December 20, 2024 – In today's Smart Macro edition of the Financial Sense Newshour, Chris Puplava, CIO of Financial Sense Wealth Management, discusses recent market developments and why it's caused us to make adjustments to our investment strategy. Chris explains how the Fed’s "hawkish cut" this week along with breakouts in the U.S. dollar and 10-year Treasury yield have raised risks to the outlook, echoing dynamics from the 2022 market downturn. Rising rates and a stronger dollar are shrinking global liquidity, which if continued, will likely lead to more volatility or an ongoing correction. While the U.S. economy remains sound, excess optimism and stretched investor positioning prompted our team to lock in profits, raise cash, and shift to a more neutral stance. Chris anticipates the potential for further downside in 2025 but notes the Fed may eventually halt quantitative tightening, supporting markets if conditions deteriorate. For questions or comments related to today's interview, email Chris Puplava at chris[dot]puplava[at]financialsense[dot]com.
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Transcript
Cris Sheridan:
Well, this week was a momentous week for the markets. There was a hawkish cut by the Fed that weighed on stocks. And also, we see, as we're discussing right now on December 20, on Friday morning, how there's now the risk of a government shutdown based on pressure from Elon Musk with a spending bill that was unable to get passed at the last moment, raising the risk again of a government shutdown. A number of things that we're going to discuss today. Joining us, as always, for our Smart Macro edition of the Financial Sense Newshour is Chris Puplava, our CIO here at Financial Sense Wealth Management. And, Chris, I want to start off, this year we moved from a neutral risk allocation in client portfolios to above risk. That was clearly a good move with the momentum that we were seeing in the market and a lot of the strength that we saw this year. But now we've seen a number of things change. And you recently sent out a note to our investment team about raising some cash. So where do things stand today and why the change in view?
Chris Puplava:
Well, we were thinking initially that the peak would happen in the new year, maybe January or February, similar to the views that Felix Zulauf had on this podcast a few days ago. And our reason for that is that's historically what's happened after a presidential election. The markets tend to rally going into the new year. There's lots of fund flows that come into the market in early January from 401(k)s that kind of prop the market up. And also, just in the final part of the end of the year, you tend to see a lot of corporate buybacks get completed. A lot of them are on a calendar basis. So based on that—the buybacks, the normal seasonal pattern, plus a lot of inflows typically that come in in January—we felt the market would continue to rally roughly into Inauguration Day. And at that point, it would be extremely overbought, sentiment would be overdone, and it would be due for a correction.
And our thought would be that correction would kind of reset sentiment and the overbought condition of the market. Then the market would rally. But our big concern for next year would be a breakout in the dollar and interest rates that would ultimately cause the market to roll over. Well, that actually has happened this week, in that this correction that we are anticipating next month could have already started.
A reason for that is looking simply at technicals. When you look at the dollar and we look at it against a whole host of other currencies—over 30 world currencies—there is widespread carnage in the currency markets, and the dollar has definitively broken out of a sideways trading range that it's been in for the last two years. Further, we saw the U.S. 10-year Treasury yield break out of its declining downtrend to argue that the trend is now up.
So, based on a breakout in interest rates and a breakout in the dollar, that, to us, was the recipe for a repeat of 2022. In ’22, we saw a surging dollar and surging interest rates in the U.S. that ultimately caused the market to roll over and witness a tremendous amount of pain in virtually everything outside of oil and the dollar.
So, given the fact that we have seen a surge in both the dollar and interest rates, we have begun to pare back our exposure to the market, getting closer to a neutral stance. And in the beginning of the next year, we may be selling even further to go even below neutral. So we're watching things closer right now. It was, in our opinion, a shot across the bow. There's a lot of excess optimism still that needs to get run out. And there's also further positioning.
When you look at these surveys and fund managers’ results, there's a lot of investors that were over their skis in a sense—or at maximum risk, as we were. We were hoping that we would be able to do some selling in January into a new tax year, but it looks like that peak may have come early.
