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MARKET Watchby Romulus at Backpack Trader
There is always a cost. Decisions and actions are powerfully reflect those costs.
Wal-Mart became the largest retailer in the world by selling the lowest cost goods. Apple Computer borrowed billions of dollars in 2020 because loan terms were better than ever before. Wal-Mart would go out of business if it tried selling luxury products and Apple would not borrow money today at these much higher rates.
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One of the strongest forces influencing the cost of goods and services in an economy is the cost of money itself. The cost of money is defined by the interest rate environment. Higher interest rates mean it is more expensive to borrow money. The cost of that money goes up, which will eventually push prices of all the goods and services up as well. This is what happened since the summer of 2020. Interest rates hit an all-time low that August and have moved steadily higher since then.
The cost of money went up. Everything else went up in price soon after. This is called inflation.Everything costs more today than two years ago, and the chart below shows why.
There is a direct correlation between stock prices and the cost of money.
When interest rates are low, companies borrow and spend lots of money, in both productive and wasteful ways. A productive use of that money is to build a factory to make products that are in demand, such as iPhones or electric cars. A wasteful use of that money is to blend in with the crypto-crazies and hide one of the largest frauds in history.
In either case, higher interest rates lead to a decrease in activity—a slowdown in the number of factories being built and a drop in less productive pursuits.
There is another reason interest rates impact asset prices. People make investment decisions based on the relationship between risk and reward.
When rates were at record lows, bond investors could not realize anything more than a meager rate of return. Or, they could choose to invest their money into stocks like Netflix. Netflix was a larger risk than buying government bonds, but the potential reward was significantly higher.
As interest rates climbed, that risk/reward profile changed. Some investors chose the lower risk of government bonds over the option of a risky investment such as Netflix. In other words, the stock of companies that carry heavy debt competes with the prevailing interest rate market.
It is important to understand what may happen to interest rates in order to better analyze the stock market. This is one of the inputs that went into my call on January 13th to sell everything. The powerful uptrend in interest rates has slowed over the last few months, and so has the powerful downtrend in stock prices.Club Romulus: Where knowledge plus action equals profit
There is a helpful correlation here. The correlation is helpful, but it is not 100%, nor is it always going to create the effects that you may think.
For example, rates have been falling since October. Stocks have been up since then, as well. There is a growing belief among the institutional crowd that this correlation will continue. They like that because they know the federal reserve is going to slow the rate of their interest rate hikes over the next several months.
Unfortunately for this crowd, there are other factors at play that must be incorporated into their investment models. In addition, it is likely that they are missing a major ingredient in their cake. When it comes to the birth of a new bull market, the only metric worth paying attention to is the exhaustion of supply followed by surging demand.
This is something I track with extraordinary detail involving a handful of legendary intermediate and long-term indicators.
Regarding the current bear market, we still have not witnessed a selling climax, which represents one side of the equation. Major analysts are pointing to falling interest rates or China’s relaxing covid policies or the retreating Russian army as reasons for a new bull market.
However, without the selling climax, and just as importantly, a buyers’ rush, any continued market advance will be loaded with risk.
Over my 28 years in this business, I’ve seen dozens of markets that defy analytical logic. I remember in 2005 oil prices were going up and everyone said this would lead to a collapse in the transportation stocks. That is a reasonable assumption. The problem is that the market is not reasonable. It is anything but. That same year oil prices rallied, and the transport stocks posted a huge return. It came down to the simple fact that demand outweighed supply in the sector and the stocks went up.
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This bear market will end for the same reason.
The other factor the analysts are missing today regarding the bond market is the very long-term view of the last 40 years.
The 10-year US government bond peaked at just under 16% in 1981 after 10 years of inflation. That same bond yield was less than a half percent after covid.
While the recent rise was not sustainable, do you think that after 40 years, rates are only going to jump for a few months, then start going down again?
According to the chart, we haven’t seen the last of the interest rate problem.
The 200-month moving average (red line) serves as a good resistance trend line. The line was decisively broken earlier this year. It is certainly possible that a re-test of that line will be seen in the coming months. It is not probable, however, that rates will be heading down on a sustainable basis from now on.
Again, a 41-year trend was recently broken.
This will have bearish implications for stocks for a while.
Wealth, like Rome, cannot be built in a day. But, like Rome, it can be lost in a day.Watch for future announcements from Romulus about profitable market moves, important indicators, and major market swings. For trading education, mentoring, or to beat the markets with Romulus’ trading group, contact firstname.lastname@example.org.
About the author:
In his real-life existence, Romulus started on Wall Street in 1994 and traded for a hedge fund for 13 years. Since 1994, he has called every major market top ahead of time and profited from them, including the break of the Dot-com bubble in 2000, the market crashes of 2008 and 2009, and the Covid crash of 2020. Since 2020 he has been working with investors and traders to actively manage their portfolios by growing wealth, not risk, as a teacher and mentor working with Backpack Trader, a stock trading educational company.