Last time I wrote that it was best to ignore the noise and market/economic predictions of analysts and the financial media. Some interesting technical signals were already visible that normally don’t occur during structural bear markets. I leaned bullish and stated that in the worst case a retest of the lows could be possible, which would be an interesting point to increase equity exposure.

Price action during the last week has given further confirmation to the bullish outlook. Let’s look at some of the positive signs that developed during the week.

First of all, we saw a Zweig Breadth Thrust. (There is some discussion on fintwit about wether or not there was an actual signal. Some say there was, others say there wasn’t. It’s however clear that when there was no signal, it came extremely close. And if the quality of an indicator would depend on such a tiny difference, it’s probably overfitted and shouldn’t be used. So the most practical thing to do, it seems to me, is assuming that it triggered.)
A breadth thrust is a signal of changing market behavior. After a panic where almost all stocks get sold, the majority of stocks is able to quickly recover thereafter. This change in character is a bullish signal that has often marked the beginning of new bull markets.
The chart below shows all the Zweig Breadth Thrusts since the financial crisis. (According to the data used, there was indeed a signal.)

Notice that this signal never took place during the 2007-2009 bear market. The signal triggered at the beginning of 2009 when a new bull market was being born.

Below we can see that the signal also didn’t trigger during the 2018 or 2022 stock market decline. It triggered when the low was in and a new bull market had started.

This is important because some commentators are saying the current market behavior is similar to that of bear market rallies. It’s indeed true that the volatility is equally high but these signals (and the one we discussed in a previous article) normally don’t take place during bear market rallies.

Most of the time the lows were in and in a few instances the lows were retested later on. So it is still possible that we’ll go down 10% again to retest the lows but in my opinion it’s unlikely that we’ll go much below the lows of a few weeks ago.

The charts below show when lows were retested in the past after a Zweig Breadth Thrust. Note that this isn’t very common and the higher probability is that the market won’t go down again to revisit these levels.

Other bullish signals were visible last week besides the Zweig Breadth Thrust:

-The S&P500 increased three consecutive days with a minimum of 1,5%/day. This normally doesn’t happen during a bear market rally.

-The percentage of rising stocks was above 70% for 3 consecutive days. This normally doesn’t happen during a bear market rally.

So, it’s not just one signal, the weight of the evidence is bullish if you ask me.

I’ve lived through some market corrections in the past where a certain breadth thrust triggered and a lot of skepticism about the use of it was common among market commentators. People think the signal won’t work because fundamentals remain bearish or uncertainty remains high. I’ve learned to trust the thrust. More often than not, when multiple bullish signs are visible, the signal(s) work and we should ignore the noise and follow them.

When I published my previous article at the end of March, markets were down 10%. I showed that a 10% correction occurs on average once a year. I thought the market could go a few percent lower but I stated that the fundamental elements that normally precede a much bigger decline were not present.

The original purpose of this article was to share some of my fundamental models and trend following systems that showed that a recession was not imminent and the trend remained bullish.

And then came Trump.
The US stock market declined an additional 10% in 2 days, the VIX spiked to 60, and recession talk came straight back.

The economy itself was not transitioning to a recession due to endogenous factors. What markets started to price in is that a recession would be caused by the policies of the US President. In my last article, I showed that some large market declines are caused by external shocks (LTCM, Euro-crisis). I would categorize this market decline in that category. The shock is not really external, since it’s caused (and can be stopped) by the US administration itself. But it’s certainly not endogenous since the cause isn’t a normal recession or an overly tight Fed.

So, it’s rather useless to share my economic models since it will be Mr. Trump who decides if we’ll go into recession or not. And Mr. Trump’s ideas are rather difficult to fit into a model if you ask me…

So what will happen?
Short answer: I don’t know.
Long answer: I don’t know.
Longer answer: I don’t know, and I don’t care.

The mistake most people will make right now is that they’ll focus too much on the fundamentals. Let’s have a look at what branch of analysis people have become experts in over the last few weeks: First they became experts on trade policy (Why is trade important for Trump?), then they became experts on negotiation tactics (The huge tariffs are a negotiating tactic, right?), then they became experts on the economic and market impact of these trade policies (Trump is indicating there is no room for negotiation.), then they became experts on explaining why it was all a negotiation tactic in the first place (Trump says a 90 day pause will be activated.), then they became experts on the US Treasury market (Yields are rising when the stock market is declining.), then they became experts on the US Dollar (Dollar is declining when yields are rising.), then they became experts on the global monetary system (Foreigners have lost confidence and are selling all US assets.),…

All these people are able to instantly become an expert on every topic. They are able to explain each and every move in the market. Amazing! We must read all these theories to understand what’s going on so that we can try to find out what will happen and how we should invest.

Wrong.
People can’t deal with uncertainty, they need an explanation for everything. But the simple truth is that when uncertainty is extremely high, nobody really knows what will happen.
Instead of putting all your effort in trying to understand and predict the fundamentals, it’s better to keep it simple.
I’m a firm believer in combining fundamental with technical analysis. But, in times like these, the only fundamental analysis that you can use are narrative based. And as you know, I don’t like narrative based fundamental analysis. I like to use leading indicators and models to filter out the noise. Right now, that’s more difficult, and that’s why I prefer to ignore all fundamentals in the current circumstances.

So, how can we analyze the current situation? In my opinion, it’s best to only look at the technical, sentiment and positioning indicators. This gives us a view on the panic that’s taking place in markets and is an indirect way of trying to understand what market participants are pricing in. Since we can’t predict what will fundamentally happen, we can try to understand what market participants are pricing in. If they are pricing in the worst, the outcome only needs to be better than expected for markets to rally.

There are a lot of sentiment and positioning indicators that show extreme bearishness among investors. Below, I show the difference between AAII bulls and bears (10dma). Bearishness is extreme, something we saw at previous market bottoms.

Admittedly, bearishness was already extreme when the market was down 10% and some have asked questions about the relevance of this survey. However, there is a huge number of other indicators showing the same thing. So, for me it’s clear, panic is clearly in the air.

We can also see this in the fact that the market declined more than 10% in just 2 days. This happened only a few times before in history: during the 1987 crash, the 2008 financial crisis, and the 2020 Corona-crash. As the chart below shows, most of the time it was too late to panic.

This doesn’t mean that the market can’t go down in the short term.
In 1987, the 10% decline in 2 days marked the bottom. In 2008, markets declined another 25% over the following months and in 2020, markets dropped another 10% in a few days time.
But, if you can sit through the volatility, the table below shows that you should be fine in one year time.

An important point to make when talking about positioning data and sentiment surveys is that they can sometimes be very low, and stay very low. If you look back at the AAII bull-bear data that I showed earlier, you’ll see that during 2008, sentiment was consistently very bearish but markets didn’t bottom. In some way, a lot of these indicators are more correlated with price action than that they are necessarily predictive of a bottom in the price. They are an important signal that when everyone is bearish, it’s probably better to become bullish. But sometimes, the bearishness is justified and markets can continue to decline despite the bearishness.
That’s why the signal we’ll discuss below is important. The market is sending some signals that we normally don’t see during bear markets.

After the fast decline, we saw a fast rise in the stock market this week when Trump announced a 90 day pause with regards to tariffs. This kind of extreme volatility usually happens during bear markets. The chart below from Tier1 Alpha shows that the biggest market up and down days usually cluster together and they usually occur during bear markets, not in bull markets or normal market corrections. So, this is being interpreted by some as being bearish market behavior and not something bullish.

But, we are seeing some signs that normally occur at the beginning of a new bull market, and not during a bear market.
On April 9th, we saw a 90/1 upside to downside volume day (Source: Milton Berg). As the chart below shows, this normally happens around excellent buying opportunities, not in the middle of a bear market.

Let's zoom in on these previous instances to get a better understanding of short-term price action.
In 2011, markets retested their lows and actually went a little bit below them. However, most of the damage had been done and it was clear that dips were a buying opportunity.

In 2018, the signal marked the exact low.

In 2022, markets retested their lows and just as in 2011, went a little bit below them. However, it’s clear that you should have been buying aggressively.

So, what to do?
Nobody really knows what will happen. The combination of extreme market volatility and policy uncertainty leads investors to look for answers. The problem is that nobody really has the answers. In my opinion, it’s best to shut down the noise. I increased my equity position on Monday and still have a large percentage of my portfolio available to invest. History shows that markets could retest their low and even go a little bit lower. But, it’s also possible we have seen the lows. My guess is that the tariff news will be with us for a long time to come. The question is if markets will get used to it or not. The US Economic Policy Uncertainty Index is at it highest level in decades. Uncertainty is now higher than during the COVID-19 pandemic. Did the markets bottom when COVID-19 uncertainty peaked? No, as the chart below shows, markets bottomed when uncertainty was high and rallied when uncertainty stayed at this high level. After that, uncertainty decreased a bit but stayed structurally above the levels that preceded the COVID-19 uncertainty.

So, even when uncertainty around the tariffs remains elevated, this doesn’t mean that markets can’t rise. Volatility will remain high and if we retest the lows, I’ll probably use it as another buying opportunity. I think it’s best not to give too much attention to the headlines in the coming weeks. If you can’t predict what will happen, it’s best not to try to.

You can also follow me on X: adaptiveinvest

The S&P suffered a 10% decline from its peak earlier this year. The big question on everyone’s mind is whether or not this will develop into a much bigger decline, a bear market.

Before we start our analysis, we should remember the following words from Jesse Livermore: “Markets are never wrong - opinions often are.”
Those who have read my work in the past know the importance I put on being flexible and open minded. I’ve been wrong in the past and I’ll be wrong again. There is no shame in being wrong, only in not being able to change your mind.

So, let’s have a look at markets. First thing to remember is that the current correction is nothing exceptional. The chart below shows how often, on average, the market undergoes a correction of different magnitudes during a given year. On average, the market has a correction of 5% 3 times a year. A correction of 10% is seen once a year. Remember August 2024 or October 2023? Those times felt scary as well but were great buying opportunities.

In my opinion, the difference between those earlier 10% corrections and the current one is the news flow that accompanies the current one. Trade wars, geopolitical tensions, Trumpcession,… gives the current correction a more uncertain feeling to it. But we shouldn’t care too much about how we feel, we should care about what history can teach us about what causes the big market corrections and how we can identify buying opportunities.

Before we look at the fundamentals, we’ll look at the technicals.
The following chart shows that we are not only seeing a normal market correction, we are seeing a market correction where the S&P has lost support from its 200 day moving average (dma). People like to use the 200 dma as a trend following and market timing mechanism. A move below the 200 dma is seen as bad. In October 2023 we broke below the 200 dma as well but the market quickly regained the 200 dma so it was clear it was a false break. Most healthy corrections don’t fall below the 200 dma. Right now we have broken below the 200 dma and the most recent rally peaked right at the 200 dma. This clearly isn’t looking good for the equity market.

The reason people like to use the 200 day moving average is because history shows that almost all of the gains in the S&P500 take place when the price is above the 200 dma. The chart below from SubuTrade clearly shows that when the price is below the 200 dma (green line), the market makes no progress.

Paul Tudor Jones was also famous for using the 200 dma as a risk management tool: “One principle for sure would be to get out of anything that falls below the 200-day moving average.”

So, it’s no surprise that people are becoming worried about the recent price action in the stock market.

However, as the well known mathematician Benoit Mandelbrot said, when it comes to financial markets “what matters is the particular, not the average”.

It may be true that when we look at price history over several decades that markets don’t do well below the 200 day moving average, but this doesn’t mean that there are no false signals. In fact, there were a lot of false signals in the past.

I’ll show some examples below of periods when price action looked scary, just as it is now, but no bigger bear market developed and it was best to buy the correction.

In 2010, the market saw a 16% correction. Price dropped below the 200 dma and all the rallies peaked right at the 200 dma. This price action looked really bad if you just looked at this technical indicator. However, it was not a big topping process, it was a bottoming process that was forming. We saw something similar in 2011. Price moved below the 200 dma and peaked several times at the 200 dma. Again it was a bottoming process and not a topping process.

If we loot at the 2015-2016 period, we can see an initial 12% decline, followed by a rally above the 200 dma and another 13% decline. It clearly looked like a topping process, but it was not. The rest of 2016 and 2017 were great for investors.

In 1998, markets declined 20%. A rally followed but peaked exactly at the 200 dma after which the market retested the lows. The bearish looking price action was not the beginning of something more, it was a buying opportunity.

In 1994 the market declined 9% and peaked a few months later at the 200 dma. The rally failed and the market moved lower again. The rest of the year saw a further consolidation around the 200 dma. 1995 was a great year for the US stock market.

So yes, statistically speaking, the stock market has no good returns when it’s below the 200 dma. But it is perfectly possible that a nice buying opportunity is developing even when the price action is looking bad. It’s about the particular, not the average.

So how do we know if this is a buying opportunity or not? To answer this question we need to look at the fundamentals. The chart below shows all 20% (or larger) corrections in the US stock market. We see that most of these corrections are caused by a recession (red) or by a central bank that is raising interest rates (orange). Some corrections are caused by external shocks (blue): LTCM in 1998 and the Euro-crisis and US debt downgrade in 2011.

The thing about external shocks is that you can’t predict them. Once the shock goes away, markets can rise again. Since you can’t predict them, it’s of no use to try and build an investment strategy around them.

So to answer the question if this current 10% correction will develop into something much bigger, we need to answer the question whether or not we will see a recession and/or a restrictive central bank.

Let’s start with a recession. Yields have been declining and economic data has been weaker than expected which gave birth to the newborn narrative of a ‘Trumpcession’.
The current weaker than expected data is not unexpected. At the beginning of this year the narrative was about a strong US economy and a Fed that might need to raise interest rates instead of lowering them. Now, 3 months later, and the narrative has completely changed. In January this year, when the economy was strong, interest rates and the US Dollar had been rising in the prior months. This is the equivalent of a tightening of financial conditions and it thus shouldn’t have been a surprise that data would be coming in weaker, just as we have seen.
The chart below shows the US 10 year interest rate in blue. The scale is inverted so when the line is declining, interest rates are rising. In red we see the US Citi Economic Surprise Index. A value above 0 (the red horizontal line indicates the 0 mark) shows that economic data is coming in strong than expected. I moved the red line 3 months back in time. This is the same as using the blue line (US interest rates) as a leading indicator of the red line. We see that the two lines move closely together. In other words, interest rates (and other variables like the US Dollar and financial conditions) are leading economic data. We can see that in January of this year, when everything looked great, the blue line was indicating that the red line would start to decline, which is what happened. Now we are seeing the opposite. People are scared of a recession but the blue line is rising again (interest rates are declining, so is the US dollar). This implies that in a few months time we’ll probably see that recession fears were premature.

Looking at some other models I track, I currently see no recession coming for the US economy (I’ll show these in a future post).

What about Fed policy? The Fed is expected to lower interest rates this year, not raise them. A tight Fed is not really in the cards if you ask me. So we shouldn’t expect a bear market caused by a restrictive Fed like in 2018 or 2022.

But what about the trade war? Wasn’t the 2018 bear market caused by trade uncertainty? Let’s look at the following chart. In red you can see an index that measures trade policy uncertainty. In white you can see the S&P500. The red dots show when the trade policy uncertainty index was elevated. As you can imagine, we see a lot of red dots in 2018 and the stock market had a very bad year (with a 20% decline in the last 3 months of the year). However, in 2019 we also see a lot of red dots, and the trade policy uncertainty index was actually higher than in 2018, but the stock market had a great year. How is this possible?

The reason is that Fed policy was a much more important variable for the stock market than trade policy uncertainty was. The chart below shows some important events. The day the market peaked was not when some kind of trade policy was announced. No, it was the day when Powell said “We’re a long way from neutral”, indicating that policy would become tighter. In December, there was a trade agreement between the US and China. Was this the bottom of the market? No, the market continued to decline another 8%. Later in December the Fed said that QT was on autopilot after which markets panicked. We saw a relieve rally that became a sustainable new bull market after Powell said in January 2019 that they are “always prepared to shift the stance of policy and to shift it significantly”.

Did the trade war influence the market? Without a doubt, it impacts the day to day movements in the market. But was and will it be the main driver of the stock market? Not if you ask me. We should focus on the bigger picture: what causes big bear markets and are we currently seeing those circumstances? If you as me, the answer is we aren’t seeing the fundamental elements that normally precede a much bigger decline. This means that the current correction is a buying opportunity. Can the market go lower? Absolutely. In fact, I think we’ll go a few percent lower. But I have already started buying this correction and the more we decline, the more interested I’ll become to add to my position.

Thank you very much for reading my article.
Please subscribe to my Substack and follow me on X: adaptiveinvest

After almost 4 years, gold bulls finally got the breakout they have been waiting for. Last week, gold was finally able to break out above its multi-year resistance zone.

It has been a volatile ride since the previous three attempts all failed, leading to significant declines in the price.

In March 2023, I warned that it was probably too early for a breakout, see here.

I also was not getting bullish in December 2023 because of reasons I explained in May last year, see here.

However, last month, I started to see that things were changing from both a fundamental viewpoint (see here) and from a sentiment standpoint (see here).

Of course, I didn't get every move right. Between those 'almost breakout points' I sometimes tweeted that an interest set-up could start to form on the upside or downside. Some worked, some didn't. But at the times that really mattered, when gold was looking to break out, my analysis has been spot on if you ask me.

Please note that this is not a victory lap at all. I'll be the first to admit that my view on equities has been dead wrong from a fundamental viewpoint.

But that's no shame. We are here to make money, not to predict the future.

If one of the greatest macro traders/investors ever wasn't able to predict what was going to happen, should we think about ourselves that we can?

Soros: "My financial success stands in stark contrast with my ability to forecast events.

…Even in predicting financial markets my record is less than impressive."

Is this the real breakout?

As I explained in the introduction, I think it is. Fundamentals have changed (closing in on the rate cutting cycle) and sentiment was a lot less bullish coming into this breakout. I remember the earlier fake breakouts. Everyone was talking about gold, that's not the case now. We can see it in GLD flows and futures positioning as well.

