The market is flashing a serious warning sign. Yet investors are ignoring it.
Those who fail to heed it are setting themselves up for pain. I don’t want you to be one of them…
As you know, we’re in the midst of the worst banking crisis since the 2008 Financial Crisis.
In March alone, three major U.S. banks have collapsed.
Regional banks have seen $108 billion in deposits go up in smoke.
And major global banks have seen their share prices plummet.
So it’s no surprise the banking sector is one of the worst performing of 2023.
The Financial Select Sector SPDR ETF (XLF) – a proxy for the U.S. banking industry – is down 12% since the beginning of the month.
Despite the banking panic, the S&P 500 is up 3% over the last two weeks. It’s even trading at a higher level than it was before the onset of the banking crisis.
It’s like investors are covering their eyes and ears to the carnage going on around them. And they’re ignoring an important warning sign that worse is to come.
Today, I’ll show you what that sign is… and what you can do to prepare for it.
Investors Don’t See the Danger Ahead
The chart below shows the S&P 500 (blue line) and the U.S. Investment Grade Credit Spread (green line).
The credit spread represents the yield an investment-grade bond is paying above a government bond of the same maturity.
When spreads rise, it signals that investors are demanding more compensation for the risk of owning corporate debt.
As you can see, a rise in the credit spread typically corresponds to a drop in the S&P 500.
At first glance, you may not see the danger ahead. But this chart is ringing like an alarm bell.
If the past is any indicator, the S&P 500 would need to drop another 15% from where it is today to be in line with past increases in the credit spread.
Here’s the thing: The spread is likely to get larger. And it has everything to do with Federal Reserve policy…
As you know, the Fed has been hiking interest rates to battle persistent inflation.
Last week, it raised the benchmark interest rate by 25 basis points. It’s the Fed’s ninth rate hike since March 2022.
Meanwhile, Fed Chairman Jerome Powell has enlisted the banks in his war against inflation.
He essentially wants them to tighten credit standards (a “credit crunch”) to slow down the economy, which would ease inflationary pressures.
Here’s what Powell said at a press conference last week:
The events of the last two weeks are likely to result in some tightening credit conditions for households and businesses and thereby weigh on demand on the labor market and on inflation. Such a tightening in financial conditions would work in the same direction as rate tightening. In principle… You can think of it as being the equivalent of a rate hike or perhaps more than that. [Emphasis added.]
During a credit crunch, banks significantly tighten their lending standards. Loans become much tougher to get.
And due to the perceived higher risk of making loans in a credit crunch environment… Interest rates go higher as banks demand more money.
This, of course, increases borrowing costs for almost everyone.
According to some estimates, a credit crunch could be the equivalent of as much as 1.5% in rate increases.
Last week, Powell reiterated he’ll do what’s necessary to bring inflation back down to the Fed’s target rate of 2%.
The current benchmark rate is 5%. As of the February Consumer Price Index report, inflation is still growing at a 6% rate.
So the Fed either needs to raise rates to at least 6% or see a considerable amount of slowing economic growth to hit its 2% inflation rate target.
If the knock-on effects of the credit crunch don’t bring inflation down, then additional rate hikes will likely occur.
That means we’ll see increased credit spreads… and lower equity prices.
Patience Is a Virtue in This Type of Market
The bond market is clearly signaling risk is on the rise. It’s only a matter of time before the stock market gets the message.
And when it does, volatility will rocket higher.
If the Fed continues its policy of tightening, and credits spreads rise, we’ll likely see more downside in the stock market.
The best thing you can do is remain patient until the volatility tamps down. You’ll find that better entry points are soon to come.
If you’re looking to put some cash to work now, there are strategies you can implement to generate income while you wait.
One is selling call options against any blue-chip stocks that you own.
By setting the strike price about 5% above the current price, with a maturity date one month from now, you can generate meaningful income over this volatile period.
Please note: When selling calls, it’s important to keep in mind the number of shares you own of the underlying company.
If the stock closes above your strike price on the maturity date, you’ll be required to sell 100 shares of the company for each option contract placed.
As always, make sure you do your homework before making any trade or investment.
Regards,
Michael Gross
Analyst, Palm Beach Daily
P.S. If you’re looking for another option to hedge against market volatility, Daily editor Teeka Tiwari suggests bitcoin.
While bank stocks have been falling, bitcoin is up 63% since January — making it among the best-performing assets so far this year.
But while Teeka recommends everyone own at least a small amount of bitcoin – he doesn’t believe buying it is the most profitable move you can make right now.
Last week, Teeka shared details about a tiny subsector of the crypto market that will benefit from the coming “buying panic.”
Unlike most cryptocurrencies, these tokens are programmed to pay you monthly income on top of capital gains. And they’re set to benefit from a surge of activity coming to one of crypto’s largest networks as early as next month.
During his special event, he explained what this catalyst is and what types of tokens will benefit from it. For a limited time, you can stream it right here.