On Wednesday last week the US Federal Reserve announced the expected, saying they were not raising rates at this time. Voting members also changed their outlook for 2019 from the two increases predicted in December to no movement. At first the stock market loved the news, but as the day went on investors started to digest why the Fed was not raising rates – a slowing global economy. Then on Friday we got the news that the 10 year/3 month yield curve had inverted.

What is the yield curve?

The yield curve is a way to show the difference in the compensation investors are getting for choosing to buy shorter – or longer-term debt. Typically an investor would  expect more return for lending their money for longer periods, with the greater uncertainty that brings. So yield curves usually slope upward.

A yield curve goes flat when the premium, or spread, for longer-term bonds drops to zero – when, for example, the rate on 30-year bonds is no different than the rate on two-year notes. If the spread turns negative, the curve is considered “inverted.”

Why should I care?

The yield curve generally reflects the market’s assessment of the economy, especially related to inflation. If investors believe inflation will increase they will demand higher yields to offset its effect. Given that inflation usually comes from strong economic growth, a sharply upward-sloping yield curve generally means that investors have bullish (positive) expectations. An inverted yield curve, by contrast, has been a reliable indicator of impending economic slowdowns, often alerting to a coming stock market top and recession, like we saw in 2007.  Every recession has been preceded by an inverted yield curve.

Last week we saw the 10-year/3-month yield curve invert which is our first official key warning of a looming stock market top and recession..

But we have not yet seen the more watched 10-year/2-year yield curve invert. When we see the 10/2 year invert then the clock will start ticking to a stock market top and a recession.  On January 24th we posted a blog on how an inverted yield curve and a top in the Confidence Board Leading Economic Indicator (LEI) are great tools to alert us to a looming stock market top.

Luckily for our subscribers, back in November, while the mainstream media was calling for a steep bond market sell-off,  our models projected that we would see a significant short-term bond rally. On November 12/18 we entered  a trade using an Exchange Traded Fund  (ETF) and that trade is up over 20% in just over 4 months.  Make no mistake, long-term we will see the bond market sell-off, but according to our models that scenario is a ways off.

Stay tuned!

Wikipedia defines Civil Asset Forfeiture “as a legal process in which law enforcement officers take assets from persons suspected of involvement with crime or illegal activity without necessarily charging the owners with any wrongdoing. While civil procedure, as opposed to criminal procedure, generally involves a dispute between two private citizens, civil forfeiture involves a dispute between law enforcement and property such as a pile of cash or a house or a boat, such that the thing is suspected of being involved in a crime. To get back the seized property, owners must prove it was not involved in criminal activity.”

“officers can take cash and property from people without convicting or even charging them with a crime.“

These Civil Asset Forfeiture laws were designed to stifle large scale organized crime by seizing the fruits of their criminal activity.  But today this process has almost unruly where officers can take cash and property from people without convicting or even charging them with a crime. Police departments all over have used this process to seize massive amounts of cash and property, to the point that in 2015 the growth in these seizures surpassed the total value of goods stolen from citizens through burglaries. That’s right – police officers took more goods from Americans than burglars did.

Clearly, the use or abuse of this process has gotten totally out of hand. Unlike a typical court case where the defendant is ‘presumed innocent’, in these proceeds individuals who have had their assets seized must sue to prove the assets weren’t the result of or used in a crime.  Legally regaining such property is notoriously difficult and expensive, with costs sometimes exceeding the value of the property. Many simply walk away and lose their assets because they cannot afford the legal costs.

On Wednesday in a unanimous decision, the Supreme Court ruled that the Constitution limits the ability of state and local police to seize and keep cash, property, and other assets that may have been used to commit crimes, particularly when it’s used to enrich police departments.

The decision, announced in court and written by Justice Ruth Bader Ginsburg, was a victory for an Indiana man, Tyson Timbs, whose expensive Land Rover sport utility vehicle was confiscated after he pleaded guilty to selling heroin to undercover police officers.

Justice Ginsburg wrote “The protection against excessive fines guards against abuses of government’s punitive or criminal law enforcement authority, is fundamental to our scheme of ordered liberty.”

Timbs became addicted to an opioid prescription for persistent foot pain. When that supply ran out, he turned to drug dealers and eventually to heroin. Because the police said he used his vehicle to facilitate the drug deals — a $42,000 Land Rover bought with money he received from his father’s life insurance policy — the state instituted a forfeiture lawsuit to take it away.

Timbs sold the heroin for $400. His $42,000 Land Rover ended up getting seized by the state of Indiana for the crime. The Supreme Court found the seizure “grossly disproportionate to the gravity of Timbs’s offense,” as Ginsburg wrote.

“Protection against excessive fines has been a constant shield throughout Anglo-American history for good reason: Such fines undermine other liberties,” she added. Hopefully, this  ruling will challenge asset forfeiture across the US and Canada.

Click here for more.

Stay tuned!

Most investors understand that the stock market doesn’t follow the economy, it leads it. That means we cannot wait for a recession to get out of the markets because the markets generally start to fall months before a recession kicks in.

If the stock market tops before the economy goes into a recession, how do we know when the stock market is going to top? Fortunately, there are a couple of key LEADING indicators that always precede a recession, and more importantly for investors, a major top in the stock market. These key indicators are the Yield Curve and the Conference Board LEI Index.

