XHB - The Pain Arrives

2023-09-25 12:49:55 ET

Summary

• The market suffered through its worse weekly performance since this March, and both the NASDAQ and Russell 2000 fell over 3.5% on the week.
• Interest rates continued to rise with the 10-Year Treasury yield touching its highest level since 2007 and mortgage rates approaching their highest mark of this century.
• As I have been warning for months now, fundamentals are deteriorating both on the credit and economic front.
• Unfortunately, it is likely this is just the start of a larger pullback for equities for myriad reasons.
• Why it is time to hunker down is discussed in the paragraphs below.

There are wounds that never show on the body that are deeper and more hurtful than anything that bleeds .”? Laurell K. Hamilton.

Equities endured a brutal performance in the week just passed. Investors got a good wakeup call from the sudden pullback as equities suffered their worse weekly rout since March of this year when several regional banks failed.

It was a broad-based decline. Not even Cisco Systems' ( CSCO ) $28 billion purchase of Splunk ( SPLK ) could save the Nasdaq from posting a 3.6% decline on the week. The small cap Russell 2000 posted similar losses while the S&P 500 fell nearly three percent on the week.

All 11 S&P 500 sectors posted losses. The defensive Healthcare sector was the best performing sector with a decline of " only" 1.2%, while Consumer Discretionary was the weakest S&P sector with a pullback of 6.3% on the week. As I noted in my recent article , consumer spending is all but certain to finally crack in the upcoming fourth quarter. Market action this week confirmed that trend and fear.

Goldman Sachs reported that the credit card loss rate currently stands at 3.63%. This is the highest rate since the Great Financial Recession and is up 1.5 percentage points from the recent bottom in September of 2021, when there was a massive amount of excess savings from the Covid pandemic in the economy. Further, Goldman sees credit card losses rising another 1.3 percentage points to 4.93% in 2024. This comes as total credit card debt in the U.S. just surged over $1 trillion for the first time.

The Federal Reserve declined to raise interest rates again during the conclusion of its much-anticipated meeting that ended Wednesday. However, their commentary did confirm that interest rates will remain " higher for longer ." This is a narrative I have written about often on these pages as well as on Real Money Pro over the past few months.

Source: Investopedia (09/19/2023.)

10-Year Treasury yields ended the week at 4.44%, right at their highest levels since 2007, just before the Great Financial Crisis set in. Mortgage rates are now at 22-Year high moving Housing Affordability to another all-time low and crushing the home builder stocks on the week. This move has further to go in my opinion, and it is a key reason I own bear put spreads on the SPDR® S&P Homebuilders ETF ( XHB ).

In addition, the monthly Leading Economic Indicators fell again on Thursday for the 17th straight month. Something that hasn't happened since 2007/2008.

Another large office property went into default this week as well. This time it was around $350 million worth of loans around a 43-story office building just south of Times Square in New York City. As I warned in an article entitled " Shades of 2007 " in mid-August, commercial real estate is likely to be the 'subprime' in the next financial downturn. Several trillion dollars' worth of CRE loans and CMBS need to be refinanced at much higher interest rates over the next few years.

In many cases, the underlying assets have lost significant value since the last time loans were issued against them. This will result in a large increase in defaults, write-offs and losses for lenders, especially for regional banks that provide 70% of funding for CRE loans. The big REIT W. P. Carey ( WPC ) just announced it was ridding itself of all its office holdings via asset sales and a spinoff. I expect others in the space to do the same to dispose of these toxic assets before their values fall fuller.

Finally, as a new article on Seeking Alpha noted, the S&P 500 is at an important technical level at around 4,320. It the index doesn't hold here, it could easily set up a retest at its 200-day moving average, which currently is around 4,190.

I think we will see some sporadic rallies for the rest of the year, but the overall direction of equities is likely to be down from here as the country heads into either a recession or has a significant bout with Stagflation. Neither of which will be good for equities.

As a result, my portfolio remains quite conservatively positioned. Roughly half the portfolio is in short term treasuries currently yielding 5.5%. Approximately 40% is in mostly conservative covered call holdings. The rest is in cash as well as some bear put spreads positioned to benefit greatly from a continued downturn in the markets.

I am only making incremental trading moves here. I did take nearly fourfold profits Friday from my bear put spreads in RH ( RH ) and Darden Restaurants ( DRI ). I will probably leave some money on the table by taking this action, but the options were expiring in October. And as the saying goes " Bulls make money, Bears make money, Pigs get slaughtered ." I also executed some covered call orders Friday on the SPDR® S&P Biotech ETF ( XBI ) as the ETF is back at strong multi-year technical support levels.

I anticipate this will be how my portfolio will be positioned at least through then end of 2023, as more pain for investors seems to be in cards now as the third quarter rapidly comes to a close.

It has been said, 'time heals all wounds.' I do not agree. The wounds remain. In time, the mind, protecting its sanity, covers them with scar tissue and the pain lessens. But it is never gone .”? Rose Fitzgerald Kennedy.

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