Broker Check


| June 14, 2023

I’ve mentioned previously just how much time I spend pouring over data, and listening to/reading market research and opinion.  That has been on overdrive (somehow) in the past several weeks, as I have found myself increasingly perplexed by what was unfolding in markets.  We had recently reached levels that I had decided to implement “max hunker-down”, which – as those of you who have been following along will remember – was the point where I take portfolios to the lowest risk exposure I was willing to go (which is different for every client of course). 

Yet, as markets reached these levels (4220 on S&P 500 was my level to be exact), I did not pull the trigger.  I simply couldn’t get myself to do it, and I needed to examine further why I was feeling as I was.  So, I cleared the calendar for the week, and embarked on another “deep dive”.  The process involved revisiting some of the more useful research I had run into in the past, and checking for any recent updates from the authors – one in particular which will be discussed at length below.  From there, it involved hours and hours of conversations between the three of us – in addition to some of you reading this (though you were likely unaware you were part of the process).  All finally led to prioritizing all of the information digested – then organizing it in a way that would hopefully bring some clarity.  Thankfully – and so thankful I am - it did just that.

As I was going through this week-long journey, I kept finding myself thinking “I bet clients would enjoy some of this”.  So, after the third or fourth time with that thought, I decided to organize the most pertinent information into this special update – a whopping two weeks after the last one.  With that decision made, I had to then decide to break the promise I try to make to myself each week (for self-preservation purposes) to “shut it off” come Friday afternoon.  Instead, I found myself still in the office at 1am Saturday morning – still sitting here typing at 2am Sunday morning – all in an effort to transfer a pile of data, charts, etc. that largely resembled something you would find posted in a kindergarten classroom (at least in terms of its artistic simplicity) into something presentable.  We will see how I do. 

Final note before we get into it - as much as the update a couple of weeks ago was intentionally designed to be brief and non-technical, I will promise neither in this one.  This update is meant for those readers who are truly interested in economics and financial markets.  If that’s not you, then you have my blessing to stop reading right here, knowing that the overall message communicated in the last one has not changed (much).  Today, I’m just going from “general and simple” to more “specific and technical”.  With that, for those deciding to continue on, let’s dive in…

I’m going to start by sharing one of the more useful pieces of macro research we have found out there.  While the theory is not our own, the charts I will be sharing are.  No matter how “good” a research piece seems, we always try to verify the information on our own.  Macro theories – and the charts most always accompanying them – can (and often are) always be molded to fit a pre-determined narrative.  Same applies to sports, politics, and just about everything else in life.  It’s human nature 101.  And while we are certainly not immune, we do everything in our power to acknowledge our own biases in such analysis.

This particular research was done by Michael Kantro – Chief Investment Strategist at Piper Sandler, and frequent contributor to FinTwit (financial twitter) and many of the podcasts we listen to regularly.  You can find him and his work most easily on Twitter (@MichaelKantro).  Overly simplified, while I don’t remember his specific views on the state of the markets – though it seems likely similar to our own – he believes that recessions all follow very specific patterns.  Specifically, he believes that housing peaks first, followed by orders, then by corporate profits, and finally ends with a peak in unemployment.  He calls it his “HOPE” model.  Of note, he strongly believes that it is only when unemployment begins rising that the markets will feel the most pain.

So, we decided to put this to our own test, going back some 50 years.  The charts and analysis that follow cover just about every significant cycle in recent history – so if the theory is sound, it should hold up in each.  For housing (the H), we used data for US private building permits.  For orders (the O), we used ISM manufacturing new order data.  S&P 500 earnings were used for the profit (the P) analysis.  And finally, we used initial claims for unemployment for the employment (the E) data.

We are going to start with the 1970s and early 80s, as this is our most recent example (before today) of an inflationary economic environment, and then work forward through the 90s, 2000s and ending with where we find ourselves today.  The goal of this exercise is top examine these periods – especially with an eye on this HOPE model – and see what (if anything) it can tell us about where we might find ourselves today…


(Please see disclaimers at the end for the full and sourced version of this and the 3 following illustrations)

So there is a LOT of noise in the above chart.  For the sake of simplicity, let’s focus on the 2 larger recessions (noted by the shaded columns on the chart) – the recessions beginning in 1973 and then in 1981.  As you can see, both of these recessions followed the HOPE model perfectly.  Both housing and orders peaked well before the recession started, and also well before the stock market turned lower.  Even more interesting, the beginning of the market downturn coincided almost exactly with unemployment beginning to rise, and the market bottoms ultimately occurred at the same time that unemployment peaked

Couple other interesting notes we observed in this period.  First, it is interesting that earnings peaked about the same time that the market was bottoming at the end of the ’73 recession.  The two biggest parallels between this period and where we find ourselves today are (1) it was early stages of an inflation shock, and (2) the “Nifty Fifty” were all the rage during this period – similar in many ways to the tech (and now AI) darlings of today, and the extreme valuations that were present in many cases.

