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TopDown Charts: Market Cycle Guidebook – October

October delivered the third month in a row of losses for both stocks and bonds; and with that brings renewed focus on the prospect for short-term bounce especially as the much anticipated seasonal year-end rally effect gains attention.

The two major macro risk scenarios are basically either recession (and all that comes with that), or resurgence (more inflation, more monetary tightening, higher yields, and steeper recession risks down the track). Each have quite different – but equally tricky paths. Click here.

This month:

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Roth MKM: ISM, Confidence, JOLTS & Other Observations

The ISM Manufacturing Index and its sub-components for October point to sub-trend RGDP growth and weakness in both capital spending and earnings growth.

This is a level consistent with stall-speed earnings growth and stagnant capital spending.

Although headline GDP growth for Q3 was exceptionally strong, an unemployment rate gradually meandering higher is more consistent with a sub-trend growth economy nearing a cycle peak

This would also be consistent with the “gap” between the Conference Board’s Jobs Hard to Get and Jobs Plentiful indices (below), which has been closely correlated with the unemployment rate. Click here.

True Insights: Powell beats UGLY ISM in two sentences – Stocks fly

The inclusion of the word ”FINANCIAL” and credit conditions” was key in Powell’s words this week, and strongly suggests that the Fed is putting more emphasis on the recent rise in (long–term) interest rates in the Fed’s decision–making. The market read that as the end of the tightening cycle.

Powell tried to nuance his claims by stating it would require a structural deterioration of financial conditions – so not just a 10% correction in the stock markets – before they will trigger a looser Fed policy. But by that time, most stock investors had flocked to their trading accounts and muted Powell.

The odds are elevated that markets will be right this time, and the Fed has indeed completed its last interest rate hike, but the reasons behind this are far from great. Take this week’s ISM.

Based on the historical relationship between the ISM Manufacturing Index and year–over–year returns on the S&P 500 Index, the S&P 500 Index should decline to 3,530 points. That represents a 17% drop from the current level. Click here.

TS Lombard: Oct employment; Recession?

The “Sahm rule” (0.5 percentage point increase in unemployment from cycle low = start of recession) suggests 3.9% unemployment (October) means recession has begun.

Still, the net flow of unemployed-to-employed minus the reverse is still in expansion territory (see chart).

The dis-inverting yield curve, pricing in 13.5% chance of a cut in March, syncs with what the Sahm rule suggests. The equity market has not received the memo. Click here.

Rosenberg Research: Bonds About to (Finally) Have More Fun! + chartbook

The ratio of the total return index of the S&P 500 to the 10–year UST–note has soared to a record high these past three years. While the equity market has corrected and is range–bound over the past year, the Treasury market has been pummelled. But the ratio has hit an extreme, and that is the point.

Just as the ratio hit an extreme low  following a huge three–year bear market in stocks and bull market in bonds back in March 2009, which proved to be a terrific time to do a switch from Treasuries to equities — every extreme is met with a mean–reversion trade. 

The yield curve has been inverted for over a year; this abnormal condition only occurs 15% of the time. The bottom chart below shows what happens when (if?) the curve reverts to the mean of the past two decades.

This would imply a 3% yield on the 10–year Treasury note, which would deliver a net positive return of +16% within a twelve–month horizon (even more for the long bond). Click here for report and here for extended chart pack. Click here for note, and here for chartbook.