weeks ago, I wrote that I thought the pullback would be short and mild. Actually, our colleague Andrew Adams has “nailed” this market on a short-term trading basis. The media’s causa proxima for the decline was a brief inversion of the 2-year to 10-year T’Notes signaling a recession is coming.

However, Janet Yellen opined she didn’t think the economy was headed for a recession. Janet might be correct because the global bond market has not been a freely trade market for over a decade. Due to the central bank corner on bonds, why would historic correlations be valid now?

And as I have often said the real yield curve is the 90-day T’bill to the 30-year T’bond and that is not inverted. It should also be noted that the 2-to-10s has inverted before and nothing happened to the economy. Moreover, in past inversions stocks have tended to peak 12 months later.

So that is the media’s reason for yesterday’s Dow Dive, but you can choose from a plethora of other reasons (Russia blowing up their own weapons, a build-up of Chinese forces on the Hong Kong border, India and Pakistan, Venezuela, Argentina, etc.). Whatever the reason the S&P 500 (SPX/2840.60) closed at the lower end of its 2840 – 2860 support zone and if that level fails, we likely test the August lows (2822). Bear in mind the SPX’s 200-day moving average is at 2795.73, which would be a slight “undercut low” of the August low of 2822.

What I really think has happened is that given the years of quantitative easing, exceptionally low interest rates, low inflation, etc. what we have is a new “toolbox” and we do not know what “tools” to use in quantifying the current economic, bond market, and stock market environments. Our friend, CNBC’s uber-smart Steve Liesman, hinted at this yesterday in our interview, but I do not think many folks picked up on it; and, it is a very important point. I ran into my old Financial Institutions analysts Dick Bove

yesterday at the studio and he asked me if I thought we were headed for a recession? I said absolutely not! He replied then the banks are a stone-cold buy because yield inversions do not hurt them. The only thing that hurts them is bad loans and that is just not happening. Commercial and industrial loans were up 1% six months ago and now they are up 6% year-over-year.

Yesterday was a 90% Downside Day with 96% of the total Upside to Downside volume coming in on the downside. However, total Downside Points trade did not register a 90% downside reading. This was the second 90% Downside Day seen in the past two weeks and that typically how bottoms are made. To clarify things, I ran the models last night. There is no change. The long-term and intermediate model are still constructive, and the short-term model remains on a sell signal. Nd then there was this from Leon Tuey:

“Today was another climactic day. On the NYSE, Down Volume overwhelmed Up Volume by a margin of 19-to-1. This is climactic. It's capitulation. I can't recall the last time that happened. Sentiment backdrop is now ideal as fear is universal. Notice how black the headlines are. Technically, at last, a number of the technical indicators are registering oversold readings. Recently, I thought the market would bottom in about 2 - 4 weeks, but the latest data suggest that the bottom may arrive sooner, particularly if the selling continues. The bottom may come in days, not weeks. As advised, re-deploy cash on further weakness.”

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