The second quarter stock market performance was another cycle of rinse and repeat.  The market made its way through the quarter as it has since the fall of 2022, riding on the back of the tech stocks known collectively as the Magnificent Seven. The top ten stocks accounted for about 62% of the S&P total return. The standout performance was again turned in by Nvidia with a return of nearly 150% year to date.  Outside of the top ten stocks the remainder of the S&P eked out only a small gain year to date. It is not a healthy market. Any bad news for the Mag 7 and the market will find itself facing a pullback. 

The Federal Reserve has been keeping its lending rate at 5-5.25% in hopes of bringing inflation down to 2%. While the pace of inflation has slowed over the course of the year, it remains closer to 3%. The overall impact of inflation has been to destroy 25% of consumer buying power since the beginning of 2021.  25% is also the amount of each dollar spent by the federal government that must be borrowed.  This year’s deficit will be near $2 trillion. The massive overspending by the federal government is the impediment the Fed faces to reaching its 2% inflation target. 

While the Fed waits for inflation to come down, the US economy grows weaker. Fed chairman Jerome Powell is beginning to indicate the Fed must cut interest rates or face pushing the economy into a recession.  He is probably too late.

Recession comes on slowly and then all at once.

For 80% of the US population the recession has already arrived. Full-time jobs are being lost each month while workers are moving to part-time jobs, sometimes as many as 2 or 3 to make ends meet. Hourly wages are not keeping up with the rate of inflation. The $2 trillion handed out by the American Rescue plan kept the recession at bay but has now been spent. Credit card delinquencies beyond 90 days are at levels not seen since the Great Financial Crisis. Consumer sales for the first 6 months of the year totaled 0.15%, and that does not account for inflation. One after another, consumer discretionary businesses are stating that their would-be customers are out of money. Value meals are back at the fast-food shops. The Fed forecast unemployment at 4% by the end of the year. It hit 4.1% in May.

When the Fed begins lifting or lowering rates there is a lag time of about 18 months before the impact is felt.  The impact of the rate hikes is still coming in. The stock market prognosticators are betting on a rate cut at the Fed’s September meeting. The Fed does have a problem.  A small rate cut of .25% would be seen by the stock market as a signal for risk on, which would be inflationary.  A .25% cut would do nothing for the weakening economy. A rate cut of .75% would reveal to the market that there is cause for concern and could result in a market sell-off.  That would mean the remaining 20% of the population would also be aware of the recession. By waiting too long to raise interest rates and too long to reduce interest rates, the Fed has put itself in a corner. Historically, the Fed realized too late that a recession was underway and began to cut rates in large batches.

The market will be spooked and sell-off. The rapid exit by investors will take down almost every investment.  Historically, as in every time, the long duration government bonds are the safety ring investors will be reaching for. The 10- and 30-year government bonds (TLT and EDV) now make up approximately 36% of our portfolio.  The rates on the 2- and 10-year bonds have been inverted for the longest time on record. Inverted meaning the 2-year pays a higher rate than the 10-year. The opposite of what should be expected.  In only one instance did the inverted yield curve not correctly forecast a recession. The arrival of the recession is marked by the un-inverting of the yield curve, when short- and long-term rates are both going down but the short-term is going down faster.  That is now happening and is referred to as a bull steeping. Bullish for the bond market and our positions.

Over the course of the second quarter, I continued to reduce our equity exposure while increasing our position in gold and adding silver, the poor man’s gold. I added FLIN, an ETF which holds large companies in India. We have no other international exposure. I reduced the oil position because oil prices fall as the recession heats up.

As we move through July, geopolitics is beginning to impact the Magnificent 7. The Biden administration is working to curtail the sale of advanced computer chips to China and that is dragging down the tech stocks.  I have been taking profits in energy and commodities. I have increased exposure to the electric utility ETF (XLU). AI computing requires a massive supply of electricity. Utilities also trend with government bonds in a recession.

The global recession continues to worsen. The global export market has slowed drastically, drying up countries’ access to the dollar. China’s debt to GDP is over 300% and Japan’s is 250%. Both countries are facing banking and financial problems which could spread globally. China and Japan have both been selling their US treasury positions to prop up their currencies. In Europe there is political upheaval with globalists facing off against nationalists. Years of uncontrolled immigration, the Ukraine war and the heavy hand of green energy have driven increased popular support to the nationalists.   The Ukraine and Israeli/Hamas wars are threating to expand.  China is inserting itself into both of those wars while threating to ignite conflict in the South China Sea with the Philippines. China is on the edge of depression if not already there.

If you have made it this far then you know I am full of good news. I would love to talk more about it with you. If you would like to schedule a time to meet or talk, please give me a call on my cell, (865) 368-1917. Thank you for your trust.