Gold is very overbought right now but this is a positive thing longer term. The table below shows that the average gain in 6 months is another 8%. However, this average gain includes the 4 periods when the gold price declined. If we exclude those, the average gain is much higher at around 17,2%.

Source: Bespoke Invest

Can we just exclude those 4 periods and how do we know we won't experience one of those negative outcomes again?

The chart below indicates the four periods when we saw a negative return after the price being extremely overbought. In 2011 and 2020, we just had seen a multi-year rise in the price and the weekly RSI was extremely overbought. Right now, the move has only just started so we can't compare these periods. In 2015, we were stil in a downward trending market. This is also different to today since we just broke out from a multi-year consolidation. In 2022, the extreme overbought level came because investors were buying in panic because of the start of the Russia-Ukraine war. Again, not comparable to today since the price is breaking out without the help of an external shock or overwhelming bullishness/panic-buying.

So, if you ask me, I don't think we'll have one of those negative outcomes.

This breakout is the real deal. Price, fundamentals and sentiment are confirming it.

What's next?

What will happen next? Will the price continue its steep rise from the last two weeks without looking back? Will we see a consolidation first or maybe a retest from the breakout?

Let's start with the big picture by looking at a weekly chart. (Please don't give too much attention to all the horizontal support/resistance levels, some may indicate daily levels, other weekly levels, just focus on the top line which shows the weekly resistance zone.)

We see a very strong breakout candle in combination with a weekly RSI around the 70 level. If you look back at 2019, just when gold broke out from its base that formed between 2013 and 2019, the RSI was at a similar level. The breakout just started and continued for several months. So, on the weekly timeframe the breakout is confirmed and there is a lot of room to run higher.

Let's now look at the daily timeframe. The RSI is very overbought. In fact, it's just as overbought as it was after the initial rally after the 2019 breakout. In 2019 we saw a 6,4% rise from the breakout level. Right now, we saw a 5,6% rise. So, the price action is rather similar. (You can see the percentage gains from the breakout level in 2019 and right now indicated in green on the chart below.)

What followed in 2019 was a 4 to 5 week consolidation where the price declined 2,8% from its highest closing price from that initial move after the breakout. If the same would happen today (assuming Friday's close is the highest closing price in this initial move higher), gold could correct to around 2117 USD.

But, and this is very important, the extreme overbought RSI was a sign of strength, not one that should give you the idea you need to sell. Because what happened next is that gold regained its small loss from the consolidation and then rose an additional 9%. If the same happens today, this would bring us eventually (after the consolidation) to 2374 USD.

The next chart shows the other periods when gold reached a similar overbought level as now during the 2019-2020 bull market. In early 2020 we saw another consolidation where the price declined 2,3%. Again, the overbought level wasn't a sign to exit, it just was a signal that gains needed to be digested by the market. Afterwards, the gold price continued its journey higher. In the summer of 2020, after the breakout above the 2011 high, the overbought level didn't matter until it did. It eventually market the top of the bull run but not before the price rose another 6%.

But there is one very big difference between the cases analyzed above and the current situation. We are currently seeing a breakout above all-time highs after a multi-year consolidation. The cases above took place when gold was still trading below its previous all-time highs of 2011. This is an important difference. There are no natural resistance levels anymore right now, there were in 2019-2020.

So maybe it could be interesting to look at the breakout that took place in 2009. This breakout was, just as now, a breakout to new all-time highs after a lengthy consolidation. In 2009, the initial rise from the breakout was almost 19%. Compare this to the current rise of 5,6%. If we would see something similar happen today, the gold price would rise to 2410 USD before a correction starts.

How likely is it this will happen? First we must note that the price is now already just as overbought (on a daily timeframe) as it was in 2009 after the initial rally. This despite the current rally being much smaller. However, if we look at the weekly timeframe, the RSI stood at 80 in 2009 whereas it just stands at 70 today.

Looking at some of the other times when the daily RSI was just as overbought as it is right now, we can see the following.

In 2016, after the initial rise from its December 2015 bottom, gold got very overbought. What followed was a multi-month consolidation whereafter new highs followed. The maximum decline was 3,85%.

In 2010 and 2011, when gold reached similar overbought readings, the price corrected 4 to 6%. In late 2009 however, gold declined more than 13%. But this was after the very strong initial rally after the breakout we discussed earlier. The weekly RSI was much more overbought than it was now.

So, the weight of the evidence suggest to me that a consolidation with a max drawdown of around 3% seems to be expected. After that, the gold price will move significantly higher. The more negative cases we saw are not comparable to today because the moves that preceded them are not comparable to now or because they happened in a different part of the cycle.

Are we sure there will be a consolidation/correction?

No. And the reason can be found in the breakout that took place at the end of 2002. After a consolidation of 3 years, gold was finally able to break out of its base. The initial rally was around 16%. The daily RSI got just as overbought as now but only a 2% intraday correction took place. There was no multi-week consolidation, just a one day correction. At the peak of the move, the weekly RSI reached 80, much higher than where it is today. If the same happens again, this would bring us to around 2400 USD.

This case looks similar to the 2009 breakout we discussed earlier. The initial price gains after the breakout are much higher than now. Prices both peaked when the weekly RSI was at around 80. In 2009 the daily RSI stood at the same level as it is right now when the price peaked. However, and this is a difference, in 2002 the price kept rising when it stood at the daily RSI it is now.

Conclusion

So, where does that leave us?

I think there are two possibilities:

1. We are close to a local high in gold. From that high, we'll see a multi-week consolidation where the price correction will be limited (around 3%). After this consolidation, gold can continue its rise higher.

2. The price continues its steep rise just like in 2002 and 2009. This could bring us to a price target of 2400 USD without a consolidation or meaningful correction. Important to note with this scenario is that in both cases, gold saw a severe retest from the breakout level after the rally was done. This means that once we are at 2400 USD, we should expect the price to decline again to around 2060 USD, a correction of around 14%. After this steep correction gold can continue its rise higher.

So, which one of these two will it be? I don't know. But now that we have a view about the most probable outcomes, we can see how we should trade around these.

If scenario one unfolds there is nothing for me to do. I've got a (leveraged) position in gold. I'll just sit through the consolidation with the possibility to increase my exposure as the consolidation takes hold.

If scenario two unfolds there is currently nothing for me to do. But there will be a lot to do when the price reaches its target of around 2400 USD. At that point I'll sell the entire position with the idea of getting back in at significantly lower prices.

If scenario one unfolds and we eventually reach 2400 USD (after the consolidation), I don't expect the price to fall all the way back to the breakout level.

So, gold has two options. Either it moves sharply higher right now after which we'll see a very sharp retest. Or we take the more orderly route by having a consolidation now after which the price can rise again.

If you would have read independent investment research in the beginning of the year, the general consensus was that the first half of the year would continue to be rather difficult for the market after which a better second half would follow.

Consensus was wrong and the first half of the year has shown strong market returns.

In this article I would like to continue to explain my strategic framework for the equity market. Please note that these are no tactical views but they are a framework to invest through a complete market cycle.

I don't think we've seen the lows in this market cycle but this doesn't mean I'm always bearish. I update my tactical views on twitter. I haven't been long or short this market since the beginning of the year for the simple reason that I don't like to trade against my core strategic fundamental view. I'm big picture still bearish so I'll go short the market but won't go long on bear market rallies. I'll go long when I think we've seen a sustainable market bottom and the beginning of a new bull market. So this year, I've been sitting on the sidelines.

With the technology sector being up more than 35% since its low at the end of last year, the question to ask is if my big picture bearish view is wrong or not.

Please note that several technical indicators signaled buying opportunities throughout the year. 2023 offered some great opportunities if you invested in the right sectors. However, the analysis in this article is about the framework I use to analyse a complete market cycle and therefore I won't discuss any tactical tools or views.

Stages of a market cycle

The chart below shows the average evolution of a bear market.

First, inflation starts to increase (red line) and the Federal Reserve reacts to this by increasing short-term interest rates (grey line). Long-term interest (dark blue line) rates started to rise before the pick up in inflation and continue to do so during the Fed hiking cycle.

This rise in the discount rate puts pressure on valuations and the stock market (purple line) declines. (Please note that the market can perfectly rise during Fed rate hikes when the economy is strong and earnings are rising, I showed this here.)

When the Fed rate hikes start to have an impact on the economy and on earnings, we see that earnings start to decline (light blue line) and the stock market (purple line) also continues to decline.

Note how the stock market (purple line) bottoms way before earnings (light blue line) do.

Chart 1
Source: Jurrien Timmer, Fidelity

The first part of this story is what we saw during the first 6 to 9 months of 2022. The stock market declined because the discount rate rose sharply and valuations declined. This while earnings remained strong. (You can see this on the chart below: the stock market declined and this was caused by lower valuations, the grey line, even though earnings, the green line, remained strong.)

Chart 2
Source: Michael Kantrowitz, Piper Sandler

Since the market bottomed in October of last year, we see that the driving force behind the rally has been rising valuations (grey line on the chart above) because earnings (green line on the chart above) have been declining.

Before we continue to analyze the two charts above, I would like to talk about earnings. As we saw on the first chart, the market bottoms well before earnings do. The chart below shows that historically this time gap is about 3 to 6 months.

Chart 3
Source: Warren Pies, 3Fourteen Research

So if October 2022 was the market low, we should have seen the bottom in earnings for this cycle.

There is however one problem with this, I don't think we have. I've shown you my own leading indicator on earnings before and it's not looking good. Below I share two other models that are showing the same negative outlook as my own models are.

Chart 4
Source: Beowulf's Treasury

Chart 5
Source: Morgan Stanley

So if earnings haven't bottomed, chances are very low that October 2022 was the ultimate market low.

It's interesting to note that some independent investment research providers are bullish on the market even though they think earnings will continue to decline. On the face of it this doesn't need to be so strange because the market frontruns these earnings. If you look at the performance of the stock market over the period of 1 year, valuations have a much bigger impact than earnings do on its performance.

Their reasoning goes as follows: interest rates will decline and therefore valuations will increase and so will the market despite lower earnings. I've shown in detail before (see here) why this line of thought is wrong. In short, valuations are driven by anything that alters the perception of financial and/or economic risk. If interest rates decline but credit spreads rise, valuations decline.

The chart below shows this. The highlighted areas are periods when interest rates and valuations both declined together because the perception of risk, credit spreads, increased.

Chart 6
Source: Michael Kantrowitz, Piper Sandler

You can see this on the first chart from Fidelity as well. The stock market (purple line) doesn't necessarily bottom when interest rates peak (grey and dark blue line). The market continues to decline because the green line, which represents the interest rate on BAA-rated bonds, starts to increase when the yield on government bonds stabilizes/declines, thereby leading to a rise in credit spreads. This rise in credit spreads shows a higher perception of risk by investors and thus leads to lower equity valuations.

If you now look back at the second chart in this report, you can see the same process in action again. The higher valuations (grey line) since the bottom in October last year were accompanied by lower credit spreads.

Is the risk priced in?

The chart below from Bridgewater shows a similar decomposition of the drivers of a bear market as the first chart did. Here they focus on inflationary bear markets in particular. We see the same pattern that we discussed earlier. First the discount rate rises which puts pressure on the stock market (effect shown by red line). Cash flows only start to struggle later on when the rate hikes start to impact the economy. The negative impact of these declining cash flows (represented by the blue line) only ends well after the stock market bottoms. The green line is the line I want to focus on. It shows that the final push lower in the stock market is caused by a rise in risk premiums. This is exactly the same thing that the first chart from Fidelity showed by the rise in credit spreads.

Chart 7
Source: Bridgewater

We'll now focus on two risk premiums. Credit spreads and the equity risk premium (ERP).

I've shown before in detail why I don't think credit spreads can decline sustainably as long as the economy is weakening. You can read about it here. (Of course credit spreads have declined the last few months causing valuations to rise but this is a tactical move. I'm interested in knowing whether or not we've seen the absolute peak in credit spreads or not for this whole cycle. If I know this, I know whether or not a sustainable new bull market has begun.)

Next I want to show some other reasons why I think credit spreads are too low.

The chart below shows that banks have been tightening lending standards (dark line) quite hard. A tightening of this magnitude has historically always led to a recession (grey areas). Because there has been a lot of talk about soft and hard landings, a lot of people seem to think that a recession is priced in. This is wrong. As the chart below shows, credit spreads normally move together with these lending standards. This is because there is a high correlation between lending standards and corporate default rates. A decline in the availability of credit leads to more defaults and higher credit spreads. We've seen the banks tightening their willingness to make loans but credit spreads haven't reacted to this yet. It's only a matter om time before they will. To me this is a very clear indication that recession risk is not priced into the market.

Chart 8
Source: Ian Harnett, Absolute Strategy Research

The following chart shows credit spreads together with a model that estimates the correct level based on several inputs. Historically there is a very close fit between the model and actual credit spreads. Again, according to this model, credit spreads are too low.

Chart 9
Source: Simplify Asset Management, shared by Tier1 Alpha

There also seems to be this idea with investors that contained credit spreads show that risks are contained. This is wrong. Warren Pies from 3Fourteen Research notes the following: "In general, credit spreads do not blow out until there is equity market stress. Much more reactive than predictive...Credit spreads rarely offer an advanced signal."

The chart below shows this. The horizontal axis shows 3 month equity returns. The vertical axis shows the 3 month change in credit spreads. In the top left panel you have rising credit spreads and a declining stock market. This is just as expected but the interesting thing to note is that the relationship is not linear. Just as Warren Pies noted, credit spreads are more reactive than predictive.

Chart 10
Source: Warren Pies, 3Fourteen Research

Next, we'll have a look at the equity risk premium (ERP). The ERP is the excess return earned by an investor when they invest in the stock market over a risk-free rate.

Looking at valuations in isolation, some analysts state that equities currently offer good value. While this might be true, the problem is that you can't look at valuations in isolation. With 10-year US government bonds currently yielding 3,8%, the alternative to equities has become much more interesting than before. It's not possible to compare the current S&P500 forward PE ratio of 18 to periods in 2017 or 2019 when the valuation was similar because interest rates were way lower back then. It's also not possible to compare the current 'low' valuation to those seemingly high valuations of 2021 because again, interest rates were way lower back then. To correct for this, we can use the ERP because this measure is an estimate of the excess return you get from investing in stocks over bonds.

The chart below shows an estimate of the ERP. It uses a combination of several models to arrive at a single estimate. Since there is no way to get an exact measure of the ERP, it's not the exact level that is of interest to me but its movement.

Normally when you have a recession, there is an increase in the ERP. Investors are afraid and they demand a higher return on equities over the risk-free rate to compensate for the increased risk. You can see this on the chart by the sharp increase in the ERP around the shaded grey areas which indicate a recession. All bear market bottoms are also accompanied by a sharp increase in the ERP. Markets bottom when equities become interesting again compared to its alternative, bonds. Over the last few months we have seen a decrease in the ERP. This shows that equities are not as cheap as a look at valuations would indicate. It also shows that a recession isn't being priced in at all by the equity market. As Michael Arnett from Absolute Strategy Research notes: "This chart of the US Equity Risk Premium shows that there is almost zero probability of recession priced into US markets. ERPs RISE in recessions - the last six months have seen the ERP FALLING on a consistent basis. Investors are betting on recovery, not recession…"

(Please note that a low ERP isn't necessarily bad for forward stock returns. There was a low ERP during most of the 1980's and the 1990's but stock returns were great. That's why I primarily focus on the movement of the ERP in relationship to the economic environment that I'm seeing/expecting.)

Chart 11
Source: Ian Harnett, Absolute Strategy Research

Not only the movement in the ERP is interesting to analyze, it's also interesting to compare the ERP to where fundamentals indicate it should be in theory. The chart below from Nordea does exactly that. In red we can see a measure of the ERP. In blue we have a fundamental model that shows where the ERP should be based on several economic inputs. As you can see, the fit is very close historically. Over the last few months however the ERP has been declining whereas fundamentals indicate that it should be rising. If the model is right, it implies that valuations are currently way too high.

It's not the first time there has been a divergence between the ERP and the model. We saw the same thing during the 1998 LTCM stock market decline. The market declined around 20% and the ERP rose. The model indicated there were no fundamental problems and thus a divergence between the model and ERP developed. In the end the model was right and the ERP declined sharply again thereby creating a rising stock market.

We saw another divergence just before the Great Financial Crisis. The ERP was declining but the model was rising. Again, the model was right and what followed was a big decline in the stock market. We have a similar setup today.

Chart 12
Source: Mikael Sarwe, Nordea

What is the economy telling us?

Investors are talking about soft and hard landings, about future economic weakness being priced in, about a Fed pivot being bullish for the market,..

A lot of these basic ideas are wrong.

A Fed pivot is only bullish for the market when there is a soft landing. When we have a hard landing (economic recession), a Fed pivot is not bullish for the market. (I showed this in detail here.)

Most of the talk about soft and hard landings is also not helpful because most people don't seem to know that there is a very clear relationship between how markets behave around both type of landings. The interaction between monetary policy, the economy and asset markets is crucial and has repeated itself throughout history. I showed this in detail here.

One of the elements that differentiates a soft landing from a hard landing is the way the unemployment rates behaves. Simply put, a hard landing is when the Fed raises interest rates, the economy weakens, and the unemployment rate starts to rise thereby creating a recession. A soft landing is when the Fed raises interest rates, the economy weakens, but the unemployment rate continues to decline. The way asset markets behaves once the Fed stops raising interest rates is completely different.

I've shown before in detail why I think that we'll see a hard landing and why leading indicators are showing an increase in the unemployment rate is coming (see here and here).

Some might argue that a rise in the unemployment rate is a general consensus view. If it happens, it won't matter for the stock market because it's expected. In my opinion, this is wrong. History clearly shows that when there is a hard landing and the unemployment rate rises, the market never bottoms before the rise.