So, we can chalk up a W for the HOPE model in this period – let’s move ahead to the 90s…


I want to spend significant time on this period, as this was the analysis that gave me the most pause when it comes to our current outlook for the economy and stocks.  Note the period beginning in 1994 and going into 1996.  The Fed was raising rates, we had a peak in housing (kind of), followed by a peak in orders, followed by a peak (kind of) in earnings – and finally – a spike and peak in unemployment.  Yet, there are two things missing.  First, there was no ensuing recession.  Second, there was no deterioration of note in stock prices.  In fact, between that period and the end of the cycle in 2000 – the S&P was up some 230%!!  We will delve into this further when discussing the current environment – but there could be a LOT of similarities here if things played out perfectly.  Note that the Fed raised rates to 6% by ’95, and basically left them there for the remainder of the decade.  Sound familiar?  On the other hand…

When we fast forward to 1999, we can clearly see the HOPE model at work again – in perfect sequence.  Once again, the market peaks as unemployment rises – though it is interesting to note that the market bottom came well after the peak in unemployment.  This can likely be best explained by the occurrence of  September 11th – but I have not delved into trying to figure that one out in detail.  The biggest similarity between this period and today is no doubt the oft-described comparison between the “dot com” stocks of 2000 with the tech stocks of today.  It should be noted however – and we will dive into this later – that even though valuations of many stocks today might be considered ridiculous , they are largely not yet nearly ridiculous as the valuations back then.  As always – and don’t we know this by now – valuations are not a great short-term timing tool.  In fact, they are next to useless toward that end.  They are, however, historically a good indicator of expected long-term returns.  See countless previous updates for further discussion on that.

Might the environment today ultimately play out as it did in ’94 or ’95?  Or is it ’98 or ’99?  Time will tell.  Moving on to 2000s and the “Great Recession”…

H-O-P-E, in perfect sequence again.  Stocks peak as unemployment begins rising, again.  Market bottoms as unemployment peaks….again.  It sure seems as though Mr. Kantro is on to something here.  Interesting parallels between this period and today.  First and foremost, the degree of the rate hikes – though it was much more gradual than the 500 basis points that we just did…in one year!  This continues to scare the poop out of me, more than all else.  Then, there is the obvious housing bubble that brought the house of cards down back then – compared to the rapid increase in housing costs in the past several years through today.

I will say, however, that this is hardly identical.  While both periods arguably demonstrate significantly overvalued house prices, the mechanisms for getting there are entirely different.  Back then, everyone was leveraged to the hilt buying multiple houses they couldn’t afford – and the banks were more than willing to lend them money for even more.  Neither is the case today.  OK, there is more than a little of the former I would guess – but not to the same degree.

Very interesting to note that – while the “bubble” was in housing and not really in stocks (investors were still largely scarred by the 2000 experience) – the S&P still dropped 50% from peak to trough.  As a result, this was the first time in 15+ years that valuations on stocks reverted back to historical norms (and then some).  Because of this – and at the bottom – investors in the S&P had made no money on their holdings if they had purchased 15 years prior.  Again, and until proven otherwise (we might be getting close), valuations ultimately matter.  A lot…

I want to highlight one other thing here that I forgot to mention in the previous two periods.  Note the amount of time between the “Fed pause” (when they stopped hiking) and the ultimate bottom in stock prices (and peak in unemployment).  2.5 years in this example, 2 years in the previous, and 14 months in ’73-74.  I know I mentioned this at length in my outlook for this year – but the Fed has still not even paused this time around.  Moving on to today.

