Crash Watch Becomes Crash Warning – Investment Watch

by Craig Hemke via Sprott Money News

A regular reader of these weekly columns will recall that the Fed first warned us of its intentions back in April. US markets had held firm in the following months, but now finally appear to be on the verge of falling.

As you probably know, the old adage is “don’t fight the Fed,” so when the Fed tells you they intend to “inflict losses” and “cause pain,” you should probably take them at their word. At TFMR and through our writing here for Sprott Money, we’ve been on “Crash Watch” since Jerry Powell’s speech in Jackson Hole. It was last week that we posted this latest update:

Again, however, concerns about US equity markets began in April. what happened then Here’s former New York Fed chief Bill Dudley giving us all a warning in no uncertain terms: Fed needs to ‘inflict more losses’ on stock investors to tame inflation, former central banker says .

In the five months since, we’ve written about it four times. Here are the links:

And why should a precious metals enthusiast worry about a drop in the bull market? Because a fall in equities almost always leads to a liquidity squeeze where ALL assets are sold due to margin pressures and the desire for cash. This also applies to COMEX gold and silver, and you only need to remember 2008 and 2020 for proof.

So now, as the title of this post suggests, we’re officially moving from “Crash Watch” to “Crash Warning.” Because? Mainly because the sharp upward movement in nominal and real interest rates will soon become too heavy a burden for equities.

Could a quick move in the 4.00% 10-year US Treasury note do the trick? So far, markets have been able to avoid higher nominal rates, but remember that it only took a move to 3.25% in 2018 before the equity disaster struck. Perhaps a ten-year yield above 4.00% would be a bridge too far this time? May be. Either way, I think we’re about to find out.

However, the biggest driver of stock and gold prices is actually “real” or inflation-adjusted interest rates. When real rates are negative (inflation expectations exceed nominal rates), “risky assets” generally perform well. However, when real rates turn positive, the opposite happens.

The easiest way to measure changes in real interest rates on a daily or weekly basis is by following the TIP ETF. This fund exclusively holds US Treasury inflation-protected securities, and rises and falls inversely to real rates. As you can see below, this fund has had a horrible 2022 as real rates have risen sharply. In fact, with a current price close to $106, the ETF is currently trading at levels not seen since February 2011.

And here’s where the concern comes in, and why we’ve upgraded our Crash Watch to a warning…

The chart below is a weekly chart representing the TIP and the large S&P 500 ETF, the SPY. You can clearly see the very close long term correlation. The TIP is in candlesticks and the SPY is shown as a blue line.

Do you feel like there are three possibilities?

  1. The TIP rallies and rejoins the SPY as real rates fall.
  2. The SPY drops to reunite with the TIP.
  3. The two are somewhere in the middle.

If the TIP stays near 106 or moves even lower, it’s hard to see the bears holding firm. The above chart suggests a drop to near 250 in the SPY or around 2500 in the S&P 500. That would be about a 30% drop FROM THERE! If you have mutual funds in your retirement accounts, are you prepared for this possibility?

The chart below also shows this. Note that since the paradigm-shifting event of QE1 in March 2009, the S&P 500 has fallen back to the same trend line on several occasions, all coinciding with some jaw-dropping move by the Fed or acting out ‘another way to raise interest rates. Isn’t 2022 just the latest chapter in this ongoing Federal Reserve traversal trend?

Unfortunately, COMEX gold as a “risk asset” shares the same concerns. Below is another candlestick TIP plot, but this time COMEX gold is the blue line. Could there be a drop in liquidity below $1,500? It certainly seems like a possibility.

Eventually, of course, the Fed will capitulate. They will have no choice, and the next program of rate cuts and QE will melt your eyebrows. Metals and miners will soar accordingly, but that’s only after we’re forced to endure some pain from 2008 or 2020 again.

Keep watching this space for updates and the eventual issuance of the “All Clear,” but for now, please understand that the crash that seems to be coming could materialize at any moment, and once it does, it’s likely that the things develop quite quickly. .

Again and as always, prepare accordingly.

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