Déjà Vu: Stock Market Bulls Ignoring Warnings of Economic Weakness

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As history ominously repeats itself, echoes of past financial crises reverberate through the stock market. Retail investors, blinded by bullish fervor, ignore the warning signs as the AAII Bulls 50-period MA reaches heights reminiscent of the eve of previous crises in 1974 and 2007. The chip bubble inflates market optimism, masking underlying fragilities in the economy.

Amidst this speculative frenzy, the reality of a weakening U.S. economy lurks in the shadows. Despite the facade of strength, astute observers recognize the need to tread cautiously. A prudent strategy emerges: take profits in cyclicals and seek refuge in defensives, fortifying portfolios against the impending storm.

Despite mounting evidence of economic headwinds, the market remains fixated on the prospect of rate cuts. The CME FedWatch Tool paints a grim picture, with the market pricing in a mere 1.4% chance of the Fed abstaining from rate cuts. Conversely, a chilling 35% probability looms large—a stark reminder of the market’s vulnerability to monetary policy shifts.

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All business models heavily reliant on long-dated instruments and leverage stand vulnerable if proper risk management is neglected: pension funds, insurance companies, shadow banking, real estate, and more.

Bear steepenings in the yield curve pose a significant risk, particularly if they occur amidst weak nominal growth. However, the current nominal growth rate exceeds 4% and is expected to remain robust. Hence, while the bear steepening trend persists, equity markets remain resilient. Nonetheless, vigilance is crucial as this rare and potentially perilous trend in bond markets unfolds. If the yield curve continues to bear steepen and nominal growth falters, the repercussions on risk assets could be severe.

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Global Recession Odds are 50/50 Citigroup Warns

Citigroup analysts have recently indicated that the likelihood of a global recession is now almost 50%, exacerbated by rapid interest rate hikes by central banks aimed at combating inflation. This inflation spike has been attributed to the aftermath of the Ukraine conflict and the ongoing COVID-19 pandemic. The analysts warn that the path to disinflation could significantly hinder growth, reflecting a grim outlook for global economic expansion over the next year and a half. Similarly, Barclays has highlighted the fragility of the global economy, projecting a slowdown to just 1% growth for developed economies in 2023, with the euro area expected to slip into recession by the end of the fiscal year.

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