Now we get to the point – what do things look like today?  I’d like each of you who have made it this far to stop reading here – look at the above chart in light of everything we have discussed – and first come to your own conclusion, before reading further…

Thank you.  So, let’s see if our conclusions were similar.  My main conclusion?  That there is no conclusion.  In fact, when I mentioned how thankful I was for the clarity this exercise bestowed upon me, the clarity was this: there is no clarity to be had.  That was actually helpful, as I was previously so convinced by the data of what was to come (nastiness), that this exercise allowed me to see another possibility.  Let me lay it out…

On one hand, if we shift the somewhat ambiguous housing top to the left, we have the HOPE model playing out – and we are then assuming that unemployment will continue to drift higher from here while stocks go on to make new (and much more painful) lows.  That is certainly a very real possibility, and one I’m more inclined than not to agree with.  But hold on one minute here. 

When unemployment first ticks higher, it coincides pretty closely with the beginning of the market deterioration beginning last year.  But it also peaks again, and then declines.  The market makes a somewhat “clear” bottom in October of last year, which we will discuss later.  Housing has a brief tick higher, before resuming its downtrend of late.  Orders are the one area that it’s tough to make a case for, and to be sure, the most respected (in our view) macro guys out there have been screaming about orders for a long time now.  This is not new information.

But still, what if (1) this is 1994, and the leading indicators are giving us a head fake, or (2) the rate hikes were so fast and vicious – and especially since we haven’t even officially gotten “the pause” yet – that we have another year or so of gains (or at least not losses) before the real pain begins.  Unlikely?  Maybe.  Impossible?  Most certainly not…

Yeah, we’re not done yet.  Not even close.  Grab yourself a beverage of your choice and let’s move away from HOPE and on to some other areas that we personally find to be of great importance.  Here we are going to add two additional metrics worth studying.  First is the “10/2 Treasury Spread” – which is simply comparing the yield (interest rate) on a 10-year treasury vs. a 2-year treasury.  A “normal” spread will be a positive reading – as one would normally expect to earn more interest the longer they agree to lock up their funds.  An “inverted yield curve” occurs when the opposite is true – one earns more interest on shorter-dated treasuries than longer ones.

The yield curve does not often invert.  When it does, it is near universally accepted as a signal that troubling times are ahead for the economy.  Simply put, the market is telling you that the Fed is going to have to cut interest rates in the not-too-distant future, because of these troubles ahead.  As the saying goes, “the bond market always knows”.  So, it makes sense to look at the shape of the yield curve in trying to determine what is to come.

Next, what would a special update from me be without me at least mentioning valuations?  Not much, for sure.  For this, we will go back to our most trusted valuation metric – that being the Shiller PE Ratio (or Cape Ratio).  As a reminder, we prefer this metric as it both “smooths out” the earnings cycles by incorporating the last 10 years instead of the latest quarter – and also adjusts for inflation.  Let’s have a look…

Find sourced version in the disclaimers below

Well, unfortunately, that chart just said to us “I’ve got bad news, and I’ve got bad news – which would you prefer?”  First, there has never – I repeat, never – been an instance of an inverted yield curve not leading to recession.  Never is a long time.  To make matters worse, it appears the deeper the inversion, the longer (and more painful) the recession to come.  It’s at this point you might not want to look at where we stand with the inverted yield curve at today…

But I always at least try to find a positive, and here there are two.  First, we’ve got that near-inversion in good-ole ’95.  It’s a stretch, but maybe this could be a similar head fake for reasons previously discussed?  Second, it’s not at all surprising that the last time we saw this much chaos in the yield curve was during the 70s and 80s.  The positive here – if that is in fact what we are looking at – is that interest rates stayed elevated (and got more so) for a long time.  I love higher interest rates.  So should 99% of you.

That said, back to Dr. Doom.  I expressed in our outlook for the year that I was anticipating one of two outcomes.  One was for a 2000 or 2008 economic/market implosion.  Quick, painful (for those that hadn’t properly managed risk), and interest rates right back to zero (maybe negative this time).  That was the good outcome (we finally get to add risk at decent long-term value, and that’s where the real long-term return is at).  The less desirable outcome of the two was a repeat of the 70s.  Inflation everywhere, vicious market volatility with no clear direction, and it seemingly lasts forever as the Fed constantly battles inflation and the economy at the same time.  It’s not fun (I don’t imagine) – but again, the interest rates sound nice…

I don’t think we really need to get into the valuations – it’s just good to see for context.  Needless to say, the more expensive stocks are, the more room there is for negative reversion (in other words, outsized downside).  I’m going to sneak one more negative in here – first because it fits, and second because I’m about to move into much more positive territory.  Let’s talk bell curves and tail risks for a moment.  In my world, a “left tail risk” is an extremely unlikely and negative outcome.  A “right tail risk” is the opposite – extremely unlikely, but positive outcome.  As I’ve said many times – I don’t focus on either because, well, they are extremely unlikely.  That said…

I think about left-tail risk more than I do the right-tail.  Why?  Because missing a right-tail event is simply frustrating – the very definition of FOMO (fear of missing out).  Or I guess in this example, it’s AOMO (act of missing out).  On the other hand, getting blind-sided with left-tail risk is not frustrating.  It’s devastating.  Financial ruin at worst.  Why am I bringing this up?

