Markets have a way of making a fool of most investors.

On June 16th, 2022 the current bear market made an interim low and started rallying. On June 22, as the market began to rise, I warned readers to beware of the sucker’s rally. Sucker’s rallies trick people into thinking the worst is over, drawing investors back into the market only to wipe them out as the bear market resumes.

The market stopped rallying on August 16th and has since fallen 14% and is about to re-test the June 16th low.

In my article I gave 7 signs to watch (I’ve provided them below) to measure the veracity of the rally.

For the rally to be sustained, you will likely see some or all of the following:

  1. Declining inflation (via demand destruction and/or weaker commodity prices)
  2. Declining US Treasury yields
  3. A shift in central bank policy (away from tightening to expansionary)
  4. Significant valuation compression, relative to historical averages, that accommodates potential F23 downward earnings revisions
  5. Daily moves greater than +/- 1% become a rarity
  6. Stock yields converge with 10yr Treasury yields, helping make stocks relatively more attractive
  7. Many retail investors have thrown in the towel

Most signs are still flashing red. (Maybe inflation has peaked and valuations have compressed, but clearly not to any significant degree.) The market is in a pressure cooker right now and has deteriorated significantly:

  • 2yr US Treasury yields have risen about 100bps over the past month!
  • VIX is up 30% over the past month
  • Dollar index (DXY) is up 10% since June 16th low; up 22% over the past year
  • WTI trading below $80, erasing all gains made YTD

Meanwhile the Fed has become more hawkish than even the hawks expected. Jay Powell isn’t budging an inch on the inflation fight, despite tentative signs it has peaked. Understandably so. We’re a long way from his 2% target and its folly to stop tightening this early.

With yields and the dollar rising this rapidly, I fear something will soon break. Dollar surges have typically preceded (and coincided) with market crises in the past.

A rising dollar disproportionately affects foreigners – usually emerging markets – that borrow (and must repay) in US dollars. A rising dollar effectively makes it more expensive to repay debt.

A rising dollar is also a sign of a global dollar shortage and weak sentiment, as investors look to shore up collateral and flee to safety. Moreover, at a 4%+ yield the 2yr Treasury is sucking the oxygen out of risk assets.

Will short term US Treasury yields get to 5%? Possibly. The Fed won’t stop raising rates until something breaks. And it looks like something has to break for inflation to get back under 2%. The question is at what point do rising yields and dollar index break the markets?

With financial conditions worsening so rapidly, I wouldn’t be surprised if something breaks really soon.

Investors: you better buckle up.

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