The vertical lines on the chart below indicate stock market bottoms around hard landings. As you can see, they always took place during the rising phase of the unemployment rate. Why would this time be different? I also added initial unemployment claims (inverted on this chart) which are a leading indicator of the unemployment rate. Once initial unemployment claims start to rise (on this chart it means that the blue line is declining since they are inverted) around hard landings (the black lines), the stock market declines with them.

This clearly shows that the market doesn't price these kind of things in.

Chart 13

The following chart supports this. On the left we see the evolution of the unemployment rate from its lows. A recession starts once it rises by 0,5% from its lows. The right part shows what happens to the stock market once this happens. As you can see, the market didn't price this in and it declines to its final low.

As Variant Perception concludes: "The final crash in a recession starts when the unemployment rate picks up 0,5% off the lows. This is the most obvious confirmation that recession has started."

Chart 14
Source: Variant Perception

So what does the market price in?

The stock market prices in a lot of things. However, just assuming that everything you can think about is being priced in is wrong. The market is much more reactive than you think. The stock market is viewed as a leading indicator. That is why it's very closely correlated with leading economic indicators like the ISM PMI. It's also why all stock market bottoms that went together with a hard landing took place when the ISM PMI bottomed. I showed this in detail in a previous article. If you look back at chart 1 from this article, you'll see this once again. The market (purple line) bottomed way before earnings (light blue line) but it bottomed together with the ISM PMI. Why? Because both are leading indicators.

When will I be wrong?

This is perhaps the most important question to answer. Below are the three most important elements that can make my conclusion wrong:

1) There are several leading indicators on the PMI's that are showing we've reached the bottom. You can see 4 of them in the chart below. If these indicators are correct, and given the interplay between PMI's and the stock market, chances are high I'll be wrong.

One thing I would like to note is that most of these indicators have a lead time of 1 to 9 months. If I look at indicators with a longer lead time of about 18 months (as shown in previous articles), I don't see signs of a bottom. Time will tell if the shorter term models will prove correct or if they will turn down again.

Chart 15
Source: GMI (top-left), Steno Research (top-right), Clocktower Group/Marko Papic (bottom-left), Deutsche Bank (bottom-right)

2) The biggest mistake I've made is underestimating the strength of the labor market. (In a future article I will investigate how we can improve the timing of a softening labor market.) Historically, the labor market dictates if we have a soft or hard landing and it also helps us to interpret what the market has priced in and what not. If the unemployment rate remains low, my thesis will be wrong. However, all leading indicators are indicating the unemployment rate will rise. Some might argue that the current situation in the labor market is completely different or that the markets will react differently. Comparisons to the period after World War II are made but even then, the unemployment rate rose when their was a recession and even then, the interaction between monetary policy, the economy and the stock market was the same as in all the decades that followed: the market always bottomed in the rising part of the unemployment rate. The market rally we saw in 2023 was not abnormal. Early this year, the market was already pricing in several rate cuts for 2024. With an unemployment rate that remained low and the market expecting a Fed pivot, a relief rally followed. This has been a rather consistent pattern throughout history. I'll show this in more detail in a future article. So it's not that the framework didn't work, it's that I thought we were in a different part of the framework. Stated differently, I didn't expect the unemployment rate would stay this low for this long.

Some final thoughts

In a previous article, I wrote about how people expecting a soft or hard landing wasn't really helpful in predicting what actually would happen. Last year for example, we saw a lot of people talking about a soft landing but there were also a lot of people talking about a hard landing. You can see this in the chart below. The orange line indicates the number of stories talking about a recession, the white line shows the same but now for a soft landing. In Q3 last year, both the white and orange line were spiking together. As I said in the previous article, you could have made a contrarian case for both last year. What's more interesting however is the sequencing between both lines. What we can see is that talk about a soft landing (white line) starts to rise sharply when we approach the end of a Fed rate hiking cycle. This optimism recedes afterwards and talk about a recession comes back. Simply stated, in every hard landing we've seen, people were expecting a soft landing when economic data seemed robust. At times when the leading indicators were indicating a recession, this optimism was proven wrong and a recession arrived. Will this time be different?

Chart 16
Source: Michael Kantrowitz, Bloomberg

Another final point I want to touch on is the yield curve. We saw an inversion in the 10Y3M yield curve in late October, early November last year. Generally speaking, this is considered by a lot of people as a recessionary signal. (Please not that in a lot of countries outside the US, it doesn't have such a good track record at predicting recession.) We're +-10 months later and people are wondering where the recession is and why the stock market is up so much. As the chart below shows, there is actually nothing strange about the current price action. The chart shows the evolution in the stock market after several yield curve inversions. As we can see, in a lot of cases, the market has a significant rise after inversion. However, the one important thing to notice is that the market never bottoms before the inversion takes place. If October 2022 was the low, this would be very abnormal.

Chart 17
Source: Cheng-Wei Chin (@ChengWeiChin1)

And this brings us to a general point I want to make. Indicating a market bottom in real time is very difficult. We know that it happens at a time when nothing looks good and that a lot of fundamentals will bottom several months later. However, if we look at where fundamentals stand 6 to 9 months after a stock market bottom, things are very consistent. So this means that if October 2022 was the low for this cycle, we can look at the current market and economic fundamentals and compare them to those that were present 6 to 9 months after market bottoms. If we do that things look very strange. Normally, when there is a hard landing, markets bottom:

-after the Fed started cutting rates (not this time, the Fed is still hiking)

-after yield curve inversion (not this time, the market bottomed before yield curve inversion)

-when earnings bottom a few months later (not this time, expectations of earnings are rising but leading indicators are indicating further weakness)

-and are followed by a very strong initial rally (not this time, we've seen a very strong rally in the technology sector but if we compare the current rally in the s&p to those after bear market bottoms, the current rally is very weak)

-during the rising part of the unemployment rate (not this time, the market bottomed with the unemployment rate being at a multi-decade low)

-when leading economic indicators like the PMI bottom (could be the case this time if the shorter-term models are correct)

Thank you very much for reading my article.

If you want, you can follow me on twitter: click here.

Let's talk about gold.

In the middle of January, I warned that a correction was getting close, see here.

A correction came indeed and I highlighted an interesting risk/reward point to re-enter the trade in the mining shares, see here.

This level was breached two weeks ago, providing an excellent entry point. (see here)

I didn't expect this level to be breached this fast but price action is king.

The violent move up in gold started two weeks ago. I was more cautious and didn't expect this move higher.

After the violent move higher, I saw some potential warning signals last week, see here.

In this article I want to discuss two things:

1) The potential danger for gold if this move higher was because of an excessive reaction to banking fears.

2) The behavior of gold around all-time highs.

Gold - interest rates - banking fears.

After gold peaked in 2011 and saw a multi-year bear market, the gold market really took off at the end of the previous rate hiking cycle at the end of 2018. (We saw a mini bull run in 2016 but this was part of the bigger basing process.)

Interest rates peaked (black line on the chart below) and gold rose from 1200 USD to 2000 USD. When interest rates bottomed in the middle of 2020, gold started a long bear market/consolidation.

In my opinion, we saw the peak in long-term interest rates in October last year. This tightening might also be over or in any case, I think it's clear to everyone that we are very close to the end.

This is why gold has been behaving so well. I'm very bullish on gold for the next 18 months.

However, I'm not so sure if I'm bullish for the next few weeks.

From the beginning of March until now, the 10 year yield declined very rapidly from 4,06% to 3,4%. The worry I have is that this move was possibly caused by speculators being record short bond futures (see here). Once the problems in the banking sector became apparent, these positions got caught off guard and that's why interest rates declined so violently. It's also why gold rose so fast.

Panic buying is never a good idea. I remember last year when Russia invaded Ukraine and gold shot to higher to 2050 USD. Back then, just as now, people were calling for a breakout above all-time highs and the beginning of a new bull market.

We know they were completely wrong last year.

I think they'll be right this year (on an 18 month timeframe) but I'm not convinced that today is the moment to become extremely bullish on gold.

If we look at the 10 year yield on a weekly timeframe, we can see that it's back to a very significant support level.

The daily chart also shows the significance of this level. This past week generated two reversal candles right on this support level. If this level breaks, the bull market in gold is really back. If interest rates move higher, expect a correction in gold.

To be clear, given my bearish view on the US economy, I'm expecting this level on interest rates to fail in 2023 (see here). As stated earlier, I therefore also think gold will break above all-time highs.

But what if the decline in interest rates is indeed excessive and what if these reversal candles on the 10 year yield show that it's too early to expect a breakdown in yields?

Buying bonds or gold is never a good idea when the move higher is caused by panic buying (being it a banking panic or the start of a war).

What can cause interest rates to go higher in the coming weeks? Consider the two points below:

1) The realization that not every bank is at risk of collapsing and that Deutsche Bank is not necessarily the next Credit Suisse (see for example here, here, and here). If panic subdues, interest rates can go higher again. (Given my bearish view on the economy, I think credit problems will continue to become more prevalent as we continue throughout the year. However, the question is if sentiment is too bearish or not on this credit risk right now.)

2) The realization by the market that it's being too aggressive pricing in rate cuts. I think there is a window of opportunity for inflation to surprise to the upside again as the following chart by Francois Trahan shows. (Please note that these are tactical opinions to optimize my entry points. Big picture, I'm bullish gold for the next 18 months.)

Source: Trahan Macro Research

The combination of these two elements can cause a move higher in interest rates from the current support level, thereby putting pressure on the gold price.

I might be completely wrong on this but looking at the panic buying in call options for gold, I think it's important not to blindly buy because other people are panicking and screaming new highs are imminent.

Source: FT, Bloomberg

Gold price action around all-time highs.

Gold has reached new all-time highs in both the Euro and GBP. Lot's of people are saying this is a sign of new all-time highs coming for gold in USD as well. I agree with this.

However, history shows that it can take some time for gold in USD to follow the price action in the Euro and GBP.

The following chart shows gold in the three different currencies. The red vertical lines show when gold peaks. As you can see, in 2008, 2011 and 2020, gold peaked in all three currencies simultaneously.

The vertical green lines show when gold breaches out of its resistance zone and reaches new all-time highs in the different currencies. It's interesting to note that there can be quite a big time gap between this happening in the Euro/GBP and the USD.

So yes, I think gold will reach new all-time highs in the USD. But, I wouldn't take the price action in the Euro and GBP to rationalize that this move is imminent.

Another important point I would like to make is the historical price action of gold when it's preparing to break out above all-time highs.

The chart below shows the 1978 breakout in gold above its 1974 all-time high.

As you can see, the price consolidated a few weeks right below the breakout level before actually making the move higher (last blue arrow).

In 2007, gold moved above its 1980 all-time high. Again we see a consolidation of multiple weeks (black arrow) below the breakout level before the actual breakout took place.

In 2009, when breaking above its 2008 all-time high, there was again a consolidation of multiple weeks (last black arrow) right below the resistance level.

And if we look at the breakout in 2020 above the 2011 all-time highs, once again we see something similar. Price consolidated for multiple weeks before making its move.

When we look at the current situation below, we can see that the gold price is getting very close to breaking above its former all-time high resistance level. Will it just blast through this level without any problem? History suggests that a multi-week consolidation wouldn't be abnormal before the actual breakout takes place.

When looking at the breakout above the 2013-2018 basing pattern, we can see that gold consolidated multiple weeks before breaking out. This despite interest rates declining during this consolidation.

Looking at the breakout above the 1560 level, we can also see that a multi-week consolidation took place while interest rates rose.

Taking everything together, it wouldn't surprise me to see gold consolidating around these levels before making its big move higher.
Admittedly, the potential resistance zone is rather big (1980-2066USD).
It will therefore be less clear when the actual breakout took place. In previous breakouts above all-time highs, this level was more clear.
I must also admit that my view on bonds can be completely wrong (like every view I have for that matter). I'm looking for potential higher interest rates for the next few weeks. For the next few months however, I'm a bond bull so if yields break down, I'll need to act.
I'll let me guide by the price action, as Jesse Livermore noted: “Markets are never wrong - opinions often are.”

1) The concept of a hard vs. soft landing.

2) Is everything priced in?

But first, let’s have a quick look at the market action and perceptions over the last 3-4 months.

Introduction

After a difficult 2022, markets bottomed in the middle of October.

The S&P500 rose almost 17% until early February.

S&P Midcap Value stocks rose more than 35% and reached new all-time highs. (something you wouldn’t expect if the bear market was still intact)

KWEB (China Internet ETF) almost rose 100% in 3 months time.

This rally in risk assets was caused by a sharp decline in the US dollar (-12%) and a decline in interest rates (US 10 year yield declined from 4,2% to 3,37%).

Another element supporting this strong rally was the perception of investors. In Q4 last year, pessimism was high and there was a large consensus among economists that a recession was coming (see chart below). Surely, if everyone agrees and knows a recession is coming, it’s probably all priced in. (I disagree with this statement as I’ll explain in this article.) The China reopening and the sharp rise in its credit impulse propelled the hopes of a soft landing and the risk rally took off.

Since I became structurally bearish in January 2022 on risk asset (see here) and since you haven’t seen me write a bullish article since, you probably think I disagree with the above ideas. This is correct. In this article I’ll explain why. (Please note that this article lays out my strategic views. I’ve switched from bearish to bullish from a trading perspective a few times since the start of 2022.)

The concept of a hard vs. soft landing.

We’ve heard a lot of discussion last year about soft and hard landings. Recently, commentators started to debate a third possibility called ‘no landing’. A soft landing means that the Fed hikes interest rates and the economy and inflation slows without the Fed causing a recession. A hard landing means the Fed overdoes it and causes a recession. The ‘no landing’ seems to mean that the Fed hikes interest rates but the economy stays strong and there is no real softening in the economic data. Some recent strong economic figures caused the appearance of the ‘no landing’ idea.

I disagree with this ‘no landing’ idea. In fact, I think that a lot of commentators don’t even fully comprehend the hard vs. soft landing debate. In this article, I’ll show you a simple framework between the economy and markets that works very well. There seems to be this idea that markets front run the economy and even if the economy gets worse, given the fact that the stock market already declined significantly, it’s probably all priced in. Markets bottom before the economy and earnings, right?

This idea is right from a very high level view but in my opinion it’s too simplistic to use as an active investor.

There is actually a very interesting historical relationship between monetary policy, the economy and asset markets. The sequencing between different moves in these 3 factors is crucial and has repeated itself throughout history. And the hard vs soft landing debate is crucial in understanding how it works.

Once you see the interactions at work between these three elements, you’ll never have to wonder again where we are in the market cycle and whether or not it’s time to take risk or not. The sequencing of events also helps to show what’s being priced in by the market and what’s not.

I perform this historical analysis with the purpose of knowing where we stand today in the market cycle.

Let’s first look at the theory, afterwards I’ll prove it with data.

So, what is a soft landing and what is a hard landing?

Let’s look at the first two factors: monetary policy and the economy.

The chart below shows a graphical overview of the types of landings.

A hard landing occurs when the Fed is hiking rates and at the same time we see one (or multiple) of the following elements: an inflation shock, a rising unemployment rate, tightening lending standards. (Shoutout to Michael Kantrowitz from Piper Sandler who has been explaining this publicly for a long time.)

Please note that the unemployment rate doesn’t necessarily need to be rising during the rate hiking cycle. It’s however important whether or not it starts to rise afterwards. By using some leading indicators (more on this later) we can have an informed view about this.

A soft landing occurs when the Fed is hiking rates but none of the above happens.

Let’s now introduce the third factor: the behavior of asset markets around these landings.

The chart below gives an overview of the market behavior around the two types of landings. I also added all historical bear market bottoms of the last 60 years to show you how all of them fit into this framework. (The dates itself mark when the Fed stopped raising interest during the cycle in question.)

Stock market behavior around soft landing: The stock market bottoms as soon as the Fed stops raising interest rates (I call this a Fed pivot I, Fed pivot II is when the Fed starts cutting).

Stock market behavior around hard landing: Here there is a distinction to make. If the economy is in or very close to a recession, the stock market will keep declining even when the Fed stops raising rates and even when it’s cutting rates.

If a recession is still some time away, the stock market will rise when the Fed stops raising rates but will eventually decline again sharply.

So, this is the theory, let me now show you that this is actually how it historically played out.

We’ll discuss the four elements (from the ‘defining elements’ column above) below. After the historical analysis, I’ll explain what it means for the current cycle we are in.

1) Fed rate hiking cycle and market behavior

We start with the market behavior around a Fed pivot I. So we are looking at the market forecasting part in the chart overview above. First I need to prove that when there is a soft landing, a Fed pivot I is indeed sufficient to create a new bull market in stocks.

The following charts show the S&P500 on top. The orange areas indicate a recession. The bottom panel show the Fed funds rate. The vertical green lines indicate a Fed pivot I after which the stock market enters a new bull market. The vertical red lines indicate a Fed pivot I after which the stock market continues to decline (or will eventually decline significantly when a recession is not imminent).

As you can see, all the green lines, when a Fed pivot I is bullish for stocks, were not followed by a recession (no orange area follows the green lines). So when there is no recession and we have thus a soft landing, a Fed pivot is the trigger to get bullish on the stock market.

We can also clearly see that all the red lines are followed by a recession and that a Fed pivot I was not bullish for the stock market. When a recession is not imminent (1989 and 2006) we see a rally (of around 20%) in the market which eventually turns into a bear market as soon as recession hits. In the following part I’ll explain how to spot the difference between a recession being close or not.

2) Rising unemployment rate

So we now know that there is a big difference in market action around a soft and hard landing. In a soft landing a Fed pivot I is bullish, in a hard landing not.

But how do we know if we’ll have a soft or hard landing? That’s what the following three elements are about.

The chart below takes the chart from above but now adds the unemployment rate. You can clearly see that after the vertical green lines when we have a soft landing, the unemployment rate continues to decline. After every red vertical line, the hard landings, the unemployment rate starts to rise.

But how do we know if the unemployment rate will rise? I explained this in detail in my previous article (see here).