Cris Sheridan:
And again, at our company, we try to exercise strict risk management, making sure that we lock in those gains as well. Of course, 2024 has been a really good year for the market. We were above risk in our allocation across client portfolios, more on the aggressive side. And now, like you're saying, raising some cash into the end of the year, as we've seen a number of factors coming into play that are raising risk in your mind. You named two of them: an ongoing increase in the U.S. dollar, which is drying up liquidity; and then, when we also look at interest rates, which are also moving up, that's problematic from a financial market standpoint. And like you said, we saw that during the prior down move in the market in 2022. Same types of dynamics at work here. Even though, you told us two weeks ago, when we look at the underlying fundamental backdrop of the U.S. economy, things still appear to be pretty sound. It's more the financial market factors that are now more of a risk weighing on the market currently.
Chris Puplava:
That's correct. One of the big ones is the dollar because, you know, the world transacts in dollars, and when the dollar strengthens, you basically look at global money supply starting to shrink. Because when you rebase the European money supply or the British pound money supply—or just basically the supply of money and credit from other central banks—and you rebase that in dollar terms to get an idea of total global dollar liquidity, that shrinks when the dollar rises.
And so we have a lot of volatility, which is why it's really important to keep an eye on the dollar. When we look at the dollar over the last year, it's more or less traded in line with Fed rate cut expectations. So, when the expected number of rate cuts priced into the market rises, the dollar falls. And when the number of cuts priced into the market declines, you see the dollar start to rally.
So, for example, part of why we saw such a weak market this week was when you look at the Fed, every quarter they come out with their summary of economic projections. In the September summary of economic projections, the Fed was forecasting four rate cuts for 2025. Now, they’ve cut that down to two. And when you look at what the market is expecting, the market’s looking at only one and a half cuts. So the market is now pricing in less than two rate cuts next year. Consequently, with less Fed easing, the dollar has strengthened.
The concern I have is that if the economy does hold up and if manufacturing accelerates next year, then we could see the dollar strengthen even further because a strengthening economy is going to require less Fed stimulus.
One of the things that we’ve talked about over the last few months was our Financial Sense Wealth Management’s Global Stimulus Index. And what that is basically doing is encapsulating central bank policy, which tends to impact markets with a lag. When we look at that, it was projecting a bottom in manufacturing at the end of this year and a significant upturn in 2025 going into the first part of 2026.
Well, if we expect a rising manufacturing economy, then it stands to reason that with rising growth, you’ll have rising inflation and rising interest rates. Growth, inflation, monetary policy, interest rates, and the dollar—they’re all joined at the hip. If we see an upturn in all of those, then we could run into some trouble, as I mentioned, because the 10-year just broke out, the dollar just broke out. And that’s ultimately what really caused the market to sell off in 2022.
When I’m just looking at the charts, to me, it looks like the 10-year may run into a high of around 5 to 5.5% over the next six months or so. The dollar looks like it wants to retest its 2022 highs. And when you go back to ’22, the market didn’t bottom until October, which is when interest rates peaked and the dollar peaked. So, if we’re going to see a rising trend in the dollar and in interest rates, to me, that spells weakness for the general market.
Cris Sheridan:
Got it. Okay. So, a lot of this, again, is tied to what we see with 10-year interest rates more broadly. So, if interest rates are moving higher, that is problematic. And like you pointed out, this is a similar environment to what we saw in 2022, which caused the market to turn downward.
So, as long as interest rates are moving up and the dollar’s breaking out, that is going to be more of a risk-off environment, which is why we raised cash this week, given the significant breakouts that we saw both in the 10-year and in the dollar. And then, of course, there’s the hawkish cut that we saw by the Fed that was a catalyst, I would say, for this week’s sell-off.
What are you primarily going to be looking at to see whether or not it would be warranted to move back into an aggressive posture? Is that just going to be the dollar and interest rates?
Chris Puplava:
It’s going to be that, as well as market breadth and looking at the credit markets. When we look at the credit markets, particularly looking at distressed debt versus even junk debt, I’m not really seeing a huge pickup in spreads. So, it could be the market was overdone, and this is realigning things.
We still may trade sideways or slightly up going into January, where the major decline has yet to materialize. But, you know, really what we have to keep an eye on are all these other measures.
When I looked at the market, there was a major sell-off this week on Wednesday and Thursday, and it’s leading the market into a short-term oversold condition. So, I wouldn’t be surprised to see the market rally going into next week and for the main part of this year.
The market can hold up where it’s at and trade sideways or slightly up. But what I’ll be watching for is if we do rally, is it on weaker breadth? Are the market internals deteriorating even further from here? Are credit spreads starting to move up? And is the dollar continuing to rise?
