Commodity Insight: Stocks stretched too high, T-bonds stretched too low

Several fundamental events have combined in recent days suggesting that stocks as measured by the Dow Jones could drop 50% to 60% from current levels.

A few of those events are the Federal Reserve hiking rates to a new 22-year high, inflation remaining sticky and stocks already stretched to extreme high levels as investors and traders are aggressive buyers because of FOMO, fear of missing out.

Here are a few other ideas about the stock market moving forward. From the Hulbert Financial Digest, “August has been the worst month for the stock market, on average, lagging the other months’ average by 1.7 percentage points. Since 1986, in fact, August has been a worse month for the stock market than even September, whose reputation for stock market losses is widely known.”

Historically, September is the most bearish month of the year, but October is when all the “stock market crashes” took place. And now, at hand, the three most bearish months for stocks, according to Hulbert Ratings, are August, September and October.

Stocks are not cheap, historically speaking, and they are already in the midst of a huge bull move. For instance, the S&P is up nearly 20% this year, but is up 400% since the end of the financial crisis in 2008.

The Dow Jones that was as low as 18,100 in March 2020 in recent days has been nearly as high as 35,900. By any measure, stock values are not only stretched out greatly to the upside, but fit the historical definition of a “bubble.”

There is also a school of thought that believes stocks move opposite commodities. At times, that is true but that correlation shifts over time.

A few weeks ago, the dollar fell to a three-month low and this week the CRB index, weighted towards grains, livestock and crude oil, and in that order, closed at its highest levels since January 2022.

Moving forward, my work suggests the CRB can outperform the Dow Jones and other stock indexes, as well.

The major firms on Wall Street, as always, are bullish stocks, but less bullish Treasury bonds. A major strategy employed and encouraged is for investors to cling to a portfolio of long 60% stocks and long 40% bonds. Wall Street loves paper assets.

However, last year, Treasury bonds endured their worst year in history. From CNBC is the headline, “2022 was the worst-ever year for U.S. bonds. How to position your portfolio for 2023.”

The key points of the article reads as follows:

• 2022 was the worst year on record for bonds, according to Edward McQuarrie, an investment historian and professor emeritus at Santa Clara University.

• That’s largely due to the Federal Reserve raising interest rates aggressively, which clobbered bond prices, especially those for long-term bonds.

“Even if you go back 250 years, you can’t find a worse year than 2022,” McQuarrie said of the U.S. bond market.

But I am bullish on U.S. Treasury bonds. If inflation continues to ratchet lower and Fed pauses or ends further rate hikes, I fully expect T-bonds to not only stage a historic bull move, but far outperform the stock market, as well.

And keep in mind that the T-bond market is stretched out to the downside in a similar fashion to how stocks are stretched out to the upside.

In addition, government backed T-bonds are coming off the worst year they have ever experienced, according to McQuarrie, in 250 years.

If my work is correct that stocks, per se, are poised to get a 50% haircut while T-bonds move higher there are several strategies to consider.

One, if holding a stock portfolio, consider banking profits where possible. There is nothing wrong with taking profits.

Or, be a hedger similar to a grain or livestock producer when they feel prices may work lower and do not wish to endure the market causing pain.

As an investor with a stock portfolio, consider buying T-bonds against stocks. Hang on to stocks, but be over-weighted on the long side of bonds.

Don’t forget that Wall Street favors a portfolio that is long bonds, as well as stocks. If you don’t own some T-bonds, consider doing so.

Moving forward, shrug off, if possible, FOMO. Do the best you can to hang on to your money.

Also understand that the single most difficult decision to make when investing or speculating is “when to get out” with a profit, or a loss.

There is no simple answer to that question. There is no answer.

I favor government-backed T-bonds that appear to be undervalued and stretched to the downside.

I look at stocks, but they appear pricey and stretched to the upside. Time will tell.