Below you see one of the charts I showed in that article. In orange you can see the US unemployment rate. In blue you have a breadth model. A large spike in the breadth model has historically always led to a big increase in the unemployment rate. Look at 1984, 1995 and 2018 on the chart below. These were all soft landings and never was there a warning signal from the breadth model. This time however, the model is indicating that the unemployment rate will rise considerably. The housing market, another great leading indicator for the unemployment rate is indicating the same (please see my previous article for charts).

We can also use this breadth model to differentiate between the two hard landings (one were recession is imminent and one where it is not). This helps us to know if there will be a significant stock market rally before the bear starts or not. As we already know, 1989 and 2006 are the two historical examples when we had a recession but the market first had a big rally before the started to decline.

Please have a look at the chart below. In green it indicates the moment when the Fed stopped raising interest rates for these two market cycles (1989 and 2006). In red I indicated when the stock market peaked. When the Fed stopped hiking, the breadth model was still very low and was not indicating any risk. The time between the green and red arrow provided a window of opportunity for the stock market to rally. However, eventually the breadth model gave a warning signal and a bear market started.

If we look at the model right now, we can clearly see that a warning signal has been given.

3) Inflation shock

The next element to differentiate between a hard and soft landing is whether or not the economy encounters an inflation shock. The chart below shows in blue when we are in a rate hiking cycle. The orange line is a representation of inflation shocks. When the inflation shock gets too big (and the orange line turns red), this has a negative impact on the economy and thus raises the possibility of a hard landing significantly.

When the blue line is rising (the Fed is thus raising interest rates) but the orange line is not rising too much (not becoming red, no inflation shock), we have a soft landing. We can see this in 1966, 1984, 1995 and 2018. I indicated these periods with a green circle.

When you have both the Fed raising rates and an inflation shock (rising blue and orange line, the orange line turns red indicating the significance of the inflation shock), you get a hard landing. These periods are indicated with red circles.

It’s also possible to have a hard landing without a significant inflation shock (indicated by orange circle). Please note that during these periods the unemployment rate rose and the unemployment breadth model gave clear warning signals.

If we look at the situation of today, it’s rather clear we have a significant inflation shock. This implies we’ll see a hard landing.

(Chart inspired by the work of Michael Kantrowitz from Piper Sandler.)

4) Tightening lending standards

Finally we can have a look at lending standards to differentiate between hard and soft landings. As you can see below, every soft landing was accompanied by easy lending standards. Every hard landing was accompanied by tight lending standards. Looking at the picture below, it’s quite clear we’re heading to a hard landing.

Source: Piper Sandler, Michael Kantrowitz

Now that we’ve had a look at the four elements, let’s put them all together to see what it means for the current market cycle.

The table below shows an overview of the elements discussed above for each cycle. If the box is colored orange, the element in question was present during the cycle in question. If the box is green, it’s not.

As we can see, a soft landing was only accompanied by a rate hiking cycle, that’s why in the last column the colored green (with ¼ points given because only 1 element was triggered).

The hard landings or recessions were always accompanied by 3 or 4 of the elements discussed.

Currently we 4 of the 4 elements that are giving a warning signal. In my opinion, a hard landing is guaranteed.

Is everything priced in?

In the beginning of this article I shared a chart that shows the general consensus among economists that we’ll see an economic recession.

If you’re a contrarian you can see this as a signal that we’ll have a soft economic landing.

Or even if we do have an economic recession, it won’t be a surprise and therefore it’s priced into asset markets and you can become bullish. (As I said earlier, I don’t agree with this line of thought. I’ll explain why later.)

However, if you are a contrarian and you want to make the case we’ll have a recession, you could use the following chart.

Source: Trahan Macro Research

The chart shows that the idea of a soft landing is being heavily discussed in the financial media. If everyone thinks we’ll have a soft landing, maybe we won’t.

The general conclusion to make from these two charts (consensus of economists on a hard landing and heavy discussion in the media on soft landing) is that they don’t matter. In 2000 and 2007 when there was a lot of talk about a soft landing, we saw a recession. And if you look at the chart of the economists you see that indeed sometimes when they are worried nothing happens (1984, 2018) but sometimes they are worried and they are right (1974, 2008).

The framework I outlined above is much more robust than just thinking everything is priced in because something seems to be consensus.

We already saw that market action around soft landings is very consistent. The next thing to analyze is the market action around hard landings.

In a soft landing, stocks bottom when the Fed pivots, each and every time.

In a hard landing, this is different.

The vertical lines in the following chart indicate all bear market bottoms. The green lines are soft landings and the black lines are hard landings.

The circles in the bottom panel indicate when the Fed pivots and stops raising interest rates. The green circles are soft landings, the red circles are hard landings. As you can see, the stock market bottom for soft landings (green lines) occurs when the Fed pivots (green circles). And the stock market bottom for hard landings (black lines) occurs after the Fed pivots and in general has executed several rate cuts.

So, what’s the trigger for the market to bottom around hard landings?

As we all know, the stock market is a leading economic indicator. It will bottom before earnings and GDP do. There are however other leading economic indicators and the stock market is coincident with those, it’s not leading them.

Take a look at the following chart. It shows the movement in the S&P500 and the ISM PMI, two leading economic indicators. It’s clear that they both move together. One is not leading the other.

The following chart from Michael Cembalest (J.P. Morgan) shows stock market action during hard landings as well as when several economic indicators bottomed. The red dots indicate when earnings bottom. As you can see, earnings usually bottom a long time after the stock market bottoms (the DotCom collapse being the exception).

Now have a look at the blue dots. These represent the bottom in the ISM PMI. It’s clear that they bottom very close to the actual bottom in the stock market.

Source: J.P. Morgan Asset Management, Michael Cembalest, The end of the affair

As Michael Cembalest explains : “In the history of US recessions (with the exception of the dot-com collapse of 2001), equity markets bottomed well before the bottom in GDP, payrolls, S&P 500 earnings and housing starts and the peak in household/corporate delinquencies. The ISM survey has been the most reliable coincident indicator of a bottom in equities, which is why we pay so much attention to it.”

The following charts shows this as well. The vertical red lines show when the stock market bottoms during hard landings. As you can see, this coincides very closely with a bottom in the ISM PMI. The vertical green lines show the stock market bottom around soft landings. These don’t coincide with a bottom in the ISM PMI but, as we’ve shown before, with a Fed pivot.

So to know when the stock market bottoms, we need to know when the ISM PMI will bottom. The following chart shows the ISM PMI in orange and a model that predicts the ISM PMI in blue.

As you can see, we are nowhere close to a bottom in the ISM PMI.

Over the last year, the Fed has enacted on one of its fastest rate hiking cycles ever. Most of these rate hikes haven’t affected the economy yet. The effects on the economy will become visible as we proceed throughout the year.

Every warning signal that has preceded a hard landing is currently flashing red. And now that we know how the market behaves around hard landings, I think that the markets will be very surprised about what will be coming and that we’ll make new lows later in the year.

If we take a quick look at Europe, consensus seems to be that the worst is behind us. The following model from Nordea disagrees however. Europe will enter recession and neither central banks nor consensus is ready for it.

Source: Nordea, Mikael Sarwe

Other elements like credit spreads and the equity risk premium are indicating that the market is way too complacent. I’ll explain this in a future article.

To be clear, the stock market won’t bottom the month that the ISM PMI bottoms. But it will bottom in the months around it. For the time being, there is nothing in the models I follow that’s indicating a bottom in the ISM PMI in the near future. Once I see the models indicating a bottom, I’ll be looking for the signals of a sustainable bottom in the stock market. Right now, it’s still too early for that.

Can I be wrong? Absolutely. I’m wrong all the time. Luckily the market will tell me when I’m wrong. We saw significant price action in several asset markets last week. Several stock markets lost significant levels (I shared some charts on twitter). If these levels can be regained, I’ll have to respect market action.

Thank you very much for reading my article.

If you want, you can follow me on twitter: click here.

Since then, I've primarily shared technical updates on my Twitter feed without really explaining the fundamentals behind the decisions I'm making. In this article, I want to elaborate on the fundamental views underpinning my trading decisions.

Please not that this is a strategic, not tactical view. If I'm fundamentally bearish, this doesn't mean I'm short all the time.

Bear market rallies

We've seen multiple bear market rallies this year. At the end of July, I started shorting the one that started in the middle of June. I was a bit too early but my analysis proved correct and I closed my short position on September 23th (see here).

The market bottomed in the middle of October and we've seen a new rally in stocks, which recently, I started to short again (see here).

The timing of my shorts is clearly based on technical analysis. But you need more than just technical analysis. There are a lot of very popular accounts that have tried to call the bottom in the market based on several technical signals that had a great track record in the past.

Let's take the breadth thrust for example. As the following chart shows, this indicator has an excellent track record in identifying when the bear market is over. In fact, it never had a false signal since the 1970's.

It's a signal I will be using as confirmation when I think we are close to a sustainable stock market bottom.

Source: Ed Clissold, NDR

However, the signal triggered (together with a lot of other sentiment and overbought/oversold indicators) but I kept adding to my shorts. Why was I ignoring it? Because context matters. The macro environment in which we are operating is of crucial importance.

When bulls were partying in the middle of August because they thought the bottom was in because all the indicators were flashing green lights, I tweeted (see here) that I was ignoring these signals because the fundamentals were not supportive. Historically, all these breadth thrusts took place during a Fed easing cycle. Since we were still in a Fed hike cycle and because once the market is in a correction, the market never bottoms before the Fed is done hiking (see here), I ignored these signals.

Technical analysis is a great tool. However, too many people use it on a standalone basis. You need both technical and fundamental analysis. (I wrote an article on this before, see here.)

Fundamentals supporting the bearish case

So, which fundamentals am I using to remain bearish on stocks?

I came into 2022 with a bearish view on risk assets. An article I wrote in January 2022 was called: 'Risky 2022 ahead? What are the leading indicators telling us?'

In June, I reiterated my bearish fundamental views in the following article: 'Risk-off environment remains intact.'

I urge you to read those two articles to get a complete view of my thought process.

In this article, I'll write about the fundamental picture we need to see to be confident that a stock market bottom might be close.

There is some kind of view in the market that peak inflation will be bullish for stocks. It's not difficult to understand where this view comes from. The declining stock market in the first part of the year was completely caused by a decline in valuations, caused by rising interest rates, which were caused by rising inflation.

So, the logic goes, a peak in inflation will support valuations and the stock market in general. I understand the logic but I've proven in detail why this is wrong both on historical and theoretical grounds. I'm not going to explain this again in detail in this article. You can read my previous article (see here) and this Twitter thread (see here).

So, if it's not peak inflation that we need to see a market bottom, what is it?

Another popular view that a lot of people seem to hold is that we need a Fed pivot.

The Fed needs to stop raising rates (I call this Fed pivot I) or the Fed needs to start cutting rates (I call this Fed pivot II) for the market to bottom.

If we look at the following chart, we can see in the top panel the S&P500 (blue line) together with recession periods. In the bottom panel, we can see the Fed funds rate. Vertical red lines indicate a Fed pivot I when the market didn't bottom and continued to decline. Vertical green lines indicate when a Fed pivot I indicated a stock market bottom.

What do you notice about this graph? All the green lines, when a Fed pivot I was accompanied by a stock market bottom, as the bulls are arguing for now, were never followed by a recession.

All the red lines, when a Fed pivot I didn't help the stock market, were followed by a recession.

When the Fed pivoted in 1989 and 2006, the market rose because the recession took some more time to arrive. In all other cases, when the market was already in a downtrend and a recession was near, the market started to decline very soon (2000) or just continued its decline (1969, 1974, 1981).

Since we are already in a decline, the question is the following: will a Fed pivot I result in a stock market bottom (like in 1966, 1984, 1995, 2018) or will the market continue to decline.

As explained above, the answer depends on whether or not the economy will enter recession.

Not every rate hike cycle leads to a recession. However, every rate hike cycle accompanied by food & energy price spikes does lead to a recession.

In fact, as the following chart shows, every recession we've seen was a combination of rate hikes and energy shocks.

All the rate hike cycles (1966, 1984, 1995, 2018) that weren't followed by a recession have one thing in common: there was no energy shock. It were also the only times when a Fed pivot I was bullish for the stock market.

Source: Michael Kantrowitz

Another variable we can look at is the unemployment rate which currently is still very low. As we all know, the unemployment rate rises during a recession.

What the rate hike cycles that didn't lead to recession have in common (besides the fact that there was no energy shock), was that the unemployment rate continued to decline after the Fed pivot I.

To get an idea what the unemployment rate will do this time around, we can look at some models.

As the following chart shows, initial unemployment claims lead the unemployment rate by about 5 months.

Thus, to know what the unemployment rate will do, we need to know what initial claims will do.

The housing market is an excellent leading indicator for unemployment claims.

Since housing accounts for 27% of investment spending and around 5% of the economy, it has a significant impact on the trajectory of the overall economy.

The following chart shows initial unemployment claims together with the NAHB housing market index as a leading indicator. As you can see, a weak housing market (indicated by a rising blue line) is followed by a rise in initial unemployment claims.

The current weakness in the housing market is a clear indication of the weakness to come in the labour market.

Is the model perfect? Of course not. In the mid-1990's for example, the weakening housing market (rising blue line) wasn't followed by a rise in initial unemployment claims and thus the unemployment rate.

However, in the mid-1990's there was no energy shock, just a Fed rate hike cycle. Now, both elements are flashing red warning signals.

To solve the problem of potential false signals by using the NAHB housing market index as a leading indicator for unemployment, I built a breadth model.

The breadth model shows the underlying weakness in the employment picture.

When the breadth model spikes, bad things tend to happen.

Below, I annotated the chart above to give some more clarity. The white arrows indicate historical episodes when the breadth model spiked to similar high levels as today. As you can see, the unemployment rate was already rising by then (1991 and 2002) or it was soon going to (1980 and 2008).

I also colored two periods in red. The first one is the 1995 rate hike cycle. The fed was raising rates and the housing market was weakening but the unemployment rate didn't rise since the breadth model didn't give a warning. There also was no energy shock. When the fed pivoted, stocks started to rise.

The same is true for the December 2018 Fed pivot. There was no warning signal from the breadth model and there was no energy shock. In 2018, there was also no warning from the NAHB housing market index. The result was that a Fed pivot led to a rising stock market.

Today, all three signals are flashing red.

Conclusion

Recession or not is the determining variable to anticipate the stock market's behavior around a Fed pivot I. Since the models I shared in this article are all indicating a recession is coming, it's clear to me that a Fed pivot I won't be bullish for stocks. (Other independent models from other analysts I'm following are indicating the same recession probabilities.)

One final note to close this article on. Isn't a recession already priced in? The Philadelphia Fed Survey of professional forecasters is indicating a very high expectation (in fact the highest number ever) off a recession coming in the next 12 months.

Why would a recession matter if everyone knows about it?

Two reasons.

Professional forecasters may know about it, but investors haven't acted on it yet. Sentiment is very bearish (sentiment data shows pessimism being as extreme as at previous market bottoms) but equity flows haven't gone negative yet. There is a difference between saying and doing. Investors are saying they are negative, but they haven't acted on it yet. Historically they act on it as well before we see a major market bottom.

The second reason is that equities tend to bottom with leading economic indicators when a recession hits. As long as I'm not seeing this, I'm not going to become bullish on the assumption that the market has priced certain things in. Is the market really that smart? The market is certainly forward looking on lagging economic indicators like GDP growth itself but I've never seen proof that the market is forward looking on leading economic indicators. The market is reactive.

Just one quick example. This year, the market had several very big up-days when inflation prints came in lower than expected. As I wrote earlier, declining valuations because of higher interest rates caused by rising inflation were the main reason for the decline in the stock market in the first part of this year. Thus, a lower inflation print was interpreted by the market as being bullish and the market rose sharply. But did the market anticipate these lower inflation prints? Certainly not, otherwise it would have risen before them, not on the day that the news was made public. How will the market react in 2023 when earnings will be much weaker than expected (see my leading indicators in my previous article) and when the unemployment rate will start to rise? Why is a recession already priced in but peak inflation wasn't? Clearly, the idea of things getting priced in by the market is too simplistic. The interaction between investors, economy, and markets is much more nuanced.

I'll write more on this when the time is ripe.

Thank you very much for reading my article.

Commodities

In early 2022, my leading indicators were showing me to be bearish on commodities. This was a bad call for the first few months of the year. We'll never know if commodities would have had this strong run without the geopolitical situation in Ukraine and Russia (probably not) but it is what it is.

Things are finally coming together. As the following chart shows, copper is clearly breaking down from significant support levels.

Not only copper, the materials sector (XLB) and oil sector (XLE) are also showing very bearish price action patterns.

I think the decline in the commodity complex has finally started. You can read my previous two articles if you want to know more about the fundamental reasons.

Bond market

In previous articles, I showed some leading indicators on inflation and growth. Both were heading down and I showed how historically this would be bullish bonds.

Inflation remained strong (because commodities remained elevated) and therefore interest rates kept rising.

Now that commodities are breaking down, we can expect for breakeven inflation rates to also come down. As the chart below shows, there is a very strong correlation between the two. (I used copper in this example.)

Now that commodities are probably gone as a factor keeping inflation and interest rates elevated, the next question we need to answer is about the Federal Reserve.

Throughout the year, we have been hearing about the monumental rate hiking cycle that the Fed would be executing this year.

In a very short time, the Fed has raised the fed funds rate to 1,75%.

In the following chart, I'm looking at the fed funds rate (grey) and 10 year yield (blue) to see when the 10 year yield peaks in relation to the fed funds rate.

As you can see, the 10 year yield normally peaks together with the last rate hike and sometimes it peaks 1 or 2 'rate hike meetings' before the fed funds peak.

What do I learn from this? Well, I should have given this more importance when I became bullish bonds early this year. Even though I said that technicals were supportive of higher yields, I probably shouldn't have written that fundamentals were already aligned.

