DOWNGRADED!

Issue 299

By Jeffrey Trusheim, Chief Financial Officer, Mortgage Solutions of Colorado, LLC DBA, Mortgage Solutions Financial.

Mortgage Solutions presents Issue 299 of Market Pulse. This commentary will provide Trusheim's perspective of the economic, political, and technical considerations that will have an impact on the global & domestic financial marketplace. The report will provide a recap of the previous week's activity as well as a look at the important market-moving factors in the week ahead.

Fitch Ratings downgraded the United States long-term credit rating from AAA to AA+, citing “expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA and AAA rated peers. In Fitch’s view, there has been a steady deterioration in the standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025.”

David Beers, former head of S&P Global Ratings sovereign debt scoring committee and one of the analysts behind the controversial ratings cut in 2011 (which is still in force) said Fitch’s downgrade is an important reminder that the U.S. isn’t entitled to the top grade. “The underlying fiscal position and underlying debt trajectory has picked up pace. AAA is the top rating any agency can assign, but of course, the U.S. and any other sovereign that’s being rated has no God-given or automatic right to that.”

Fitch expects the U.S. general government deficit to rise to 6.3% of GDP in 2023 from 3.7% in 2022, rising to 6.9% of GDP by 2025. The interest expense on our nation’s huge ($32+ trillion) debt load is currently about $660 billion per year, and is expected to grow to $1 trillion per year. The estimated interest expense for the next ten years (2023-2033) exceeds $10 trillion! The percentage of debt to GDP has doubled since 2021. The Congressional Budget Office projects that interest on our debt will exceed the amount spent on Medicare in 2044 and Social Security in 2050, at which point it will be the largest expense in the federal budget.

IMHO, this is an insane and unsustainable path that our elected officials have put us on, and their out-of-control spending is the greatest risk to our economy. As I have opined in previous missives: I would say that Congress is spending money like a bunch of drunken sailors…but that would give drunken sailors a bad name! Hopefully, this downgrade will start a serious conversation.

No matter which side of the aisle you are on, or what your opinion is toward our government, we all have to recognize the reality of what we are facing. After the largest?($10+ trillion) stimulus ever poured into our economy, followed by a surge of high inflation, and the most aggressive rate hiking cycle in history, it is foolhardy to think that there will be little to no impact on our economy down the road. Be it one year, five years or longer…eventually, there will be (and must be)?a painful reset, to cleanse this toxic mess we have gotten ourselves into.?

THE JOBS REPORT

Non-farm payrolls in July grew by 187k, just below the estimate of 200k. The prior two months were revised down by a combined 49k, so taken together the jobs data was lower relative to expectations. The unemployment rate dropped to 3.5%, and the average hourly workweek shrunk back to 34.3 hours which was the lowest since 2011.?

However, the birth/death model added a whopping 280k jobs to this report, meaning that our economy might have actually lost jobs last month. The BLS (Bureau of Labor Statistics) gives us a pure “guess” each month as to how many new businesses opened (and hired workers) versus how many existing businesses closed (and terminated workers). The BLS calls this their Birth/Death model. No actual data…just a guess. I find it very difficult to believe that 280K more jobs were created than jobs lost last month, especially when the average monthly payroll growth during the last three months was just 218k. Go figure!

THE STOCK MARKET

After three failed attempts to close above 4600, the S&P 500 went into full retreat, falling 133 points (3%) from it’s July 27th high at 4607 to a low last Friday at 4474, before finishing the week at 4478, down 104 points. It appears that an important top has been struck that could put the markets into a corrective structure for a while.?

The trading pattern on Thursday, July 27th was quite important from a technical perspective. It produced what we call an “outside bearish key reversal.” Prices traded both above and below the prices of the previous three days, and closed below the low price of the previous three days. And from an Elliott Wave perspective, the 133-point decline from the July 27th high has produced a five-wave impulsive structure. So, to confirm a bearish setup, any bounces from here should be three wave corrective structures, and should run into Fibonacci resistance in the 4550-4560 region.?

As far as downside targets: The 50-day moving average comes in around 4400. A typical 5% Summer pullback comes in at 4375. Fibonacci retracements from the June low are in the 4300-4350 region. A 10% correction along with the 200-day moving average would be seen in the 4100-4150 region. Remember, August and September are typically the worst months of the year for the stock market.?

THE BOND MARKET

Well, to say the least, it was another exciting week on the ol’ Bonderosa! The bond market had to deal with: The Fitch downgrade, the BoJ (Bank of Japan) lifting its Yield Curve Control policy, another $1+ trillion of Treasury supply announced, sticky inflation, and the possibility of another Fed rate hike. Oh yes, and the CoT (Commitment of Traders) report showed large non-commercial accounts (hedge funds) had shorted 3 million 2-year and 10-year Treasury futures contracts. That is a cumulative leveraged short bet of about $150 billion notional short exposure. Billionaire investor and hedge fund manager, Bill Ackman, announced that he was betting against the 30-year Treasury Bond by purchasing options.?

The 10-year Treasury yield shot higher in response to all this bad news, reaching the 4.20% level, giving back all the gains for 2023 and matching the high yield from October 2022. However, that 4.20% high yield was seen on Friday morning, and by the close, had plummeted to a low and closing yield of 4.04%.?

As mentioned numerous times this year, our forecast for the 10-year Treasury calls for the yield to peak in the 4.00%-4.25% region, and we continue stay with our forecast. It is possible that we just witnessed a “double top” at 4.20% on Friday. The “equity risk premium” of owning stocks over bonds is currently at a twenty-year low. IMHO, this just might be a good time to go the other way, and favor bonds over stocks. Bonds are coming off their worst year EVER, and are oozing with bearishness. Yes, I am talking my position, but I’m mostly in 6-month T-Bills, and have started to scale into longer maturities. When I see risk-free Treasury yields trading higher than an income-focused equity portfolio…it’s time for me to rotate and swap my asset allocation. But that’s just me.

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Have a great week!

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Jeff Trusheim is the CFO of Mortgage Solutions Financial. Jeff is a 30+ year veteran in the Wall Street arena, with a background in economics, risk assessment and finance (banking and mortgage). He has previously worked in Fortune 500 companies in growing their portfolio and economic footprint.?