Right now, the market is oversold on a short-term basis. I wouldn’t say so on an intermediate-term basis. So, it could trade sideways for a while. But overall, I definitely think the market dynamic has shifted, and I think the risks are now tilted more towards the downside.
At this stage, after a major run and a major advancement, we’re not looking to chase the market at this point or use this weakness for buying. If anything, we would use further strength for selling.
Cris Sheridan:
So, Chris, if we do see risk materialize more moving into 2025, and there is an ongoing market decline from extremely bullish sentiment on the investor side—of course, that has now come down with the correction this week—but still, investors were very much on the greed/euphoria side. There’s been a reset to that.
What are you looking at from a monetary policy perspective? Because we did, again, see the hawkish cut this week. That is, the Fed cut interest rates by 25 basis points, a quarter of a percent, but also lowered their guidance in terms of the number of cuts they expect to make for 2025.
Given the firming inflation outlook, where do you think we could see some movement from Chair Powell and the Fed in the face of an ongoing market decline?
Chris Puplava:
Well, we’re still seeing interest rates being cut by foreign countries. In particular, we’re still seeing a lot of weakness in China. When you look at the Chinese 10-year, that’s collapsed to less than 2%. I believe that’s a record low for them.
So, the world economy is still struggling. And if we see the whole world economy continue to struggle while the U.S. is holding up relatively well, that could obviously lead to the dollar surging further. Interest rates here in the U.S. continue to rise based on our relatively strong growth.
But ultimately, one of the things that is currently going on is, even though the Fed is cutting interest rates, the Fed is also simultaneously shrinking its balance sheet. So it’s stepping on the gas and the brake at the same time.
One of the things I do think will happen is, if interest rates start to move up next year, I think that will force the Fed to stop shrinking its balance sheet.
For example, we’ve got nearly $10 trillion of debt coming due that needs to be rolled over in the next 12 months. That is a lot of debt—a lot of supply—in the U.S. market. And if rates are moving up and the supply is rising like that, it’s going to create a toll on U.S. government finances, particularly in terms of our interest expense.
So, I think it could ultimately, if things get disorderly, force the Fed to step in—not only stopping shrinking its balance sheet but reversing course and being the buyer of last resort to bring some stability and bring a peak in interest rates.
That also would bring a peak in the dollar. If the Fed is expanding its balance sheet again, that could be the major catalyst we need, if we do, in fact, break down like we did in ’22, to see an ultimate peak in the dollar and interest rates as the Fed steps in.
So, I think that is a distinct possibility for next year and something I’ll be watching.
Cris Sheridan:
Okay, so 2025 may be the year that the Fed stops quantitative tightening, which it is doing right now by allowing the number of Treasuries and mortgage-backed securities to roll off its balance sheet. And potentially, if we do see a deeper decline and a response in the credit markets—which you follow very closely—the Fed could move towards expanding its balance sheet once again.
But, of course, we’ll have to see how things play out. That is a potential scenario we could be looking at in 2025, especially if, as you heard Felix Zulauf say on our show this week, some of what he is expecting materializes.
Chris Puplava:
That’s correct. We might see yet another Powell pivot in 2025 to bring risk assets back higher and bring a peak in the dollar and interest rates. So, I think, you know, we’ve seen a couple of Powell pivots when things got disorderly. I think we’re heading for another one in 2025.
Cris Sheridan:
So, Chris, in sum, this week we locked in some profits and raised cash across client portfolios, slightly dialing back our risk exposure to the stock market.
As you said, you are concerned when you look at the move higher in interest rates, in addition to the fact that investor sentiment gauges and fund manager surveys, as you mentioned, were showing signs of euphoria. And as Warren Buffett said, you want to be fearful when others are greedy and greedy when others are fearful.
So, from a contrarian standpoint, raising some cash and locking in profits makes financial sense to you at this juncture, which is, again, what we did this week.
As we close, if any of our listeners would like to come on board and learn more about how we can assist them with our comprehensive asset management or financial planning services, what would be the best way for them to get in contact with you?
Chris Puplava:
They can email me at chris[dot]puplava[at]financialsense[dot]com, or they can reach me at 888-486-3939.
Cris Sheridan:
Chris, always a pleasure to get an update with you on Smart Macro, and we look forward to speaking with you in another few weeks.
Chris Puplava:
Thanks, Cris. Enjoy, and I hope everyone has a great Christmas.