With the current pace of rate hikes per Fed meeting, we probably haven't too much Fed meetings left before this rate hiking cycle is over. Since longer-term yields peak between 0 and 2 'rate hike meetings' before the last rate hike, we're getting very close.

But how do we know when to pull the trigger?

Take a look at the following chart of the 10 year yield. It broke out above a significant resistance level and is now retesting this level. If this resistance level, that now turned into a support level, fails, it's time to bet on bonds.

Stock market

In early 2022 I warned that the S&P500 would decline 15 to 20%. As you can see, I now think that we'll see an even bigger decline. Let me explain.

We want to know what the price of the stock market will be.

To know this, we need to know what earnings the companies will produce, and how much investors are willing to pay for these earnings.

Price stock market = earnings x investors willingness to pay for these earnings

The willingness of investors to pay for a certain amount of profits is what we call the P/E ratio or stock market valuation.

If investors are bullish and there are no clear risks, they are more willing to pay for a certain amount of earnings, thus they bid up the market valuation or the P/E ratio.

If we write it with mathematical symbols, we get:

P = E x P/E

Of course, the difficult part is knowing what the E and the P/E will be.

Let us start with the E part of the equation.

The reason I'm becoming more bearish and why I'm expecting a bigger decline than 20%, is because analysts have earnings expectations of around 10% growth for the S&P500.

If you take this growth rate, you can calculate the earnings number that this implies (because we know last year earnings).

If you then take these earnings and multiply them by the current P/E ratio, you arrive approximately at the current price level of the S&P500.

This means that if analysts are correct, the S&P500 is probably correctly priced right now and that we are very close to a bottom. (This point was laid out by Jurien Timmer of Fidelity.)

There is however one very big problem. I think analysts forecast of earnings growth will be completely wrong.

The next chart shows S&P500 earnings growth in blue and my leading indicator in orange.

The red triangle shows to where analysts think the blue line will move. They are expecting 10% growth. My model however is going straight down. I don't think we'll see a collapse in earnings as big as my model is indicating, but I certainly think that earnings growth will be much weaker than expected.

If earnings are much weaker than expected, this means that the stock market will continue to decline because the current price is fair value if you assume 10% earnings growth.

Let's go back to our formula: P = E x P/E

What if valuations rise? This can offset the lower earnings and this way the stock markt doesn't have to decline further.

Let's have a closer look at this idea.

I see some people talking about the idea that a peak in inflation and interest rates will be good for the stock market.

If we look back at Q4 2018, we can clearly see that this doesn't have to be the case. The stock market declined 16% from the point that interest rates peaked. (indicated in red on chart below).

(I also indicated in green a period of rising fed funds rate and a rising stock market. It's not because the current rate hiking cycle is going together with a declining stock market, that this always is the case.)

Why is a lower interest rate not always good for the stock market? Because there is no clear link between a lower interest rate and rising valuations (P/E ratio). The chart below (by the excellent Michael Kantrowitz) shows (indicated by the orange areas) periods when lower rates go together with lower P/E ratios. The explanatory variable is the credit spread (here shown by BAA spread). When interest rates decline, but credit spreads rise, valuations decline because we are in a risk-off environment.

Source: @MichaelKantro

We now know that lower interest rates are not necessarily good for the stock market and that the risk-on or risk-off environment, as indicated by credit spreads, are much more important.

So the next question becomes how probable is it that credit spreads will rise from here. This would be good for the P/E ratio and could thus be an offset for the lower earnings I'm expecting.

The following chart shows the BAA credit spread (in orange) together with the ISM PMI in blue. (Take note that the ISM PMI is inverted. A rising blue line thus shows a declining ISM.)

As I've shown in previous articles, I'm expecting the ISM PMI to decline sharply. The blue line will thus increase significantly.

Credit spreads are closely correlated with the blue line, thus with the economic cycle.

If the ISM PMI goes lower, we can expect credit spreads to get wider. This would imply that there is no room for the P/E ratio to increase.

In the red circles, I indicated two periods when the economy continued to slow (rising blue line) but credit spreads didn't rise further. It's thus possible that the economy continues to weaken but that credit spreads don't move higher.

However, we want credit spreads to go lower if we want to see higher P/E ratios.

In the following chart, I indicated by green areas the periods when credit spreads (orange line) went lower. As you can see, all these periods were accompanied by declining blue lines which means that the ISM PMI was in a rising trend. Given that all my leading indicators are showing that the ISM PMI is going down sharply, I find it very difficult to see how credit spreads could fall and P/E ratios could rise. (Very difficult doesn't mean impossible however. If you look more closely at 2019, we saw a declining ISM but credit spreads didn't widen and the P/E ratio actually increased. However, during that period we didn't see an oil price shock. Looking at history, oil price shocks seem to be one of the defining reasons when a rate hiking cycle does or doesn't lead to a recession. Since we have an oil price shock right now, I remain of the opinion that a rising P/E ratio is a low probability event.)

So, if we go back to our formula: P = E x P/E

If earning forecasts are correct, the market is correctly priced. But if my leading indicator on earnings growth is correct, and given the fact that I don't see how the P/E ratio can rise, I think the total decline in the stock markt from its peak could be 30-40%.

Fed policy

When will the fed stop its rate hiking cycle and potentially start to cut interest rates? Some people seem to believe that because inflation is this high, it's impossible for the Fed to turn dovish.

If we look at the 1960's and 1970's, we can see that this isn't correct.

The following chart shows the inflation rate in blue and the fed funds rate in black. The vertical red lines show when the fed started to cut interest rates. As you can see, the Fed has historically cut interest rates when inflation was still rising or hadn't started to decline yet. In these historical cases, inflation was around 5%, 8% and 13%.

I think history clearly shows that the Fed can, and will, turn dovish even when inflation is elevated.

I also included the S&P500 in the lower part of the chart above. We can see that the stock market bottomed around the turning point in Fed policy. This might be interesting to remember for this cycle.

The next chart shows again the S&P500, together with the vertical red lines that show when the Fed started to cut interest rates, and the US ISM PMI as a measure of economic strength. We can clearly see that the Fed gave more importance to the weakness in the economy than to inflation. Even with inflation elevated, the Fed will turn dovish.

Conclusion

The risk-off environment remains intact.

The time to buy bonds is coming closer. But please take note: do not buy bonds at a random point. Wait for a clear breakdown in interest rates. I was bullish bonds for fundamental reasons at the beginning of the year but I've haven't yet invested in them because technicals were not supportive. Be patient and wait for the opportunity to present itself.

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest

In this article, I want to update these views.

The thing that should stand out to you is the fact that my views remain the same as they were at the beginning of the year for all asset classes.

Those that have been following me know that I don't mind changing my opinion when the facts show that I'm wrong. Even though most of my predictions have come to fruition (I was wrong on commodities and partly wrong on bonds since I was not expecting this big of an increase in interest rates), you could think that the price action in bonds and commodities would change my opinion.

In this article, I'll explain why my opinion remains the same as in January.

We are currently at an inflection point with regards to where we start in the economic cycle. The current situation reminds me of Q3-Q4 2018. Back then, interest rates rose sharply and gold was in the dust. In December 2018, Goldman Sachs was calling for multiple rate hikes by the Fed in 2019 and Jeffrey Gundlach was calling for much higher interest rates.

The exact opposite happened. Interest rates declined sharply in 2019 and gold had a wonderful year. (If you wear of the opinion that rates would keep increasing in 2019, you wouldn't have become bullish on gold.)

Why did this happen? Because the economy slowed dramatically. How could we know this? Because leading indicators were predicting it.

Below is the exact chart (thanks to CrossBorder Capital) I was using at the end of 2018 to form my bullish bond and gold outlook for 2019.

The black line shows the US PMI (a measure of economic strength) and the red and yellow line are a leading indicator of the US PMI. These leading indicators were showing that the US economy would slow dramatically in 2019. So, I became bullish bonds and gold at the exact moment that "experts" were calling for higher rates.

Source: CrossBorder Capital

Today we see the same.

Below is the chart I shared in January of this year. The blue line show US PMI, the orange line is the leading indicator (please note that I haven't updated this chart since my article in January).

As you can see, economic growth will decline sharply in the coming months. There are several other models that I track and they are all showing the same thing.

If we look at history, we can see that interest rates almost always decline when the economy is slowing (as represented by declining US ISM PMI).

Add to this the fact that the ISM PMI itself is a leading indicator of inflation (the following chart by MrBlonde_macro shows this) and we know that both growth and inflation will probably start to decline very soon.

Fundamentally, this should be very bullish for bonds.

Source: @MrBlonde_macro

I was too early with my peak inflation call in January but I'm more convinced than ever that we are close to peaking.

Whereas in January of this year technicals were still supportive of a move higher in interest rates, we are now seeing the opposite.

I shared some charts on twitter 2 weeks ago that show this, see here.

Since then, the evidence has been building that we are close to a turning point: both the copper/gold ratio and banks/utilities ratio are not confirming this move higher in interest rates.

Add to that the following model developed by Teddy Vallee and you see why I'm bullish on bonds.

Source: @TeddyVallee

The other thing that is giving me strong conviction is the behavior in gold.

In early 2021, when the 10 year interest rates rose above 0,96%, I warned that the move higher was just beginning and that this would be bad for gold.

The following chart shows the relationship between interest rates and gold. When rates rise, gold declines (red areas), when rates decline, gold rises (green areas). (I know that interest rates can rise together with gold like in the 1970's and that it's probably better to look at real rates instead of nominal rates but I use what works in practice, not what should work in theory.)

The blue areas indicate when gold was able to hold strong despite the rise in interest rates. We saw it in 2018 and we are seeing it again right now. To me this is a clear signal that the gold market is not believing what interest rates are signaling (just like the stock market internals are not believing it for that matter).

When interest rates start to decline, this will be rocket fuel for the gold price.

If we look at the gold price in euro's, we can see that it has already moved above the highs of 2020 and already executed a successful retest as well. For those that have read some of my earlier posts, you should know that gold often moves first in other currencies and that the move in USD follows later.

If we look at the gold mining shares, we see something very interesting developing.

In early March, GDX tested resistance at the 40 USD level. Since then, it has been consolidating right below it with corrections getting smaller and smaller. This looks like a market that wants to break out and with fundamentals aligning in a big way (my expectation that interest rates will come down), that's exactly what I think the market will do.

Some final words on crypto currencies.

When gold peaked in the summer of 2020, a lot of "experts" were calling for a breakout after 1 month of correction, 3 months of correction, 6 months of correction,...

I also identified 2 or 3 possible set ups but I warned each time that I was not convinced of the fundamental picture. I leaned bullish because of technicals. Gold seemed to be breaking out but after some time, prices declined again.

We know now that the correction took around 16 months. The number of people that have called a gold bottom during these 16 months is uncountable.

The reason that technical analysis didn't work so well is because fundamentals were nog aligned.

You see how the technicals are working rather good in gold since early this year? Not surprising because the fundamentals are getting aligned.

I'm afraid that the same is happening in crypto assets. Bitcoin is rather easy to analyse from a technical standpoint when we are in a bull market. Resistance levels are rather clear, consolidations form as they should form, and breakouts don't fail.

What we are seeing now in crypto is that technical analysis seemed to stop working. Breakouts don't hold anymore as they did in the past. That's why I wrote the following at the end of March: "To summarize, I'm bullish bonds and gold and despite the breadth thrust in stock markets and bullish breakouts in high beta assets like Bitcoin, I prefer to ignore it because I'm afraid it could be a bull trap."

Since then, the S&P is 2% lower and Bitcoin is 8% lower. With the fundamental picture for Bitcoin not being bullish, you shouldn't be surprised that breakouts are not working as they should.

For those wondering what fundamentals I'm looking at, see this tweet and my prior articles.

Can I change my mind, of course I can.

As Stanley Druckenmiller explained, open-mindedness is one of the most important things to have in financial markets: "If you are going to go the rout of making concentrated bets, you also have to go the rout of being completely open minded. When the facts change, being wrong, you can’t sit down there and double down. If things don’t start to work out, you have to exit the position.”

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest

(You can find the original article here.)

Three of these views proved correct:

1) I was positive the economy, I wrote: "This means that in the coming months, we’ll see some of the best economic data ever."

2) I was positive risk assets and I thought interest rates would move higher in 2021. I wrote: "Both the equity market and interest rates will move higher on the strong data (on a rate of change basis) we’ll see coming through in the next few weeks/months."

3) Because interest rates had just broken out, I was bearish gold. I wrote: "Given the trajectory higher in interest rates, I’m not bullish on gold for the next few weeks/months."

My last view was incorrect:

4) I thought interest rates and the stock market would peak together somewhere in 2021. I indicated that a rising USD would put pressure on the market and that the Fed would need to step in (perhaps with YCC). This would be the moment to buy gold.

Even though I correctly called the USD bottom in 2021 (see this article) and there were several technical signals that we could be seeing a top in risk assets, the general market kept rising. I was thus too early in this view.

However, as I explained in another article (see here), a lot of risk assets like commodities, crypto currencies and technology stocks have seen considerable drawdowns. Also, small cap and mid cap stocks have essentially gone nowhere since March/April of 2021. In my opinion, the call was thus not completely wrong with regards to the risk asset part of it.

Enough about last year, let's look at what 2022 will bring.

In this article I'll have a look at my leading indicators with regards to the fundamentals.

I know that a lot of people just look at technicals and those that use fundamentals, often believe in a certain narrative instead of being data driven.

I wrote an article in the past on the importance of using fundamentals. When I say that you should use fundamentals, I mean you should use leading indicators. You shouldn't buy an asset because 'the fed is printing money' or because 'we are living in a bubble'. These are just stories that are popular on twitter but don't help you make money.

With the use of leading indicators, you can form an educated view on the future direction of asset markets without having to believe in some kind of story. (I wrote an article on this in the past, see here.)

I'll thus share with you some leading indicators in this article so that you can develop your own views.

Once we had a look at the leading indicators, I'll share some of my initial thoughts on what this wil possibly mean for several asset markets. (More detailed analysis will follow in future articles.)

If you read my investment outlook of last year, you know that both growth and inflation are the two most important factors affecting asset markets.

As Bridgewater explains:

Bridgewater (source: The all weather strategy): "While asset classes incorporate expectations about a wide number of economic factors, growth and inflation are the two most important determinants of asset class pricing (both because of their direct impact and the fact that they encompass expectations about most other relevant factors). Asset class returns are largely the result of whether growth and inflation end up being higher or lower than expected, and how these expectations change."

Last year the leading indicators were showing that both growth and inflation would become much stronger. This was one of the reasons why I was bullish risk assets last year.

What are the leading indicators telling us now?

Let's first have a look at growth. The ISM PMI is a leading indicator for GDP growth.

Below I plot the ISM PMI (blue line) together with my leading indicator (orange line).

The leading indicator is clearly showing that the ISM PMI has peaked and will come down in 2022.

I have another model, based on completely different inputs, that is showing the same thing:

(Beware, the leading indicator is here in blue and the ISM PMI is in orange. I didn't update the data for ISM PMI in this chart. But the point I want to share is of course that the model is predicting that we have seen the peak.)

So, as these two models clearly show, we have probably seen the peak in economic growth. (on a rate of change basis)

(Please note that when I write that growth has probably peaked, I don't mean we are heading into a recession. We'll probably see growth slow, after which it can accelerate again. But since markets move on a rate of change basis, looking at actual data against prior expectations, this growth slowdown is important.)

Let's now have a look at inflation.

Below I plot the US CPI inflation rate (orange line), together with my leading indicator (blue line.

The model is clearly showing that inflation has very likely peaked.

Now that we know what growth and inflation will do in 2022, we can have a look at another very important factor driving markets: earnings.

The leading indicator I developed for S&P500 earnings is based on the insights that Stanley Druckenmiller used for what he called "...one of the best bets I ever made."

As you can clearly see, the leading indicator is going straight down.

The way I primarily like to use this indicator is as follows: when we have had a stock market correction and earnings have declined but the leading indicator is showing strength, that is the best time to buy stocks.

You can see this for example in early 2020 (with the Corona crash). Earnings (blue line) and the stock market had collapsed but the leading indicator was showing that earnings would rise sharply.

I indicated this on the following chart.

What I take away from this model is that the support that the stock market had from earnings will be gone.

To summarize, the macro economic backdrop will be completely different than the one we had last year.

The following chart by Prometheus Research shows this clearly. The grey line shows the probability that is priced into asset markets for a declining growth and declining inflation regime. (the other colored lines show the probability of other possible regimes)

As you can see, we saw a high probability in early 2020 for this worrisome regime. What followed was the Corona crash. In 2022, the model is showing an increased probability of this regime coming back, exactly as my own leading indicators are showing.

Source: Prometheus Research, @prometheusmacro

Now that we know what the leading indicators are showing us, let's have a look at the potential impact on several asset markets.

Please note that the thoughts I'll share on several markets are just "my first thoughts". I won't immediately take positions based on them because I'll need to do more research first to confirm some of these ideas. I'll update you in future articles.

Stock market.

I think we'll see a significant correction in the broad markets this year (15% drop or higher?).

As explained earlier in the article, a lot of markets have already seen significant corrections. The following chart from Sentimentrader is very interesting. It shows the percentage of Nasdaq stocks that are down 50% from their 52-week high. As you can see, 40% of Nasdaq components have lost half of their value. Even more astonishing is the fact that the broad Nasdaq is still at all time highs.

When the big components finally start to roll over, the Nasdaq will follow and it won't be difficult to see a significant correction in broader markets.

Source: Sentimentrader

I indicated 4 other instances (orange vertical lines) when the percentage of Nasdaq stocks down 50% were as high as today.

The last two times, these were buying opportunities. (early 2016 and the end of 2018)

The two times before that, it were selling opportunities.

We can't be 100% sure but with what the leading indicators are showing, I think chances are higher that this is a selling opportunity.