We’ve just gone through two massive asset bubbles in the last 20 years.  Our solution was to do the very same thing that caused the first two (easy money), except magnify it exponentially by keeping interest rates at zero for a decade and printing unknown trillions to manipulate longer rates (for the first time in history) to boot.  Inflation is now here, for the first time in forever.  Populism has taken hold across the globe.  There is a hot war going on involving the world’s second largest nuclear arsenal.  Countries are actively trying to move away from the dollar as the only viable reserve currency.  I can go on, and on, and on.

The mother of all bubbles.  The “everything bubble”.  Likely?  No.  Possible?  No better man to ask than our next main character…  


From Twitter @hussmanjp


From Twitter @hussmanjp

I feel ya Dr. Hussman.  I wrote all about bear market rallies in our outlook for this year.  No question, they are real – and you just illustrated some of the best of the best.  As a reminder, a “bear market rally” is a vicious rally in stock prices, that very regularly occur during extended bear (down) markets.  Dr. Hussman has highlighted those in the 2000-2002 period that produced 20%+ trough to peak results – first because we just achieved 20% in the most recently rally, and more importantly because a 20%+ market is considered a “bull market”.  This is why you hear so many of late talking more about the “new bull market” and that the “bear market is dead”. 

So, Dr. Hussman – who believes that fair market value for the S&P 500 might need to drop some seventy percent from here to achieve “fair value” (now THAT’s left-tail risk!) – is just correctly pointing out how common it is for these rallies to occur, and that they in no way signal an absolute end to a bear market with any level of certainty.

I told you this was about to take a positive turn, and here we go.  Let us now examine a couple of things about the bear market rallies he discusses, and compare them with what we are seeing today…

First, all of the rallies he is referencing above are very short-term in nature.  This makes sense, as these bear market rallies are traditionally some combination of short-covering (forced buying to cover bets against stocks going up) and investors “panic buying” due to previously discussed FOMO.  They last just long enough to get enough investors back in, and then BAM – slapped back down to even lower lows. 

The second important note is that not a single rally shown – in either example – manages to clear the previous high-point in the downtrend.  This is a simple technician’s dream – lower highs, and lower lows.  The trend is crystal clear, and not a single one of these rallies shown violates that trend.

So yes, I agree with everything that he is stating – that 20%+ rallies mean very little, outside of getting the media to start screaming about the “new bull market”, while investors nervously wonder whether or not they are being left behind by not participating.  But what he is insinuating in his examples, is that no one should be getting overly excited about the current rally we are experiencing – again now 20% higher from the October lows.  Is it that simple?  Let’s take a look, and you tell me….

The first two rallies in this downtrend were of the textbook, bear market variety.  Short, vicious, and clearly no new trend established.  But that is where the similarities between today and 2000 almost completely end.  The current rally is over eight months old – that’s a wee bit long for a short squeeze.  Even more important, there is now a very clear (albeit fading) uptrend off of the lows.  Forget lower highs and lower lows that you would see in a downtrend – there is actually now higher highs and lower lows!  I came to realize that – in specific terms – this was the main reason that I found myself unable to “max hunker-down”.  This is not bear market behavior.

Now, there is one final and vicious battle that is taking place literally as I type this – which I hopefully have made clear above.  Since we made new lows in October – following the previous rally – we technically have to trade above that level to officially say that “new highs” have been achieved.  So, for anyone who was paying attention last week, you may have noticed that every single day (if I am remembering right) we made a run at 4325(ish) - the intra-day high in the previous rally – and failed every single time.

