May Reed's Report Insight

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I think that this chart on top really describes the situation quite well. We've been in a trading range for a year in the s&p, and we have a smaller range really since December and then we have an even smaller range in that over the last month or so. So we're in a range within a range within a range that keeps getting tighter and we have really similarity and a lot of different markets CLTs, the long bonds have been in a range since mid November as well. Traders and investors are not very certain about what's going to happen and they've had a lot of tug of wars and battles that are pretty violent in the range, but we remain range bound and basically, the parameters are 3500 - 3600, that support level. The 4300 and so that's like here and here and really, that's the key break and we need to break one way or the other of this big range to really determine anything. The small ranges, you can break out and you'll have a target at the next range until you've really broken clearly or you start to see some really strong internals one way or the other that will lead you to suspect to get a break, you really still in this range and the range is people don't exactly know what's going to happen. The other thing it's important to understand is that the states of this range are actually really pretty big. 

This is a secular uptrend line and you can see that we've tested that and that test came at exactly the same point as his 200 week moving average and we've talked about how important that moving average is historically. Big corrections, or even minor recessions head to bottom at the 200 week moving average, when you get below that and you break below it clearly, you tend to get much bigger recessions, much bigger bear markets, oftentimes, you're only halfway done or even less with the potential downside and so this is a secular battle here. This range whether we pop and retest the highs, maybe have a blow off, if the Fed blinks very early, or whether we break down here, that's going to be really a key determinant, whether we're in something like the 70s, or we're continuing with this secular uptrend with one more burst of bubble. That's really kind of what we're looking at, it's really an important decision and it's why one of the reasons that the market is going back and forth, and not able to decide, really need more catalysts, or pick for a plurality of investors to be able to bet one way or the other.

While the macro analysis continues to be negative, and it continues to grow more and more negative, suggesting that recession is likely ahead. Leading economic indicators are at levels, you can see the red line here is when you have recession levels, goes this is the six month rate of change and the LEI falling below minus 4%. There's other things that people use year over year falling below minus 5% and this falling below the 18 MA, all of those signals work really well historically, for every recession, really, since World War Two. LEIs started coming out in 1937 and so they have a very good track record, they have been retroactively changed periodically to improve their performance retroactively, but real time, they've been very useful. What I want you to see is really clear, blatant signal in all three in the LEI. That's really never happened without a recession following since the 1940s. 

Then the yield curve, we've talked about the yield curve, the yield curve isn't something that I think just correlates, it's cause and effect. We call the yield curve the brake, or the accelerator of bank lending and so we have a really highly inverted yield curve, more highly inverted than they have been since the 70s and 80s. That means that the incentive for banks is really low to lend. Usually when you get really big inverted yield curves, you start having banking troubles down the road, 6, 8, 10, 19 months down the road, somewhere in that range and you start getting credit tightening where bank lending really starts to grind to a halt and you can see here since 1980, this is done and you can go back to the 60s and do the same thing. The numbers are essentially within these parameters, somewhere between zero and 19 months after you get your first inversion, you've gotten a recession every time since World War Two. We're at nearly 10 months now since we started to get inverted and so when you get the leading economic indicators and yield curves, and yield curves are part of leading economic indicators, so there is a little bit of overlap there, but we've got some other things, the Eurodollar curve, spreads swaps that are really good forward looking at leading indicators, those are all have been negative and projecting recessions for a long time with some plurality. 

Usually, when we get that the next thing you look for to determine if this is really happening is you look for a combination of credit tightening or lending start to dry up and you look for troubles in the banking sector. Well, we certainly have had that, right, we see now very tight lending standards in the US, in Europe, and actually, throughout the developed world. You look at financial conditions, indexes, they're down at levels we have not seen since the 70s and 80s, really tight conditions and you have this earning season, more CEOs complaining about credit tightening than we've had in any quarter for many decades. It's happening in Europe, South Bay in Austria, it's happening throughout the developed world, this credit tightening and that's what you would expect when you get yield curve inversions and particularly when you get LEI collapse like that. We have our banking troubles, we've had the biggest deposit flight since the 1930s. This year in terms of bank deposit flight that has led to bank failures, it hasn't been a big number of banks, but in terms of assets that the banks had, it's higher than we reached in the GFC. 

These things do two things. The yield curve, right, is where short term rates are above long term rates, and so it doesn't really make very much sense for banks to borrow short and lend long when their rate spread is negative. That's just a losing proposition. That's a disincentive to lend and now we have huge deposits flight, which means that the banks don't have any assets to lend on. Those are declining. Now, what I will talk about is how this has been kind of a run for a while on a very small number of banks, but it continues to be a bank walk, if you will, because right now, the average bank deposit is under 1% rate and the average money market fund, it's a pure T bill money market fund, it's essentially risk free, is somewhere between 4.75% and 5%. So you can make yet a lot more money from just putting your money either in T bills or in T bill money market funds that have no risk, essentially, then you can hold it in a bank where you might have problems and you're not making nearly as much money. 

So yes, the run out of the banks that are in trouble is kind of stalled and it may reappear periodically, when one or two banks get into trouble, but the bank walk that slow trickle of deposits continue to lead continues because the rate spread between what banks are paying for deposits and what you can get in T bills and money market funds is so extreme that people are just moving their assets gradually, that's going to continue to erode bank assets and make it harder for banks to loan out much. You can see historically, we get any kind of tightening lending standards, you get a year over year change in commercial loans that turns negative and so here we are, we're up at levels that we've reached before. We can see that the rate of growth is starting to come down and we suspect that we will get a negative rate of growth in actual commercial and industrial loans that grinds investment in new factories and things like that to a halt and that's what slows GDP growth. So bank failures amplify the effect of higher rates and curbing credit. Lending standards are already tightening and that generally leads down the road the next thing to happen, you start to see a slowdown in growth.

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