Before you panic and sell everything, I think the stock market has some time left. I'm still long the Nasdaq but in a few weeks time, I'll be 100% cash, ready to profit from the scenario I'm seeing for 2022.

If the market decides to start its correction earlier than I anticipate, I'll risk manage my current position of course.

Bonds.

Early last year, I indicated the breakout in interest rates and wrote that it would be bad for gold.

Last week, it seems that interest rate have broken out again. You could interpret this as a clear signal that a new move higher in rates has started.

The fact that financials (XLF) have also broken out, would support this view.

However, this price action is the opposite of what my leading indicators are telling me.

With both growth and inflation slowing in 2022, how likely is it that interest rates will move substantially higher? Not so likely if you ask me.

We must also not forget that the Federal Reserve will start to tighten monetary policy in 2022. As always, they have the timing perfectly right (I'm not serious to be clear...), they'll tighten into a growth slowdown.

For now, the price action is telling that interest rates will go higher, but my current guess is that fundamentals will trump the technicals.

Commodities.

With inflation peaking, and the correlation between commodities and inflation being very high, I think chances of another good year for commodities are rather low.

I shared on twitter some charts supporting this view, see here.

On top of that, Barron's came out with the following front cover: "The commodities boom". On their site, you can read the following: "Why it's time to invest in commodities, and how to do it."

Anyone who has any experience in financial markets knows how awfully wrong the timing of these magazine cover stories often is. If you are not familiar with this, I shared some examples on Twitter, see here.

Finally, with the PBoC tightening liquidity, chances are not very high that commodities will have a good year in 2022. The following chart by CrossBorder Capital clearly shows the strong relationship between liquidity and commodity prices.

Source: CrossBorder Capital, @crossbordercap

Precious metals.

Gold and silver had a terrible year in 2021. The reason was of course that real growth came in much stronger than markets anticipated.

With both growth and inflation peaking this year, I think the worst is over for gold.

I'll be looking to identify nice buy set-ups in these markets.

It's been a long time seen I've written on gold, but expect this to change in 2022.

Crypto currencies.

In November I wrote an article stating that you shouldn't be afraid to buy the breakout in Bitcoin. (see here)

Now that Bitcoin and other cryptocurrencies have declined substantially in value, you might be of the opinion that the article I wrote and my analysis in it was absolute garbage and that I lost a lot of money.

Luckily not. Why not? Because I know that the key to success is not my ability to predict markets but to admit my mistakes and to change my positions. That's exactly what I did, as I detailed in another article (see here) and on Twitter.

I think both articles contain a lot of valuable lessons for a lot of people. I get a bit annoyed when I see all the Crypto "experts" on Twitter with all their fancy charts. They're learning the hard way that too much of a strong belief in fancy charts and a lack of risk management are not very helpful for long term investment success.

Anyway, what are the leading indicators telling us for crypto currencies? Well, the fact that the two most important crypto currencies (BTC and ETH) have now had confirmed failed breakouts, is not giving me much hope for the bullish side.

Add to that the risk-off environment I see coming in 2022 and I can't see any reason to become bullish on these assets.

I'll update my views on Twitter and in future articles.

Thank you very much for reading my article!

What I would like to do is give an investment insight with regards to how a lot of people seem to invest in Crypto assets. In my opinion, a lot of (inexperienced) investors are making a big mistake in the way they invest in these assets.

This is thus not about the why, but about the how.

Before I share the two important insights, I'll give a quick reminder of my views on Bitcoin throughout this year:

-Late April I warned that the Bitcoin price action was not looking good. Prices dropped sharply.

-Late July it looked to me that Bitcoin would break down. I was wrong on this and it bottomed. I changed my views and became bullish after it could break above the 41 000 level.

-Early October I made a video about the bullish price action I was seeing in Bitcoin. (see here) We reached all time highs again and I wrote I would like to see a consolidation after which we could move higher. The consolidation happened but we saw a strong failure over the last few weeks.

I shared the following chart in an article of early November (see here) in which I explained why you shouldn't be afraid to buy all time highs in Bitcoin.

Needless to say, this call was completely wrong, as we can see on the following chart of Bitcoin.

(Quick side note: Even though that call was completely wrong, the investing insight from the article is still completely right: you shouldn't be afraid to buy strength and all-time highs. The best traders in the world do it and if you look at it from a statistical viewpoint, it is the right thing to do.)

How did I manage my positions? Well, I've been positioned in ETH and not in BTC. I started building my positions in the middle of September. As you can see on the following chart, ETH remained relatively strong in comparison to BTC. BTC failed on the weekly timeframe to hold its breakout above all time highs. ETH however managed to stay above those all time highs.

The fact that ETH remained relatively strong, game me the opportunity to take a wait and see approach. (If I was positioned in Bitcoin, I would have sold much earlier.)

On the 10th of December I sold my whole ETH position. Why? Just as Jesse Livermore would advise not to be afraid of all time highs (as explained in this article), he would also advise to be cautious when prices don't react as they should. See tweets below:

Normally when BTC can break above all time highs, we see a parabolic move. The following chart clearly shows this:

source: @Erik_Hansen_

I gave ETH several weeks of time to prove itself, knowing well that BTC had already failed.

But it's taking too long and the price action is just not looking constructive if you ask me. (In 2017 we also saw a failed breakout first in BTC before the parabolic move started but that price action was much clearer then now. See here for charts.)

I'm not going to share a bunch of charts here, you can see some of them on my twitter account.

The important thing to note is that I went from being extremely bullish in early November, to selling my whole position. I'm not willing to let a profit turn into a loss because I want the price to rise or because I'm stuck to my fundamental views. Risk management is key:

This brings me to the two important lessons I want to share. These are lessons on how you can intelligently invest in crypto markets. (This is thus no opinion on why you should invest in them.)

I think a lot of people make two mistakes.

Mistake number 1: There are a lot of people that make fancy charts based on technical analysis and on chain data (The interesting thing about crypto is that we can use this on chain data to see what people are actually doing, this way we can get unique insights into the crypto markets that we can't get in other markets.)

There is nothing wrong with making these charts. I follow a lot of people and I use their analysis in my investment process. The problem is however that a lot of people seem to believe almost fanatically in certain indicators. (Whether they are technical or on chain indicators.) They also seem to invest on probabilities instead of possibilities.

Before I go on with this probability vs possibility debate, let's first talk about all these indicators.

When you start out investing, you tend to follow a lot of people and you start to get into contact with technical analysis and all kind of indicators. You think you need to find the person that can help you to get the magical indicator. Unfortunately, after a lot of years you will learn that this perfect indicator doesn't exist.

Please, take the following advice from Aksel Kibar, it will save you a lot of effort (and money):

Why do you think I almost never use indicators on my chart? Because I learned the hard way that they don't work. If I use them, I use Fibonacci retracements/extensions and RSI. And the way I use them is most of the time not the way that they are taught in the textbooks...

Why do you think that great traders like Mark Minervini, William Eckhardt, Monrou Trout,... seldom use indicators?

Because they learned the hard way that they don't work.

Don't believe me? Look at what they say:

Jack Schwager: “Any indicators that you consider overrated?”

Monroe Trout: “Most of the common ones: Fibonacci retracements, Gann angles, RSI, and stochastics. I haven’t found anything there for any of these indicators.”

Jack Schwager: “Do you have any opinion about popular technical overbought/oversold-type indicators, such as RSI and stochastics?

William Eckhardt: “I think these indicators are nearly worthless.”

Do I want to tell you that all technical analysis is bullshit? Absolutely not, technical analysis is a big part of my process. But what I want to share is that the way a lot of people use it is completely wrong. There is no magical indicator and there is no secret model that always works. Remember this when you invest your money based on fancy looking chart you see on Twitter. You can use it in your process (like I do), but don't let it be a factor that will impact whether you make money or not. To make this more clear, we need to look at the second mistake a lot of people make.

Mistake number 2: There are two intelligent ways, and one very stupid way, to invest in Crypto assets in my opinion.

Let's start by one of the two intelligent ways. If you have a broadly diversified portfolio with stocks, bonds, gold, commodities,... and you want to invest a part of this portfolio in crypto, I see no problem at all. You can do 'buy and hold' since the risk is only a small part of your whole portfolio and it is thus contained.

A very stupid way to invest in crypto assets is to use this 'buy and hold' approach and invest a significant part of your capital in these crypto assets.

Warren Buffett is the ultimate buy and hold investor. The reason for his long term success is that he admits that he can't predict the future of most companies. This way, he only sticks to what he knows and invests in a very select group of stocks; those with certain competitive advantages, a stable business model,...

Warren Buffett isn't successful because he can predict the future. He is successful because he admits that he can't predict the future of most companies and therefore sticks to a very limited number of stocks, as he explains:

Warren Buffett: “If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes.”

The mistake that buy and hold crypto investors make is that they take this buy and hold mentality of Warren Buffett to invest in an asset that has none of the characteristics that makes buy and hold work.

I hope that I don't have to explain that the future of digital assets is much more uncertain than the future of well established stocks with competitive advantages, a strong consumer base,...

If you ever see someone quoting Warren Buffett's line 'Be fearful when others are greedy and be greedy when others are fearful.' with regards to the crypto market, you now know that they have no idea what they are talking about. Buffett can say this because the type of companies in which he invests are very specific. Crypto assets are on a whole other level.

Now, what is the second intelligent way to invest in Crypto assets? This is the method I use. I use the insights from great traders like Druckenmiller and Soros to invest in this space.

Warren Buffett is successful because he manages his risk by investing in a very small spectrum of stocks.

The diversified investor who invests in crypto manages his risk by only investing a small part in the space.

The buy and hold crypto investor doesn't manage his risk at all.

How does Druckenmiller (and Soros) manage his risk when investing? Well, he's a great trader and just as Jesse Livermore, he doesn't let his fundamental views influence his money making ability. If the market tells him he is wrong, he'll adjust.

Stanley Druckenmiller: “If you are going to bet big, you have to be ruthlessly objective about your position. I’ve put on positions I was a 100% sure I would have for 2 or 3 years and 10 days later, in my opinion the facts changed, and I’m out of them. If you are going to go the rout of making concentrated bets, you also have to go the rout of being completely open minded. When the facts change, being wrong, you can’t sit down there and double down. If things don’t start to work out, you have to exit the position.”

He doesn't advise to just stay in the market and pray you are right. No, he advises to admit your mistake and manage your risk. That's his key to success.

Let's look at Soros. As the following quote shows, he is extremely uncertain of his views. This gives him the flexibility to change his mind quickly. The reason for his success is not his ability to predict markets (he made plenty of mistakes). The reason for his success is that he was always quick to recognize his mistake and to risk manage his positions.

Soros: "I was afraid to admit my success because it might undermine my sense of insecurity. Once you take your success for granted, you let down your guard. When you are in trouble, you just sit back; you know you are successful and you will always get out of trouble somehow. That’s when you have lost your ability to get out of trouble."

Note that one of the best investors ever is very uncertain of his views and didn't want to admit his success because he was afraid that it would impact his ability to risk manage his positions. Compare this to the experts on Twitter...

Let's go back to the following sentence I wrote earlier: They also seem to invest on probabilities instead of possibilities.

Investing on probabilities is a good idea because it implies that you take into account alternative scenarios playing out. But it doesn't necessarily give you any risk management.

Have a look at the following chart. The colored line shows the evolution of the Bitcoin price. The grey line is a composite of several technical and on chain Bitcoin indicators. The higher the grey line, the higher the chance that we have seen the top in the Bitcoin market. As you can see, a peak in the grey line indicated both the late 2013 and late 2017 top in the Bitcoin price.

Source: https://colintalkscrypto.com/cbbi/

Someone who thinks in probabilities will look at the current situation and say the following: "The indicator is not as high as was the case at previous market tops. Therefore the probability that Bitcoin hasn't topped yet is higher than the probability that we have entered a bear market. Since probabilities are in my favor, I'll stay invested in the Crypto market."

As you can see, no risk management here. As Alex Barrow from MacroOps wrote: "Thinking in probabilities leads to false confidence and suboptimal outcomes."

Why is the Druckenmiller & Soros way of investing in Crypto much better?

Let's look at what I did. In early November I was a huge bull on the Crypto market. Since price action didn't follow through, I adjusted my views and risk managed my position by selling my investments. If the Crypto space continues to decline in value, I'll lose nothing. If the market takes off again, I'll be open minded enough to get back in.

What will the buy and hold investors get who have a significant part of their portfolio in Crypto? If the price rises, they'll make a lot of money. But I'll make a lot of money as well because I'll get back in.

The difference is that when the price continues to decline, they'll lose a lot of money. Me on the other hand, I'll lose nothing.

Why? Because I gave attention to the possibility that this cycle is different than previous ones.

Who will you follow? An analyst on twitter with a nice looking chart who is certain of his fundamental views that prices will go higher?

Or the insights of Soros, Druckenmiller and Livermore? They would advise you to be open minded, to risk manage your positions. Think in possibilities, not in probabilities. The world is a very uncertain place, nobody can predict the future.

The probability that we haven't seen the peak might be higher than the probability that we have (not necessarily my opinion), but the possibility that we have seen the peak is the risk that will ruin a lot of investors.

Please manage this risk, it's the only way to long term success, and in my opinion, a much better way to invest in the Crypto market.

Thank you very much for reading my article!

You can follow me on Twitter: @adaptiveinvest

A few weeks ago, I made a video (see here) with a recapitulation of my 2021 market views. To cut a long story short, I saw that the risk-on environment was starting to come back. I updated this view with some charts on twitter two weeks ago (see here).

In this article, we'll have a look at the price action of risk assets over the last few weeks.

Let's start with copper. When copper reached its 2011 all time high again in May 2021, I warned that we would probably see a lengthy correction/consolidation (see here). This is indeed what happened. Three weeks ago however, copper managed to break back above its 2011 all time high. This seemed to be another indication that risk on was back. Since then, copper broke back down below this level and we now need to wait and see how the price action will develop. Either copper needs more time to consolidate overhead supply, whereafter it can start to rise again. Or copper will not materially break above the 2011 highs but will correct further in 2022 when we get into a risk-off environment. (Yes, in Q2 2022, things could get very interesting, more on that in future articles.)

The theme that the risk-on environment is back was supported over the last few weeks by the price action in small and mid cap stocks.

In April, I started to warn about the possibility of a risk-off environment developing. We saw it in several asset markets but the broad risk-off price action didn't spill over to the broader equity market. (I explained my reasoning in this video from a few weeks ago.) This doesn't mean however that the call was completely wrong. Have a look at the following chart. Small and mid cap stocks went nowhere for multiple months. It's only in the last two weeks that they started to break out from a 5-7 month consolidations. Needless to say, this is confirming that risk-on is back.

(Other elements that support the idea that we saw a risk-off environment in a lot of asset classes this year:

-copper corrected 15%, I warned about copper here

-bitcoin had a correction of 50%, I warned about bitcoin here

-half of the stocks in the Nasdaq had a correction of more than 20%.)

My view that this risk-off environment would spill over to the broader equity market didn't come true and I started to become bullish again when I saw the price action in Bitcoin. I warned about the badly looking price action in Bitcoin in April, right before it had a correction of 50%. However, once Bitcoin was able to break back above the +-41 000 level, I started to become bullish again.

Three weeks ago, when it reached its all time high again, I wrote that I would like to see a consolidation, before we could move higher again. This is exactly what we have been seeing over the last three weeks.

If I look at the weekly chart of Bitcoin, I can't get rid of the impression that this is looking extremely bullish. We have been consolidating for three weeks right above former all time highs. The weak hands have been selling to the strong hands, and soon overhead supply will be gone whereafter the price can continue its rise.

Some people are afraid of buying something at an all-time high. They think they are late to the party and that the possibility of a big correction is now way higher. If only they could have bought the asset earlier on...

I'm not certain that this is a good way of thinking. Sure, when copper reached its 2011 all time high again earlier this year, I warned that it would probably see a consolidation/correction. But becoming bearish/bullish on an asset when it reaches an all time high is completely dependent on the price action that precedes it. Copper prices more than doubled from the March 2020 low without significant corrections. Sure, a healthy consolidation/correction was needed. Technical indicators like the RSI were also extremely overbought.

But the all time highs in Bitcoin are completely different. Bitcoin just had a correction of 50% and the price was able to get back to its all time high. How big are the chances that it just did this 'for fun'. Bitcoin had the perfect opportunity to fail in July this year but it didn't, it came back and has now been consolidating for three weeks at all time highs.

If you are afraid of buying all time highs, have a look at the following chart. The chart shows the price of bitcoin and each red dot indicates when Bitcoin reached an all time high. At the end of 2020, Bitcoin reached it previous all time high (set at the end of 2017) and a red dot is drawn. What followed? A collapse in the price? No, more red dots followed the first one. Once an all time high is breached, we often see a parabolic run in prices. This is not something specific to Bitcoin, we see it in all asset markets. Buying an all time high might be difficult emotionally, but rationally you should think of doing exactly that.

source: @Erik_Hansen_

I'm not the first person who has discovered this. Jesse Livermore knew this 100 years ago as well...

Jesse Livermore: "The fact that a stock is selling in new high territory should only encourage a speculator."

Another way to look at this is through the following chart.

The blue area shows the distribution of annualized returns when Bitcoin is trading off an all time high (defined by Bitcoin being more than 5% from its all time high.)

The red area shows the distribution of annualized returns when Bitcoin is near an all time high (defined by Bitcoin being less than 5% from an all time high.)

As you can see, the return distribution is much, much, much better when you buy Bitcoin near an all time high.

You can read Nick Maggiulli's full article (source below chart) and see that the same return distributions hold for different asset classes (including gold). Buying an all time high might not be so a bad thing after all.

source: Should you buy an all-time high?, Nick Maggiulli, ofdollarsanddata.com

As an investor (I personally don't trade or speculate in any asset class.), you want to buy strength. From a mathematical viewpoint, this gives you the highest probability of success.