Time for another digression, but it’s a related one.  I remain firmly convinced that the market is almost entirely controlled by some combination of flows into passive funds (topic for another update, but follow Mike Green @profplum99 on Twitter for the most thought-provoking analysis), algorithms and traders.  “Investors” – to the extent they still mattered in the first place – have largely stepped aside after suffering significant losses last year, and seeing the same information we have discussed today… 

Most passive flows don’t care about any technical level – that money goes in each and every month with 401k contributions.  But the algos and traders sure as HELL care.  There is a LOT of money on both sides of this bet, and this battle is going to be a fascinating one.  If I’m right, if and when we do break that level (possibly before you read this), one of two things is going to happen.  The most likely outcome in my view is that we hit 4400 – or even 4500 – in very short order.  The second most likely outcome is that we get a big move up as we break it on the upside, followed by a vicious sell-off (possibly the beginning of another leg lower) in the days thereafter.  Either way, my least likely scenario is a break above that level, followed by a boring market in the days and weeks ahead.  And of course, if the market fails to break above that level – and the past week proves to be the final, and failed, attempt – I would expect downside (not rocket science), which could get ugly (or not).  That’s actually harder for me to guess at – but we are going to find out soon, one way or the other.

So, at this point, you should be thinking to yourself “damn, now I better understand when he tells me what a ‘tough environment’ this is”.  More importantly, I hope you are starting to ask yourself “what should we do?”  For clients reading this, you will remember from our previous conversations me saying that I would “listen to what the market is saying”.  While I don’t pretend to know with any degree of certainty what it is indeed saying at the moment – nor does anyone else, given all of the conflicting data described above – I can say that it is at least barking at us.

Where everything coming into this year – from the data to the technical and everything in between – was screaming “caution”, it is less so now.  At least in the short-term.  What I deduct from everything discussed above – and another 100 pages of info that didn’t make the cut in this one – is that I see any of the following scenarios, ranked in order of expectation, as the most likely:

  1. We are in the early stages of a “70s-like”, inflationary bear market. Long and with corresponding and elevated volatility in all asset classes.  This is not a preferred outcome, except for interest rates which would assumptively stay elevated.
  2. We are in the early stages of the 3rd “bubble burst” of the past 20 years – this time, the “everything bubble”. Economy and markets will free-fall in a relatively short period of time.  Interest rates will head back to zero, but risk assets will finally again get back to attractive levels for long-term (and responsible) investment.  While it may not sound like it, this is the best outcome long-term for your money.
  3. We are in the ’98-99 stage of the 3rd One last (and possibly vicious) rush to the upside, before gravity (and valuations) take over under the weight of the now much higher interest rates.
  4. We are in the ’94-99 stage of the 3rd This would actually be the best outcome for investors in the short to intermediate-term, especially if interest rates remain elevated.  It is one of the hardest for yours truly to navigate, however.  I don’t know how to “buy stocks at 30x earnings, hoping they go to 60x earnings”.  That to me is gambling rather than investing – you “know” how it’s ultimately going to end, and you’re simply guessing as to the when
  5. A combination of 1 and 2 above. In reality, this would be the true bursting of an “everything bubble”, as the economy and all assets – including bonds (with duration) – go into free-fall quickly under the weight of both increasing inflation and interest rates.  This would look very similar to what we experienced in the mid-70s.  In fact, this is very similar to what we saw only last year, if it had continued (and yields on longer-dated income kept pace with the shorter end).  This would be even better for long-term investors than #2 above, especially if one entered from a “max hunker-down” position.  Not only do risk assets become extremely attractive from a long-term perspective, but one could then simultaneously lock-in higher interest rates for extended periods of time, due to the higher prevailing rates.

In the end, it really boils down to this: I can now make a better short-term case based on what the market and trend “might be trying to tell me”, than I could coming into the year.  But I think you will agree that the overwhelming evidence of the data as shared above points to trouble ahead – whether it’s next the next weeks, months or years.  It would be almost unprecedented for this not to be the case, at least in the 50 years that we just studied together.  With that in mind, it’s awfully tough to chase short-term performance that may or may not ever materialize given that backdrop. Especially considering that I can now collect 5% on short-term treasuries instead, with the interest exempt from state taxes to boot.

Still, I hear you Mr. Market – and I am listening…

If you made it this far, what I would appreciate more than anything is this:  I would love to hear what you took away from any of the data presented here.  If your takeaway was “I tried, and I don’t have any idea what you are talking about” – I would love to go through it with you individually so it makes sense.  If your takeaway was “I’m looking at the same data, and see something completely different”, or “have you considered this data instead?” – again, would so appreciate that conversation.

With that, I’m finally going to bed.  As always, and most important, we thank you for the trust and confidence you have placed in Round Hill.



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