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The RiskSIGNAL Report - The Bond Market Is Calling For A Recession Issue #10

Kurt S. Altrichter, CRPS®
Kurt S. Altrichter, CRPS®
  • The bond market’s “black swan” appears to be coming to an end.
  • Bond market traders are concentrating on recession risk rather than trying to predict when the Fed Funds rate will peak.
  • Conditions don’t look good for stocks.

The market has now exited its short-term trading range and the Ivory Hill RiskSIGNAL is still red, and we are sitting on 60% cash and we have increased our exposure to long-term Treasuries to roughly 12%. Although there are some excellent buys available, caution is still advised given the abundance of unfavorable data regarding the current economy and inflation that keeps emerging. It does seem like the markets are attempting to form a bottom, which is encouraging for the last half of the year. Even the bond market appears to be finding support and emerging from a temporary reversal trend, which could be telling us a different story.
On Wednesday, Powell & Company raised the benchmark federal funds rate by 0.75%, bringing the Fed Funds rate to a range between 2.25% and 2.5%.
Real gross domestic product (GDP) dropped at an annual rate of 0.9% in Q2. And when I was getting my economics degree, the textbook definition of a recession was two straight quarters of negative GDP, and the US has officially met that.
The government redefined what the definition of a recession is. Government officials, most notably Janet Yellen, were ahead of this announcement by hedging their definitions of recession.
This means that two consecutive declines in GDP does not constitute a recession. Only the National Bureau of Economic Research (NBER) can declare a recession, and they look at various demand metrics and employment indicators, among other things, to make that call.
I posted on LinkedIn a couple months ago that Walmart’s earnings release was most likely an early indicator that inflation was starting to control the consumer and that it should spill over into the rest of the retail sector. Q2 earnings results pretty much confirmed my statement. Walmart and Target have indicated that they are having inventory issues, and things seem to be only getting worse.
Consumer behavior is worsening every day; there is no doubt about that. Any attempt to argue that rising credit card usage is evidence of a resilient consumer base is wrong. Consumers are spending more on their credit cards because the souring costs of inflation are forcing them to buy groceries on their credit cards. The surge in discretionary stock prices we’ve seen in recent weeks was merely a weak rally.
This past week, I also paid attention to new home sales. The 590,000 figure for June was significantly lower than anticipated and almost matched the pandemic low from April 2020. In contrast, almost 850,000 new homes were sold in December 2021. There is no denying the deterioration of the US housing market. We have the highest 30-year mortgage rates since the 2008 global financial crisis, at about 6%. This has a significant impact on home affordability and buyer sentiment. The median sales price of homes has also started to decline. I believe it is safe to say at this point that the housing market has peaked, and the downward trend appears set to pick up speed.
The Bond Market is Calling For a Recession
Currently, stocks are receiving the majority of the market’s attention, but Treasuries are also doing well. Treasury yield spreads are rapidly declining as the 10Y/2Y ratio falls to 20-year lows. Even while stocks are rising, the bond market believes that a recession is much more likely than not, as evidenced by the curve’s severe flattening (and inversion in a few places).
Treasuries are now beginning to tell us the right story. More crucially, it appears that we are considerably closer now than we were even a few months ago to conventional risk-off behavior from government bonds. There is still some influence from Fed policy rumors, but it appears that bond market traders are once again concentrating on recession risk rather than trying to predict when the Fed Funds rate will peak. It appears that the top for long-term Treasury yields happened six weeks ago, barring a material change in conditions.
The 10-year/3-month yield spread, which some have said to be the true recession predictor, has fallen precipitously from 228 basis points in the first half of May to just 27 basis points right now. Whether you focus on the signals or the basic economic facts, the situation is rapidly getting worse.
Below is a chart of long-term Treasuries against intermediate-term Treasuries. As you can see, since December of last year, this ratio has been in a downtrend, meaning intermediate Treasuries are outperforming long-term Treasuries. This is usually a sign of low volatility in the stock market, but this ratio has been skewed because the bond market has been in a “black swan” for the last year or so.
BUT, recently, this chart has been trying to make an uptrend, which means that 20-year Treasuries are becoming more of a safe haven asset. An uptrend in this ratio means that market conditions are telling us that higher volatility is more likely than not.
Why this matters
We know that, in general, stocks and bonds tend to move in opposite directions. Of course, that hasn’t happened as much in 2022, but, historically, that’s usually the relationship. As economic conditions deteriorate, investors tend to move away from stocks and towards the relative safety of Treasuries. Measuring long bonds against intermediate bonds gives us a pulse on the overall buying in Treasuries and removes stock market price activity from the equation.
It’s important to examine the Treasury market independently of the stock market because it tends to more accurately reflect economic conditions and expectations. The stock market is more vulnerable to overextended trading activity (TSLA and ARKK), whereas the Treasury market tends to remain more grounded in reality. The bond market tends to be right about the state of the economy more often than the stock market. Therefore, this is an important ratio to watch.
Practical Example
In short, when long-term bonds outperform, it indicates investors are becoming more cautious and moving into safe havens. This would be an early indicator that higher volatility is more likely than not, and currently it looks like it is getting close to signaling another leg down is coming for stocks.
Kurt S. Altrichter, CRPS®
Volatility is predictable.

Market direction is not.
Those of you who are familiar with my view on markets know that I am obsessed with downside risk and that I love using early indicators of higher volatility as a weapon for offensive positioning.
Let’s put this ratio to the test via a back test.
While this signal looks strictly at Treasury prices, the practical application of the strategy will involve investing in either the S&P 500 (SPY) or the iShares 20+ Year Treasury Bond ETF (TLT). When the signal is red, Treasuries are the play. When the signal is green, this will indicate that we should move into the S&P 500. I use long-term Treasuries because it provides an opportunity for your portfolio to produce positive returns even when stocks are falling.
Bottom line, in this example, we will always be invested in either SPY or TLT at all times.
Here is the back test:
Click HERE or below for the full analysis.
RiskSIGNAL Report
Outperformance is achieved through the avoidance of major market crashes.
Best regards,
Schedule a call with me by clicking HERE
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
8400 Normandale Lake Blvd, Suite 920, Bloomington, MN 55437
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Kurt S. Altrichter, CRPS®
Kurt S. Altrichter, CRPS® @kurtsaltrichter

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8400 Normandale Lake Blvd, Suite 920, Bloomington, MN 55437