Worst is yet to come....

I must say the market is very confusing right now with many conflicting signals pointing to different directions. On one hand, we have seen quite bullish signs from the smart money, which has no interest in selling:

Commercial hedgers in equity index futures keep buying the dip. They are now holding a net long position worth about 0.2% of the market value of all U.S. stocks. Another "smart money" group, corporate insiders, continue to hold off on selling. Insider sales in Technology and Discretionary stocks are at decade lows.

On the other hand, junk bonds that are more susceptible to an economic slowdown than any other part of the bond market are telling us a different story. You see, junk bonds always pay higher yields as they are more risky. Investors demand a higher premium for the risk they're taking. Right now, their premiums are soaring. Specifically, we can see this by examining the high-yield bond spread. It's the interest rate of junk bonds minus the interest rate of investment-grade bonds. And as the chart below shows, it has skyrocketed in recent months...

When this spread rises, it means investors are worried. Notice how it jumped from a little more than 3% in April to nearly 6% earlier this month. That's a multiyear high. And it's a clear warning sign from the bond market. Tough economic times are likely on the way. But according to history, we likely haven't seen the worst just yet. The recent extreme looks a lot different when we zoom out on the chart. We see that the latest move is extreme for the last couple of years. But it's nothing compared to history. Take a look...

History shows what we're seeing now is nothing compared with previous extremes. The junk-bond spread topped 10% during the COVID-19 panic... And it was well over 20% during the global financial crisis. Heck, it even approached 9% in 2016 as crashing oil prices wreaked havoc in the energy sector.

Then, currently, earnings estimates for stocks are not accounting for much slower economic activity. While the "P" in the valuations (P/E) calculation has declined, the "E" has not. During a recession, earnings tend to fall quite significantly, as noted by Bloomberg:

"Outside of recessions, the black line in the chart doesn't stray too far from zero. But during recessions, we see that actual earnings are considerably worse than expected ones.

Per the Street insider I know of, typically analysts won't reestimate the corporate earnings during the first quarter but rather during the 2 quarter earnings season that has just started, they will face the reality and pen down a more realistic earnings estimate for the next few quarters. In other words, there is a high chance we may see a cluster of earnings adjustment to the downside, with which the market won't be happy about. 

We just finished a brutal first half to the year. And it's easy to think (or at least hope) that the worst is behind us. That could be the case. But the bond market is telling us that tougher times could be on the horizon. Based on many different indicators I have seen, I think there is a high chance we may see another brutal selloff to find the ultimate bottom of this bear market, sometime in the next few months. In other words, the real bottom may come towards the end of the year. I'm very excitedly waiting for this moment as that will be a great buying opportunity once in a decade. My parked cash is very itching for the moment to come. 🤓😜