Gold is the perfect example. A lot of people have been trying to call the bottom for the last 18 months. Me personally, I also indicated on a few occasions that a good risk-reward opportunity was setting up. But, how bullish these set-ups might have looked, they all failed. That's why I stopped trying to catch the bottom. When will I invest in gold again? Two possible scenarios are possible:

-I'm not able to catch the bottom (or anything close) in gold. (This can be because my analysis was not good enough or because I was invested in other things with a better risk-reward.): No problem, I'll just buy the new all time high when the rising trend in gold has clearly reinstated itself.

-I'm able to catch the bottom (or anything close) in gold: My current guess is that somewhere in 2022, we'll see a big change in the market character. If I look at several leading indicators with regards to liquidity, earnings, the economy,... they all are showing that a big shift is underway. In my opinion, that will be the moment to invest in gold again.

Thank you very much for reading my article. You can follow me on twitter: @adaptiveinvest

(I was busy with another project.)

For this reason, I decided to make a video with a recapitulation of some of my 2021 market views. I'll use this recapitulation as a basis to build future market views on.

There are thus not much current, up to date thoughts about markets in this video, but it's important to see what my thoughts were so that we can easily build upon them in future articles and videos.

The price action in Bitcoin is currently capturing my attention. I share some thoughts on Bitcoin in this video as well.

I was positive risk assets for several reasons.

One of these was my expectation that the US Dollar would trend lower, I wrote: “Why will risk assets go higher? Three reasons. The first one is because the USD will go lower.”

This is sort of what we’ve seen this year. Equity markets have been trending higher but the US Dollar didn’t really decline.

However, the US Dollar failed each time it tried to develop a sustainable rally.

Again in early April, I wrote that it looked like the dollar would go down again: “What could drive this new leg higher in risk assets? As I’ve written before, the US Dollar plays a big part in this. Last week, it failed for the third time to get overbought. Although there are medium-term reasons to be bullish the USD, price action still hasn’t confirmed it.

Therefore, I’m agnostic about the medium-term direction of the US Dollar, and it can thus be the fuel that drives the next leg higher in risk assets.”

That proved to be the top of the Dollar.

Things seem to be changing however.

Note on the following chart how the bottoming formation in the US Dollar in August and December last year was very similar. Price continued to set lower lows, while the RSI showed a positive divergence by setting higher lows. The low in the US Dollar was in when the RSI failed to get oversold on a new low in the US Dollar price.

Once these rallies developed, notice how the RSI never got overbought. This was the technical signal on the US Dollar that I was watching closely. As long as the RSI didn’t get overbought, thus signaling a lack of strength in the price movement, there was nothing to worry about.

With this latest rally however, RSI got overbought for the first time in a long time. Also notice how the RSI never got oversold during this latest decline in the US Dollar.

In my opinion, this is a clear shift in the behavior of the US Dollar.

Is this really that significant that the RSI got overbought? Most people see an overbought RSI as a signal for prices to go lower again. However, a lot of times, an overbought RSI signals strength in the market and prices continue to go higher.

The following chart shows that each time the RSI of the US Dollar got overbought during the last 7 years, the US Dollar got stronger, not weaker.

The rising US Dollar has already had a big impact on several markets.

I’ve been warning about copper for several weeks:

-When gold and emerging markets reached their all-time highs, they corrected for multiple months. My expectation was that the same would happen with copper. (see this link for chart)

-Copper was retesting it’s breakout level and I wrote that it better held those levels or copper would be in trouble. (see this link for chart)

This week, copper failed to hold on to its breakout level on a weekly timeframe.

Another thing I noticed was that Bitcoins’ price action was clearly changing. Since I warned about it, prices have corrected significantly.

In my tweet above on bitcoin you can see that I wrote that the price action in several assets was supporting ‘something’.

The thing I was writing about was a possible trend change from risk on to risk off.

We started to see it in the price action of certain asset classes but it is also supported by the fundamentals.

As the following chart shows, a strong economy (in rate of change terms, as represented by the ISM here) is usually not good for the stock market.

The vertical black lines show when the ISM gets above the 60 level. As you can see, stocks usually see a correction or long consolidation not much later (indicated by red circles).

Has the time come that the weakness we are seeing in things like copper and bitcoin will start to spill over to the broader equity market?

It’s certainly interesting to note that the S&P500 has reached its price target. (Fibonacci extensions work rather good to set price targets once prices get into new all-time highs, and there are thus no more resistance levels.)

As you can see, we are now slightly above the 1,618 Fibonacci extension of the Corona crash.

Notice that the Corona crash itself started at the 1,618 Fibonacci extension level of the Q4 2018 market decline.

Also notice how the equity weakness in 2015 and 2016 started at the 1,618 Fibonacci extension of the 2008 market crash.

The combination of all these factors (rising US Dollar, strong economy is not good for the market, price target reached, other asset classes starting to show ‘bad’ behavior) makes me think that the stock market could be in for some trouble. (Trouble = 10% correction or a long consolidation.) (I’ll explain later in this article when this view would be wrong.)

This is something I was already anticipating in early February when I wrote: “Imagine we are April/May/June 2021 (I don’t know the specific point in time) and the S&P500 is 10-15% higher and interest rates have reached their target.

At this moment, bullish sentiment and positioning will be extreme. Everything will be priced into the equity market.

The higher interest rates will start to put pressure on the US economy and the US equity market will start to discount this."

Let’s get to gold.

I laid out the fundamental backdrop that I was anticipating for much higher gold prices in early February when I wrote: “The markets will correct and the Fed will need to step in. The Fed will see that higher interest rates are sending the US economy back into recession when unemployment is still extremely high and the economy extremely weak (on an absolute basis). This is the moment when the Fed will need to introduce Yield Curve Control. This is also the moment that gold will start to rise again in a significant way.”

Note that at that moment, I was bearish gold because interest rates just broke out.

Gold prices declined and started to bottom in March-April. I got back in the gold market at the end of April - early May.

Gold got crushed this week for two reasons. The first is the rising US Dollar. The second is the fact that the Federal Reserve was more hawkish during its meeting this week than the market was expecting. Both a rising US Dollar and rising real interest rates crushed gold.

Let’s take a closer look at the US Dollar. I’ve written in the past why I’m long term bearish on the US Dollar. If you look at the following model, you can see why I think that we’ll enter a multi-year downtrend in the US Dollar.

(Valuations also support a decline in the US Dollar.)

How do we reconcile this big picture bearish view on the US Dollar with my earlier observation that once the RSI of the US Dollar gets overbought, it usually continues to get stronger?

As I’ve written in the past, it’s important to analyze the data differently depending on the market regime you are in. (For example, high speculative positioning in gold works well to capture peaks in a long term bear market but not when you are in a bull market.)

So, let’s have a look at the usefulness of the RSI signal in the period from 2000 to 2009, when the US Dollar was in a long-term bear market.

As the following chart shows, when you are in a long-term bear market, an overbought signal usually marks the top.

So, are we already in a long-term bear market? My model certainly indicates that we will be in one for the next few years. But if you look at the technical picture, it is not yet confirmed by the market in my opinion.

If you look at the weekly chart, it’s only when the 89 level gets broken, that we can be certain that the multi-year bear market has started.

Don’t get me wrong, I think this level will fail sometime in the future (because my model indicates it). But, we could be witnessing the start of the last dollar rally before the multi-year downtrend starts.

As the following chart shows, medium-term US Dollar strength wouldn’t be surprising given the fundamentals strength of the US economy versus the rest of the world.

Source: Martin Enlund, Andreas Steno Larsen, FX weekly: a 20% stronger USD on the cards?

The way the US Dollar behaves in the next few days will tell us a lot. If it continues to rise, we know we are in for more strength. If it starts to fall quickly (as was the case during the 2000-2009 bear market), we know that the bear market has already started and that the 89 level will probably fail in the near future.

This price action will also tell us if we should indeed get worried about risk assets or not in the short term.

Normally I would now go on and write a fundamental analysis on gold, real interest rates and the Federal Reserve. But since my views are not clear enough at the moment, I’ll skip that.

For me, only the technicals matter now.

As the following chart shows, gold is now at a crucial point. In my opinion, this is a must hold level. Gold broke down in March this year but was able to recapture this level in April, thus making it a failed breakdown. We now saw an extremely hard retest and in my opinion, it’s a must hold level.

The relative strength of silver has been very impressive during this multi month correction in the precious metals sector. As you can see, gold made several lower lows (indicated by the red line) while silver made higher lows.

If you look at the topping formation in 2011-2012, we saw the opposite. After its peak and first correction in 2011, gold had three rallies that all stopped around the same price level (red line).

Silver however made three lower highs.

It is clear that during the 2011-2012 topping process, silver was behaving much weaker.

This time, silver is behaving much stronger than gold. This indicates to me that big picture the bull market is still intact and well.

The short-term picture however, doesn’t look as good. The price action in some mining charts is just awful. The whole sector was looking very bullish but it all changed this week. I showed this big picture view of the current price action in gold versus silver, now versus the 2011-2012 top, to remind myself that if gold will structurally go lower, silver would probably not be behaving as well as it is doing right now.

Gold will need to prove itself very quickly and the US Dollar better fails or gold will have a rough time doing it…

We are at a crucial point for the US Dollar and gold. Let’s see what next week brings.

Thank you for reading my article.

You can follow me on twitter: @adaptiveinvest

In that article, I explained why I went from being fully positioned in gold, to selling my entire portfolio: “I sold my whole portfolio and went to cash. When the facts change, I change my mind.”

I concluded that article by stating that it would take more time before the next leg higher in gold would start: “So, is the bull market in gold over? Certainly not. But probabilities suggest that the next sustained move higher won’t be starting in the short term.”

At the end of February, I tweeted a thread on twitter showing that long-term technical levels that should have hold, failed.

The following article shows why these levels were so important: link.

The reason gold has had such a difficult time is because of rising interest rates. As I’ve showed in my previous two articles, there is a chance that interest rates have put in a temporary peak.

Now, take a look at the following chart from Mikael Sarwe.

Inflation is going to explode in the coming months.

Source Mikael Sarwe, Nordea

What if interest rates have already discounted a big part of this move higher in inflation that’s coming? This would imply that inflation would rise more rapidly than nominal rates, which would lower real rates and would thus be bullish for gold.

You could also argue the opposite. Nominal rates have already risen a lot but given the (temporary?) inflation that’s coming in the next few months, this move is not yet over. Nominal rates will continue higher and pressure on gold will remain.

Are there historical episodes where inflation moved sharply higher but interest rates didn’t? The following chart answers the question. As you can see, in 2007 and 2011, inflation rose sharply (blue line) but interest rates declined (black line). I indicated these two episodes in green. This was very bullish for gold.

In the second half of 2016 (indicated in red), inflation rose sharply but so did interest rates and gold got crushed.

Thus, it is perfectly possible that over the next few months, inflation will rise quickly but interest rates will consolidate. This would be extremely bullish for gold.

But how do we know that’s it not the second scenario that will play out? What if interest rates continue to rise?

The following chart shows the trajectory of the ISM and interest rates at the interest rate peaks highlighted above (2007 and 2011).

We can see that the ISM declined in both instances.

In the second half of 2016, when interest rates moved higher, so did the ISM (not shown on this chart).

The following model from Nordea shows that probabilities are high that we haven’t yet seen the peak in the ISM for this cycle.

Source: Nordea: FX weekly: Nothing else matters (than the USD), Martin Enlund, Andreas Steno Larsen

We must remember that in the second half of 2016, the move higher in interest rates started when yields were at their lows.

Given the fact that we have already seen an enormous move high in interest rates, it is my expectation (given the technical picture of interest rates I showed in previous articles) that a consolidation is the higher probability event.

Could I be wrong and is it possible that interest rates just continue to move higher when the inflation prints start to come in? Absolutely.

Luckily, the technical picture of gold is showing an extremely simple risk-reward setup right now.

Let’s first have a look at the big picture weekly chart of gold. As you can see, once the 1780 level failed, gold moved sharply lower.

As long as we are below this level, the bulls have a lot to prove.

The 1780 level served as resistance three times in 2011 and 2012 and last year, the gold price consolidated multiple weeks below this level. Once it broke above, the move to 2000+ gold started.

If we get back above the 1780 level, that will be the point to get back into gold. Until that occurs, expect this level to act as stiff resistance.

If we look at the daily chart, we can see the importance of this level even more clearly (on the daily chart the level to watch is 1770).

So, trading gold is now rather easy in my opinion.

There is a possibility that gold could enjoy an amazingly bullish fundamental backdrop over the next few months. Inflation will rise sharply and historically speaking, interest rates don’t always follow. As we saw in 2007 and 2011, gold did great in those instances.

To know if this scenario is indeed going to play out (and to profit from it), you just have to buy gold (or your favorite gold mining shares, or silver), once gold breaks above the 1770 level. This would be the market signaling that this scenario is indeed going to play out. The risk-reward opportunity is great. (And it's also very easy to risk manage your position with this setup.)

Another thing I’ll be looking at is the price action in Barrick Gold Corp.

If it can get back above the 22.18 level, this will be another confirmation signal that it was a false breakdown.

The only thing we need now is some patience. Don’t rush in and start buying. Wait for the market to confirm this view. As Jesse Livermore said: “The good speculators always wait and have patience, waiting for the market to confirm their judgment.”

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest

Quick reminder, I started the year being bullish risk assets (see this article) but 2 weeks ago, I saw some possible warning signs (see here).

As I wrote, I got stopped out of the few positions I initiated this year. (I’ve got both a price and a time stop. If the market doesn’t react the way it should at the point I buy it, it’s a warning sign. If you want to learn more about this, both Mark Minervini and Jesse Livermore wrote about this in their books.)

The possible developments I’m seeing might give me a second chance to initiate my positions.

The Nasdaq saw a correction of around 11%. Big picture, this was just a retest of former resistance, as the following chart illustrates.

It was also interesting to note that the correction was mostly isolated to the Nasdaq. The S&P500 barely corrected and European equity markets also did very well.

On Thursday, we broke above the March 17 high in the Nasdaq. This was the confirmation I was looking for that the low was in.

Corrections are never a straight line down, there are always counter trend rallies of a few days or weeks. It is when the price can break above the resistance of the most recent rally, that probabilities rise significantly that the low is in.

The following chart shows this for the most recent correction we saw in the Nasdaq.

We can see the exact same pattern in the March 2020 crash…

And in the Q4 2018 correction...

The following chart shows the strong correlation between the Nasdaq and the Semiconductor Index (SOX).

It is interesting to note that the SOX already made new all-time highs last week. Is the Nasdaq to follow?

Last week, SOX increased 9,5%. This price thrust could be very significant according to Macro Charts (@MacroCharts). He shared the following chart on twitter and wrote: “Price Thrusts usually trigger the start of massive rallies – especially in bull markets.”

Source: Macro Charts, @MacroCharts

What could drive this new leg higher in risk assets? As I’ve written before, the US Dollar plays a big part in this. Last week, it failed for the third time to get overbought. Although there are medium-term reasons to be bullish the USD, price action still hasn’t confirmed it.

Therefore, I’m agnostic about the medium-term direction of the US Dollar, and it can thus be the fuel that drives the next leg higher in risk assets. (If it gets overbought, I’ll change my opinion.)

Note in the chart above that the bottom in the US Dollar in September 2020 and January 2021 followed the same technical pattern. Price continued to make lower lows where the RSI didn’t, thereby creating a bullish divergence. Note that it is only when the RSI fails to get oversold, that the dollar bottomed.

(Just noting that there is a divergence doesn’t mean anything.)

This same technical pattern is now visible on the US 10 year yield (but in the opposite direction).

Yields continued to make higher highs, but the RSI started to show a divergence. This past week, yields made a new high but the RSI failed to get overbought…

As I’ve shown in a previous article, the weekly RSI is at one of the most extreme overbought levels in history. This also indicates that we could be seeing a period of consolidation.

Besides the price action, sentiment is also extremely negative bonds.

The following chart from Macro Charts (@MacroCharts) makes this very clear.

Source: Macro Charts, @MacroCharts

Because a higher discount rate has a bigger impact on companies whose earnings are further away in the future, rising yields impacted the Nasdaq more than other sectors.

If yields can stabilize here, this should be good for the Nasdaq.

Another sector that can profit from stabilizing yields is the precious metals sector.

I’ve shown the big picture technical set-up in my previous article and nothing has changed since then.

If it can prove itself, I’ll get back in.

One big caveat: it's not because the sentiment in bonds is extremely bearish and because the RSI of the 10 year yield is extremely overbought (on a weekly basis) and showing a negative divergence (on a daily basis), that we'll certainly see a consolidation.

In my opinion, fundamentals clearly support higher yields.

I'm long FCX at the moment which isn't impacted by rising yields as is the case with gold mining shares.

If I decide to take a position in the gold mining shares, I'll do it at a logical point where it is easy to see when I'm wrong so that I can risk manage my position easily. In my opinion, this is not yet a time to have big confidence and just buy and hold the gold mining shares.

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest

No fundamentals in this article (or maybe a bit), just technicals.

US Dollar

I’ve been (big picture) bearish on the USD and was watching it closely the last few weeks. I wrote in previous articles and on twitter that the RSI shouldn’t get overbought. If it did, we should start to lean to the bullish side. We came awfully close but in my opinion, I wouldn’t say the RSI got overbought. The vertical red lines indicate previous times when the RSI of the USD became overbought. You can see that the rally was only beginning in those instances.

If the dollar can still get overbought in the next few days/weeks, the intermediate term picture changes. The following chart shows how relative growth expectations are an important driver of the USD. (Remember the dollar smile, I wrote about it here.)

The current situation looks a lot like early 2018 from this point of view.

The only difference is the price action. The USD signaled an overbought signal at the end of April 2018, after which the USD moved much higher. Thus, keep a close eye on the USD, it shouldn’t get overbought, if it does, be ready.

Source: Martin Enlund, Dollar-o-meter, There's some 2018 in the air

To say that the only difference is the price action is a bit too quick. There is another big difference. As I have stated on several occasions, it is my view that the USD is in a multi-year down cycle.

