Between the debt ceiling cliff approaching, recession probability rising, and U.S. banks failing, there’s no shortage of problems for depositors and investors to worry about. On top of that, we’re entering the six worst seasonal months of the year – the “sell in May and go away” period, as the old saying goes.
It’s not looking positive on the political front because Democrats in the House of Representatives are working to force a vote on a debt ceiling increase in anticipation of a potential default on June 1. They need signatures from the majority of the House, including some Republicans – a tough proposition since Congress is bitterly divided along party lines now.
Meanwhile, with OPEC+ cutting oil output and petroleum production falling by 310,000 barrels per day due to a pipeline suspension in Iraq and a labor strike in Nigeria, inflation is likely to remain elevated for the foreseeable future. Bear in mind that energy is a major part of the inflation equation; when fuel prices are high, it costs more to ship goods by car, train, and plane.
That’s bad news for anyone who’s heavily invested in major stock market indices such as the S&P 500 or Dow Jones Industrial Average. It’s also problematic for people who thought they could hide out in the traditional portfolio of 60% stocks and 40% bonds because bond prices have moved in tandem with stock prices this time around.
The bond market, which is typically more sophisticated than the stock market, sees trouble ahead and is expressing its anxiety through multiple yield curve inversions. It’s a bizarre scenario in which bond traders can get a higher yield from short-term Treasuries than from longer ones.
Investors should monitor yield curve inversions closely because they have consistently preceded recessions since the 1970s. Yield curve inversions don’t actually cause economic downturns, but they do express the bond market’s expectations of an imminent recession, and bond traders have historically been correct in their recession calls.
The way it typically plays out is yield curve inversions (especially inversions of the 10-year and 2-year Treasury bond yields) will precede rising U.S. jobless claims. When the labor market deteriorates after years of low unemployment (like we just had), that’s the starting point of an impending recession.
It’s difficult to predict exactly how long it will take for the economy to collapse after a yield curve inversion. There’s a lag effect because short-term stock traders have been conditioned to buy every dip, but this is a case of “it works until it doesn’t.” Unfortunately, many traders are bound to lose in this risky game of musical chairs.
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Some investors have already lost fortunes. Anyone who held shares of regional banks like Signature Bank, Silicon Valley Bank, and First Republic Bank has lost most or all of their investments. At the same time, giant banks like JPMorgan are only getting bigger as they snap up smaller banks at fire-sale prices.
There is no reason to believe that this tragic trend will end anytime soon. Warren Buffett said there would be more bank failures, and he was spot-on since First Republic Bank imploded soon after he made that prediction. The Federal Reserve was unmoved by these bank failures and still hiked interest rates by a quarter point this week.
The major stock indices rose earlier this year because traders assumed that the Fed would cut interest rates, but the reality is finally sinking in: the central bankers aren’t concerned about an economic slowdown, and they’re engineering a slowdown in an attempt to calm down inflation.
Retail traders ignored Jerome Powell when he explicitly stated that interest rate cuts in 2023 aren’t in his base case. Since they didn’t get the hint, Powell just made the message clear: inflation “is going to come down not so quickly.” Furthermore, “it would not be appropriate to cut rates, and we won’t cut rates.”
Granted, the Fed also declared that the U.S. banking system is “sound and resilient,” but always remember that the central bankers will say whatever it takes to keep the markets calm. As an informed investor, your job isn’t to take what the Fed says at face value but to read between the lines and base your decisions on actual data and not on jawboning from central banks.
Amid this backdrop of extreme uncertainty, the Dow Jones Industrial Average is now back to flat for the year so far, but gold is firmly above $2,000 per ounce, and silver just touched $26. This makes perfect sense because the Fed-orchestrated collapse of the banking system only makes precious metals more attractive as a long-term store of wealth.
Plus, the recent boost in the gold and silver prices comes after a prolonged consolidation period that tested investors’ patience. Yet, as the old saying goes, patience pays – and the right trade now is in assets that have enduring and tangible value that don’t rely on the “wisdom” of error-prone monetary policymakers.
Chief Editor, CrushTheStreet.com
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