In our October 10th Market Commentary, we explained that the breakout of the S&P 500 Index in early October had occurred with very low participation. This may suggest further weakness ahead. The article concluded that our model remained in correction mode, but bullish overall. Currently, the model remains bullish, although it shows weakness in certain areas.

Why, then, are financial markets experiencing so much volatility if the model remains bullish? Because volatility is at the core of financial markets. Sometimes it remains low for an extended period of time and suddenly breaks out to the upside, but it is always there. While all economic recessions start with a financial market decline, not all financial market declines precede an economic recession and a bear market.    

During the last few weeks, we’ve noticed a rotation of capital into defensive groups. Strength in these groups is not necessarily bearish for stocks. However, investors’ interest in defensive stocks comes at a time in which breadth has deteriorated, small-cap and mid-cap are in short term downtrends and high beta groups remain under pressure again. On the other hand, large cap indices such as Nasdaq 100 (QQQ) and S&P500 (SPY), seem largely immune to the selling pressure, at least for now. Both indices remain bullish short term and mid to long term. Regardless of short-term selling pressure, the main trend of all these indices is up and bullish. Can this positive scenario for stocks change? Yes, at any time. But when it happens, we will change our positioning, too.

Main Points:

  • Now that the Federal Reserve’s Chairman Powell admitted that inflation is not “transitory,” it seems that the peak of it is behind us. We shall continue monitoring inflation data for confirmation. Even if we are right, it does not mean that inflation will go back to Powell’s comfort zone below 2% any time soon. It simply means that although high, inflation might decelerate from current high levels or the rate of change (ROC) may slow down. What could be the cause of it? A strong US Dollar and lower commodity prices.
  • Biden’s disproportionate and inflationary budget for infrastructure did not pass the Senate vote. In our view, the result of it might create a temporary deceleration of GDP growth. GDP = Consumption + Investment + Government Spending + (Exports – Imports). If government spending is lower than anticipated, GDP may slow down.
  • Decelerating inflation and GDP are typical of the last phase of the economic cycle (Phase 4), in which the stock market usually collapses. Even in a decelerating inflation and GDP environment, we do not believe that the stock market will collapse for a simple reason: in this particular case, the levels from where inflation and GDP may decelerate are much higher than those of a normal economic cycle. This is not a normal economic cycle. Last year, the US economy experienced two months of deflation (March and April) after GDP halted after Covid-19 went out of control, affecting the world economy. Deflation and the GDP halt were not part of the normal economic cycle. Conversely, the levels of inflation and GDP growth for 2021 are not part of the normal economic cycle either. 
    • Therefore, even in the worst case scenario in which inflation and GDP decelerate at the same time, in our estimate the current high level from where both would slow down, should prevent a recession and bear market. Let’s call it a soft landing, narrow or even shallow phase 4 scenario. No doubt in our minds that if this scenario develops during Q1 and Q2 2022, volatility will be high.

The following are positive facts for our bullish case:

  • We see no stress in credit markets.
  • Although the yield curve is not as steep as it was, it is far from being inverted or flat. Inverted and flat yield curves usually anticipate economic recessions.
  • Gold is not reacting yet as it did in past inflationary periods, which may indicate that the peak of it is behind us.
  • The battle between Growth vs. Value continues, but both have performed really well throughout the year.
  • We are starting to see some commodities turn down after 16 to 18 months of uptrends. If the trend continues, it should alleviate inflationary pressure. 
  • Lastly, our quantitative analysis shows that slightly more than 53% of the stocks in the S&P 500 Index sectors remain bullish short, mid and long term, while the main trend of all sectors remain bullish. Check our Index Trend Table here (*). Low participation for a bull market? Yes, but not enough to trigger a bear market yet…         


(*) The Greenwich Creek Capital “Index Trend Table” is not meant to be used in isolation, it is part of a more complex set of variables and it is not designed to provide trade entry and exit points.         

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Saul A. Padilla, RIA

Saul A. Padilla, RIA

Registered Investment Adviser and founder of Greenwich Creek Capital Management LLC, bringing over 37 years of experience in managing discretionary and non-discretionary investment portfolios for wealthy families and institutions. His main focus is to protect invested capital by re-balancing the allocation of cash, equities, fixed income and commodities, while closely monitoring macro-economic indicators and market trends to determine the transition phase between the completion of a Bull Market and the beginning of a Bear Market. He started his career in early 1987 mainly managing family financial investments.