More pain in the market this week with S&P down -6%. Though it is safe to assume we will get some slowing in the economy due to this hawkish Fed, we can’t be convinced that it will translate into a larger drawdown (like 2008-09) until we see some other signs. I (almost) never make market calls, except in the case of a market crisis that leads to a large and long drawdown.
We have two factors currently telling us that the potential of a larger drawdown is possible: weak price momentum and the yield curve tending to invert (2s-5s; though 2s-10s is better indicator). Other factors that we look at are still positive such as Purchasing Managers Index (“PMI”, still growing, though less so), Leading Economic Indicators (ditto), and “Financial Turbulence” (a sophisticated measure, but generally flashes a warning sign when returns, correlations, and volatility start deviating from norms; still ok). Some other factors pointing to “risk off” include relative strength in defensive sectors like Utilities (yes) and Treasuries (yes). If one or two of the factors turn negative, we could be in for a larger protracted drawdown; we won’t know that until January 3 for the PMI release. In that case, and depending on the specific client situation, I could be inclined to move some client assets into long maturity bond ETFs or cash, depending on what is driving the dive. We would get back into the market when the indicators turn positive which could take months!