Today the Fed signaled that an interest rate cut is coming in the future. The only uncertainty is “when” – will the rate cut occur in July, or later? Today’s headlines:
- How various markets respond to rate cuts
- What SUSTAINED yield curve inversions mean for stocks and gold
- Stock market’s quick recovery from correction territory
- Dow transports lagging badly
- Copper’s death cross
How various markets respond to rate cuts
The implied probability for a rate cut in July is now at 100%, which means that many market participants expect the Fed to cut interest rates soon.
Here’s how various markets performed after the first rate cut. This is the S&P. You can see that the S&P tends to perform poorly in the first month after a rate cut.
Here’s gold. Gold tends to perform poorly 3 months later, but better 1 year later. Notice how the last 2 “first rate cuts” (September 2007 and January 2001) saw gold rallying 6-12 months later. This is partially why some traders are bullish on gold right now. In their mind, the best way to trade a recession is to go short stocks and long gold.
Here’s what happens next to the U.S. Dollar Index when the Fed cuts rates for the first time. 1 year forward returns lean bullish.
Here’s what happens next to the 10 year Treasury yield. Long term interest rates almost always fall 6 months later.
Here’s what happens next to oil.
Puru made a very good observation. In a nutshell, the 10 year – 3 month yield curve is on the verge of being inverted for 5 consecutive weeks.
Sustained inversions are more important than brief inversions, which are more likely to be false bearish signals. For example:
- 2006-2007: sustained inversion, followed by a recession and bear market
- 2000: sustained inversion, followed by a recession and bear market
- 1998: brief inversion, false bearish signal
Here’s what happens next to the S&P when the 10 year – 3 month yield curve has been inverted for 5 consecutive weeks (i.e. right now)
The S&P’s forward returns start to deteriorate at the 3-6 month later point. Here’s the S&P’s maximum drawdown.
The yield curve is a long term indicator for risk:reward. It isn’t for short term (or even medium term) market timing. This demonstrates that over the next 1-2 years, the risk of a big recession-driven drawdown is significant. In my opinion, the main risk lies in 2020. But we need to consistently re-evaluate our beliefs as time goes on and new data is released.
Here’s what happens next to gold when the 10 year – 3 month yield curve has been inverted for 5 consecutive weeks.
While this isn’t an immediately bullish sign for gold, the 1.5-2 year forward returns are more bullish than random.
NASDAQ’s quick recovery
After making a -10% correction (using daily CLOSE $), the NASDAQ has recovered very quickly. It is now within -2.5% from its closing high in early-May.
Here’s what happens next to the NASDAQ when it makes such a quick recovery.
Most of the historical cases were in the late-90s. Even though this was late cycle, the stock market still went up another year.
Dow transports are lagging badly
The Dow Jones Transportation Index has lagged the S&P 500 badly. While the S&P is near all-time highs, the Dow is more than -10% below its highs.
Are lagging Dow Transports a consistently bearish sign for stocks?
No. The last 2 times this happened was July 2015 (before the August 2015 crash) and October 2007 (before a bear market).
But before that, it wasn’t such a bearish sign.
Copper’s death cross
And finally, copper made a “death cross”, whereby its 50 dma fell below its 200 dma
Historically, these death crosses were slightly bearish for copper in the short term (1-4 weeks later), and bearish for copper 1 year later.
We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. Members can see our model’s latest trades here updated in real-time.
Here is our discretionary market outlook:
- The U.S. stock market’s long term risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
- The medium term market studies (e.g. next 6-9 months) are mostly bullish.
- Market studies for the next 2-3 months lean bullish.
- Market studies over the next 2-4 weeks are mixed.
- We focus on the medium-long term.
Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.