I won’t go into all the fundamental reasons for it in this article. As you may already now, I’m not a big fan of narratives, I prefer to use models and leading indicators.

Below you can see my big picture leading indicator for the USD.

As you can see, it’s rather negative. (that’s probably an understatement looking at the fact that the leading indicator goes vertically down…)

The overbought RSI signals of July 2014, October 2016, and April 2018, all occurred when the model was showing we should expect dollar strength. Now it is signaling we should expect extreme weakness in the coming quarters and years.

So even when we would get an overbought RSI and the USD moves higher because of relative growth expectations, this will not change my big picture view on the USD.

(Please note that I’m not expecting the USD to ‘collapse’. The model might be going straight down, but I’m not at all expecting that the USD will go vertically down as well. What I’m expecting is that for the next few years, the trend in the USD will be structurally lower.)

Interest rates

Interest rates have risen sharply. On January 6th, I warned about this when I wrote: “10 year yields only broke out today. Gold bulls need to be careful because in the past, when they broke out, they moved quickly.”

The weekly RSI for the 10 year yield is now extremely overbought. The last two times it was this overbought was in May 1987 and in May 1994. (see vertical red lines on following chart)

If we take a closer look at these two instances, we can see that a multi week consolidation followed. However, the move higher in rates was not over. After this consolidation, rates went higher. This fits with my fundamental view that both growth and inflation will come in extremely strong over the next few months. I wrote about it here.

I thus think that we can consolidate for some time, but rates will go higher afterwards.

Gold

Gold bulls have had a very tough time. Once the all-important 1780 level failed, gold moved sharply lower.

The chart speaks for itself. I can’t stress enough how important this level was.

If you want to know why, please see this thread on twitter: Link

Gold mining shares

Gold mining shares are showing some very interesting technical patterns.

On November 2nd 2020, I wrote: “For GDX, I have drawn its horizontal resistance level and for the HUI, I have drawn the slightly decreasing resistance level.

If GDXJ has a slightly decreasing resistance level, and not the horizontal one that we have been analyzing up until now, the target would be 46.”

(The chart below is from 4 months ago.)

Now, 4 months later, we have reached these targets.

The following charts show GDX. As you can see, it perfectly back-tested its horizontal support level which was former resistance.

Next we have GDXJ. It perfectly back-tested its slightly decreasing former resistance level.

Same for HUI…

So gold failed, but the mining shares are still holding up. What’s going on?

Well, I don’t really care. I’ll just get back in when gold gets back above 1780. This will indicate that it was a false breakdown. I don’t mind missing the first 10-20% move in the mining shares. Two reasons for this: 1) I can still ride the rest of the move with much higher conviction, and 2) there are a lot of other assets that are performing extremely well and in which I currently have more interest. (For those interested, I’m long FCX)

Finally, I noticed something interesting on the chart of GDX. After GDX broke out of its multi-year base in April last year, it formed a head and shoulders pattern on the breakout level.

This pattern failed and we rose sharply.

You could argue that we are now building a similar pattern on a much bigger scale.

What if yields pause here and both gold and the mining shares can see a decent rally. After this, wen yields start to rise again, gold will correct and GDX will move lower to its support zone. At that time, it will look like a huge head and shoulders top on a multi-year support level. That might be the perfect time to go long.

(Please note that this is just pure speculation but I think that it’s an interesting pattern that could develop if interest rates can take a breather.)

At the beginning of each year, I have the habit of formulating my investment outlook for the next 12 months. This year was the first year that I had some difficulty with formulating a view. Luckily, I’ve put together all the pieces and have a rather high conviction view now.

In every article I wrote on gold, I warned that there was one uncertainty that always bothered me. My view on interest rates was clouded. Now that interest rates have chosen a clear trajectory, everything is clear again. Let me explain.

(Throughout this article, I make reference to the leading indicators I use for the USD, the economy, interest rates,… I didn’t include the charts again in this article because I’ve shared them all in previous articles.)

Let’s start with an update on my bullish view on Emerging Markets. I wrote in my previous article that sentiment was running high and that the USD would probably go higher in the short term. These two factors were cautioning me to buy the Emerging Markets straight away.

Since that last article, we saw a +-5% correction in equity markets and the USD reached its target, just as expected.

I was expecting that the peak in the USD would coincide with the low in the equity markets but unfortunately, this was not the case. I therefore did not buy at the low. Even though my analysis was correct, it did not exactly go as planned. I don’t really care however because my conviction that risk assets will move higher is now much bigger than when I wrote my previous article.

Why will risk assets go higher? Three reasons. The first one is because the USD will go lower. (I showed you the leading indicators I use in previous articles.) You can see on the following chart that since the bottom in March 2020, each correction in the equity market (I use the S&P500 but the same goes for Emerging Markets) coincided with the USD going higher.

Since the USD is starting to go lower again, this should be good for equity markets.

The second reason why I think equity markets will move higher is because of the sentiment/positioning.

I warned in my previous article about the high sentiment and positioning of active investment managers.

You might think that a 5% drop in the equity market was not enough to reset sentiment. The fact is however that their exposure dropped from 112 to 79 in two weeks’ time.

Have a look at the following chart. We barely saw a 5% correction in the S&P500 and the VIX spiked more than in October last year when we saw a 10% correction. I saw some analysis on twitter that showed that we have never seen a spike like this in the VIX, given the (small) magnitude of the correction. This indicates that fear in the market was rather high.

On top of that, we saw an extreme de-grossing (almost as extreme as in March 2020!) in equity markets. So the correction we saw might not seem like a lot but when you look at what impact it had on market participants, it certainly was extreme.

Source: @Moritz_of_Hesse

The third reason I think why equities will go higher is because of fundamentals. Fundamentals you say? Isn’t this the biggest bubble in history? Valuations are extreme and the economy is suffering badly. There are no fundamentals supporting this rally!

Well, that all sound very reasonable but unfortunately, I’ve heard these ‘arguments’ since April last year and they clearly didn’t work.

The fact is that the stock market is a discounting mechanism. It will not rise when everything is fine in the world. It will rise when there is a lot of uncertainty and better future times are being discounted.

The worst economic prints we ever saw occurred last year in the months of March, April, and May.

This means that in the coming months, we’ll see some of the best economic data ever. The reason is because we measure it on a year-over-year basis. If we saw extremely bad figures in April last year, we’ll see extremely good figures in April this year because the figures to which we compare them are so low. (You need to think in rate of change terms, not in absolute levels. There is a lot of empirical evidence that markets work on a rate of change basis and not on absolute levels. I won’t explain why in detail here. But I advise you to think deeply about this because it makes a lot of sense. I’ll give you a tip at the end of this article.)

This strong economic data is also being predicted by the leading indicators I use.

I know that there are a lot of problems with the economic picture if we look at it on an absolute basis (high unemployment etc.) but this doesn’t matter yet for the market. It will matter in a few months’ time, but not yet now. I’ll get to that in a minute.

This thesis that we’ll see strong economic data is also supported by the movements we see in US interest rates. As the following chart shows, US interest rates broke out in early January. We saw a retest from the breakout and are now moving higher again. The first target I have is around the 1,44% level. With the economic data we’ll see coming through in the next months, it seems clear to me that interest rates will move higher.

Given the trajectory higher in interest rates, I’m not bullish on gold for the next few weeks/months. But, as I’ll explain, I already know when I’ll get bullish again. (If the price action shows me I’m wrong, I’ll adapt of course.)

Let’s quickly recapitulate the scenario I’m seeing. (The word scenario seems to imply that it’s some kind of a narrative I’m following, which it’s not. It’s all supported by my leading indicators which I’ve showed in previous articles.)

Both the equity market and interest rates will move higher on the strong data (on a rate of change basis) we’ll see coming through in the next few weeks/months.

Imagine we are April/May/June 2021 (I don’t know the specific point in time) and the S&P500 is 10-15% higher and interest rates have reached their target.

At this moment, bullish sentiment and positioning will be extreme. Everything will be priced into the equity market.

The higher interest rates will start to put pressure on the US economy and the US equity market will start to discount this.

I think that the US equity market will peak together with US interest rates, just like they did in October 2018. (see next chart)

The markets will correct and the Fed will need to step in. The Fed will see that higher interest rates are sending the US economy back into recession when unemployment is still extremely high and the economy extremely weak (on an absolute basis). This is the moment when the Fed will need to introduce Yield Curve Control (I talked about it in this article). This is also the moment that gold will start to rise again in a significant way.

So, there you have it. Every leading indicator and asset class I’m following is perfectly in sync with this ‘scenario’ I’m seeing. This is just a small part of my analysis. I have several models and indicators I follow on the stock market and bond market and they are all leading me to the same conclusion. (Remember in a previous article where I wrote that stock markets around the world are all giving the same signal. This is in sharp contrast to mid 2018 and early 2020, just before the market saw a big decline.)

For some, it might be strange that I make a distinction between the rate of change, and the absolute level in economic data.

However, take a look at the following from Bridgewater: “At their root level, asset prices represent expectations about future conditions and asset returns are driven by how conditions evolve relative to expectations and how expectations change.”

As you can see, it’s about the relative change in conditions and expectations, and these are measured on a rate of change basis, not on an absolute basis.

(If you ever read a book on the psychological reason why value stocks beat growth stocks in the long run, you’ll understand that investors are ‘very good’ in extrapolating recent trends into the future. Thus, a change from very good data to good data is bearish for risk assets since conditions come in lower than expectations. Why? Because investors extrapolate the recent past into the future and were thus having high expectations. By using leading indicators, you avoid falling into this trap.)

Let me explain it with an example.

Imagine the situation between April 2020 and now. All the news was negative. We saw the fastest decline ever in the stock market, economies worldwide were shut down, earnings were dropping like a stone, former central bankers were warning about a new depression, and fore many months, we literally had no perspective on a better future.

The stock market didn’t care however. The market bottomed on March 23 and has been rising despite all the negative news. Why? Because it was discounting a future that we couldn’t imagine yet. It was discounting human ingenuity. It was discounting that future conditions would be better than expectations. (Just go back to last year March and ask yourself what you thought the world would look like in a few months. I think we were all thinking the world would end (Not literally of course but you know what I mean.). When your expectation is that the world will end, and with the fastest stock market decline ever in March, the market seemed to agree, it wasn’t difficult afterwards to discount a better future than was priced into the market, thus equities rose despite all the negative news.)

Now imagine we are July 2021 and a lot of people got vaccinated, the US government is talking about huge stimulus bills and economic data is coming in strong. (On a year-on-year basis, supported by the leading indicators.)

Now, everyone will think that everything is fine again. Soon, we will be able to get our old live back, time to buy stocks!

No, at that moment, we need to think about which view of the future the stock market will be discounting. It will probably focus on the fact that unemployment is still extreme, on the fact that deficits are extremely high, on the fact that economic data going forward will not beat the extremely good relative levels we just saw. That will be the stock market peak. The market will correct. The fed will panic. The release valve will be the USD, which will get smoked. Equity markets will rise again (with Emerging Markets outperforming the US market) and gold will rise again.

Let’s see how my 2021 prediction plays out. I’ll write an update when some of my views change. Of course, it won’t go exactly as laid out here but if I get the big moves right, I can trade around those and make a lot of profits, that’s all that matters. As you already know, I’ll risk manage my positions with every investment I make.

The biggest risk is the USD. Rising interest rates in the US make the US currency more attractive. A rising USD will coincide with the next equity market correction. It is at this point that the Fed will need to step in. Rising interest rates and a rising USD will put the economy back in recession, it can’t allow that to happen.

If the USD starts to rise earlier than anticipated, watch out.

At the end of last year, I was wondering how the Fed would arrive at the point where they need to introduce YCC. It now fits in perfectly with the scenario I’m seeing, all supported by my leading indicators and by the price action in the major asset classes. This only adds to my conviction on this view.

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest

This week, I want to have a look at the short term price action we are seeing.

To start off, we saw a weekly breakout in emerging markets this week, just as I was expecting.

My expectation is that the price will now go significantly higher in the short term.

When the Russell 2000 broke out in November last year, it increased almost 25% in 3 months’ time. If the Russell 2000 can do this after a breakout from a 2-year base, then I think Emerging Markets can do the same when they break out from a 10-year base.

I can understand that for a lot of people it’s probably scary to buy something at it’s highest price ever.

But take a look at the following chart from Nick Maggiulli.

The chart shows the evolution of the Emerging Markets stock index since the late 1980’s. Each new all-time high is given a red dot. You see what follows a red dot? Another red dot, and then another, and another,…

The fact is that once a market breaks out, overhead supply is gone and there is a lot of room for prices to go higher as the following chart shows beautifully.

Source: ofdollarsanddata.com, Should you buy an all-time high?

According toNick Maggiulli, the average performance over the next year when you buy EEM within 5% of an all-time high is 16,8%. When you buy it at a point when it’s more than 5% away from it’s all-time high, the average return for the next year is only 8,4%.

So, let’s go all-in, right?

Not so fast. One thing I don’t like about the current set-up is the extremely positive sentiment we are seeing in markets in general. The following chart shows the NAAIM US equity exposure. It indicates how bullish or bearish active investment managers are for the moment. As you can see, they have never been more bullish.

Source: Dana Lyons, lyonssharepro.com

The next chart from MacroCharts shows the daily sentiment index for the S&P500. As you can see, sentiment is extremely bullish and historically this hasn’t been good for the market.

Source: @MacroCharts

If you look at equity flows and option activity for Emerging Markets, you’ll see the same extreme sentiment readings.

So, what should we do?

First thing to note is that sentiment indicators are much better in capturing a bottom in the market than a top.

We should also note (and this is extremely important) that we are seeing broad participation in markets across the world:

-The Dow Jones Transportation Average has reached new all-time highs. (It was flat since the beginning of 2018.)

-The Nikkei 225 is breaking out of a 30 year base. (Yes, it has basically done nothing for 30 years.)

-The Russell 2000 has broken above all-time highs. (See earlier chart, it was flat since the summer of 2018.)

-The FAANG stocks, which have been basically flat since early September last year, are starting to break out again.

This is all indicative of broad market participation. Stock markets worldwide are all giving the same signal: you should own stocks.

This is in stark contrast to the middle of 2018 (when a 20% decline followed) and early 2020 (when we saw the covid crash and markets lost 30%) when we were seeing a lot of divergences between all of these markets.

Another point I want to discuss is the dollar. The dollar peaked in the middle of March last year and has been declining strongly since then.

We are currently seeing a countertrend bounce in the USD as shown on the following chart.

Notice the positive divergence between the USD and its RSI that formed when the bottom was developing. It was the exact same pattern as we saw in August last year. (Price keeps declining but the RSI doesn’t confirm it. Once the RSI doesn’t get oversold anymore, that’s the bottom.)

Also notice how in late September last year the RSI of the USD failed to get overbought? This was to be expected when the USD is in a bear market. The countertrend rally in the USD in August-September last year took place in 3 phases as indicated by the orange line below the USD price.

My expectation is that we will see the same thing happening this time. This final (relatively small) leg higher in the USD will hopefully put some pressure on risk assets. If the RSI of the USD can get to the top of it’s range (without getting overbought!) and we see a correction in risk assets, that will be the time to go all-in.

The following chart shows my trading plan:

Please note that this is conditional on the price action I see in the USD. If the USD bounces and its RSI manages to get overbought, this would indicate that something more is potentially in store for the USD. I’m not expecting that but we should always prepare for each outcome.

This trade has a profit potential of 20% in a rather short time with a risk of 4% (If you buy it at the upper red circle and put a stop at the lower red circle.). That seems pretty good to me.

Why am I rather confident that the USD will continue its trend lower after this bounce?

Isn't it possible that we see a new big move up just like in early 2018?

The reason I’m not expecting a big new upmove is because the fundamental picture is now completely different. I wrote about this in my previous article (see here) and also in an article a few months ago where I explained the rise in the USD in 2018 (see here).

If you look at the following chart, which shows the Chinese credit impulse, you can see that it’s a leading indicator for the EURUSD (and thus also for the USD). In 2018, it was clear that surprises in the USD were to the upside. Now, surprises should be expected to come to the downside.

Source: Nordea, Andreas Steno Larsen & Martin Enlund, FX weekly: The year of the Ox

In a bull market, surprises come to the upside. For this reason, I’ll ignore the short term sentiment and positioning risks I’m seeing. With all markets breaking out worldwide, it’s difficult to be bearish bigger picture (Remember that in the middle of 2018 and early 2020, we were seeing divergences between these markets, they were warning you of risks to come. This time, they are all agreeing.).

I’m hoping that a USD bounce can put some pressure on risk assets, thereby giving me a good entry point to go all-in.

If not, I’ll buy once we break out above the former daily high as indicated on the previous chart.

In all circumstances, I’ll sell when the price action tells me I’m wrong. (Note that this only works when your timing is good. If you just buy at a random point, there are no clear points where you can say that your thesis is incorrect, you are just guessing. In this instance, it’s rather clear when my thesis will be proven wrong. As Peter Brandt puts it: “Charts will give you the idea of the path of least resistance, but charts do not forecast. There is a danger when people start thinking of charts in terms of forecasting. Charts are wonderful in finding specific spots for asymmetric risk/reward trades.”)

Good risk management will help me to protect my capital when I’m wrong. It’s one of the easiest concepts to read about, but one of the most difficult to execute, as legendary trader Mark Minervini states: "The goal with stock trading is to make money consistentlyby taking trades that have more reward potential than risk. The problem for most investors, however, is that they focus too much on the reward side and not enough on the risk side. Simple as this sounds, few will follow the advice I’m about to impart to you.
…
Over time I have learned that investors don’t lose money or fail to achieve superperformance because of bear markets or economic hazards but because of mental hazards, the types of personal failings that cause you to say to yourself in retrospect, why didn’t I sell that stock when I was only down 10 percent?"

Thank you very much for reading my article.

You can follow me on twitter: @adaptiveinvest