Yield Curve:

Normally, long-term yields are higher than short-term yields for the logical reason that lenders want a higher risk return when lending money for 10 years than they would for lending it for 2 years.  There is a higher risk that the longer term loan may not get paid back in 10 years.. But occasionally, this relationship changes, and short-term yields rise above long-term yields. Because investors are willing to accept a lower yield in the longer-term 10-year bond over the 2-year warns that these investors are expecting lower rates in the future so the demand for longer-term bonds increases, pushing yields lower (bonds prices and yields move opposite each other).

When short-term yields are higher than long-term yields, the yield curve (spread between the long-term and short-term yields) is said to be “inverted” and when it happens it has historically been one of the most accurate predictors of recessions and the start of major bear markets in stocks.

The red circles on the following chart show each time since 1990 when the yield curve ‘inverted” (below zero). Once inverted between 12 and 18 months later we see a recession starting (grey bars).  We can see on the far right that the current spread is not inverted, but it is getting very close. The current spread between the 10-year and 2-year yield is only .17%.  

Conference Board LEI

Another leading indicator we pay attention to is the Conference Board Leading Economic Indicator (LEI).  The LEI for the US looks at 10 different economic indicators,  everything from employment, to housing, to interest rates. Like the inverted yield curve, this indicator has an incredible track record of predicting recessions.  On the chart below we can see how the red arrows highlight that when the LEI (blue line) tops out it always precedes a recession. Looking at the top far right corner we can see that the LEI has leveled off, but has not yet topped out, but we need to keep our eye on that.

A road-map to a stock market top

Now let’s look at how these indicators warn of coming stock market tops. On the chart below the pink vertical lines show when the yield curve first inverted, the yellow vertical lines show when the LEI topped out and started turning down, the red circles show when the stock market had a major top, while the grey shaded area shows a recession. We only show the last two stock market crashes in this chart, but the story is the same for decades. Every major stock market top was preceded by an inverted yield curve and a top and decline of the LEI.

In the 2000 DOT COM market crash the Yield Curve inverted 12 months before the recession and 5 months before the stock market top. The LEI topped out 10-months before the recession and 3 months before the stock market top.

In the 2007 Financial Crisis stock market crash the LEI topped out 20 months before the recession and 17 months before the stock market top.  The Yield Curve inverted 14 months prior to the recession and 11 months before the stock market top.

So while the talking heads are calling for the end of this bull market in stocks, we will wait for proof. That does not mean we will not see a very volatile market with many spikes both up and down.

Once we see the negative signals from these two key LEADING  indicators we should have at least a few months warning before we see the top in the stock markets. We regularly update Trend Letter subscribers on the status of these indicators.

At this time our models are indicating we will see a final run up in stocks, likely to new highs, before we see the top in the stock markets.

But make no mistake, while we see higher highs before the bubble finally pops, the risk of a serious market pullback has risen significantly in recent months.  We always preach to subscribers to always decide on an exit strategy BEFORE you make any investment. Always have a plan to get out in case the market moves against you.  For our subscribers we always identify our BUY and SELL Stops before we enter a trade. If the trade starts to rise, then we raise our SELL Stop. If our SELL Stop is hit, we SELL. Each investor is responsible for deciding the right BUY and SELL Stop for their situation. Work with an independent financial analyst to ensure that you are not taking on too much risk.

One thing we know is that while the next bear market is not necessarily imminent, it is inevitable.  If you’re nearing retirement or already retired, it is time to have a plan to get “defensive”.

With this historic market melt-up now over 9-years old, it is time for all who have equities exposure to prepare for the inevitable market melt-down.

Are you prepared?

Seriously think about subscribing to our hedging service Trend Technical Trader and put yourself in position to not just survive the coming melt-down, but to actually profit from it.

Stay tuned!

In Wednesday’s blog after the S&P 500 soared a record 116.60 points or 4.86%, we warned “be careful here, we are not out of the woods yet!” Monday is year-end and here are our key targets for a Monday close:

Friday’s close was 2485.74

2575 – a Monday closing below this resistance level (top red line) suggests that this recent rally will be short-lived and a re-test of 2400 is likely.

2395 – a closing below this support level (lower green line) suggests a steep correction is possible.

In the bigger picture we need to see a break down below its 9+ year uptrend channel to open the door for a steep correction.

An incredibly reliable leading indicator that has an incredible record identifying stock market tops:

 We show this indicator to our subscribers often as it is a key leading indicator. You have probably heard the term ‘inverted yield curve’ but likely do not know how reliable it is at warning of a coming recession and stock market top.  The yield curve we are referring to is the spread between the yield on the 10-year government bond vs the yield on the 2-year bond.  These yields tend to move for different reasons, with the longer-term 10-year yields moving based on the market, while the shorter-term two-year yields move largely due to the actions of the Federal Reserve.

Typically, long-term rates are higher as investors demand higher payments due to the risk of lending their money for a long time, which makes sense. But this last year the Fed has been hiking rates, which has pushed up the yield on the 2-year bonds faster than the yields have risen on long-term bonds.

Below is the current chart of the spread between the 10-year yield and the 2-year yield. We have marked with red circles each time since 1988 where the yield curve has inverted, meaning that the short-term 2-year bond had a higher yield than the longer-term 10-year bond.   The key is that every time this has happened, between 12-18 months later the stock market topped and then reversed, heading much lower. As we can see on the right hand side of this chart, the yield curve is not yet inverted, but it is very close, just .18% points away. But remember this is a leading indicator, meaning that even if it inverts next week,  we should have between 12-18 months before the stock market top is in.

That doesn’t mean we won’t see more volatility like we are experiencing now, it just means we are not likely to see the final top for a while yet.

There will be a full update for subscribers in this weekend’s issue of the Trend Letter.

Stay tuned!