Michael A. Gayed, the Publisher of The Lead-Lag Report and Portfolio Manager at Tidal Financial Group, is raising concerns about a potential market correction in April due to increasing volatility and a possible directional move to the downside. In a recent article, Gayed shared his insights on the factors contributing to this outlook, warning investors to exercise caution in the face of growing economic uncertainty.
Gayed observed that while the market conditions in March favored higher volatility without a specific direction, April seems to be showing signs of both increased volatility and a downward trend. He argues that the banking sector’s recent issues, including the collapses of SVB Financial’s Silicon Valley Bank and Signature Bank, may not be the sole trigger for a potential market correction. Instead, he believes that these events may be “window dressing” covering up larger, underlying problems in the financial markets.
The core factor behind the collapses of SVB and Signature Bank, according to Gayed, was poor risk-management practices leading to a steep duration mismatch in their fixed income portfolios. He points to the Federal Reserve’s rate-hiking cycle as the root cause of these mismatches. During the zero interest-rate policy (ZIRP) era, Treasury yields fluctuated in a relatively tight range, allowing for more latitude in interest rate management. However, with the Fed Funds rate increasing by nearly 500 basis points in just over a year, the bond market is experiencing serious volatility.
Gayed emphasizes that the effects of interest rate increases take time to manifest in the broader economy. While rate hikes are quickly reflected in T-bills and mortgage rates, their impact on corporate and government activities takes several quarters to become apparent. He believes that the consequences of rising interest rates are about to become more visible in various sectors.
In addition to the regional bank failures, Gayed mentions the near-collapse of the UK gilts market in October, the vulnerability of commercial and residential real estate markets, rising corporate borrowing costs, and financially strained consumers as signs of an impending market correction. He argues that the Federal Reserve’s continued rate hikes, despite these issues, suggest that it may have already overtightened its monetary policy, and the economy is on the brink of feeling the repercussions.
Gayed also discusses the path of asset class returns, noting that stocks and bonds have mostly maintained a positive correlation since the Federal Reserve started raising rates at the end of 2021. This trend continued into 2023, with both asset classes experiencing a strong start in Q1. However, with the Fed expected to end its rate-hiking cycle sometime in Q2, Gayed predicts a return to traditional intermarket dynamics, where stocks and bonds typically move in opposite directions.
Given the recent deterioration in economic fundamentals, the return of the flight to safety trade, and higher volatility levels, Gayed contends that stocks are more likely to be the asset class that breaks. While his short-term and intermediate-term risk signals are currently flashing risk-off, he cautions that this does not necessarily mean a market correction is imminent. Nevertheless, the warning signs he monitors closely indicate that now is the time for investors to be very cautious with risk assets.