Fear Grips the S&P 500 and Silver

How will silver respond when the temperature rises in 2023?

With fear making a slight comeback on Dec. 22, silver couldn’t escape the negativity; and while we’ve highlighted the depressed behavior of the Cboe Volatility Index (VIX), the metric rose by more than 9%.

Yet, the dip buyers helped the S&P 500 close well off its intraday lows, and the VIX closed well off its intraday highs, meaning the crowd still hopes to orchestrate a Santa Clause rally. But, with the bearish fundamentals creating a crisis of confidence, we warned on Oct. 26 that the bulls were throwing good money at a bad investment. We wrote:

With two of the four largest companies in the S&P 500 suffering, the squeeze may have already run its course. Moreover, while positioning is still heavily short, the index offered tactical value near 3,600, not 3,850. 

In addition, with the bearish medium-term fundamentals rearing their ugly head, and the Fed poised to raise interest rates by 75 basis points next week, stocks offer a poor risk-reward proposition when the FFR should hit 4%. 

Thus, with the S&P 500 ending the Dec. 22 session at ~3,822, the dip buyers are now in the red and cash is king. Likewise, market participants’ inflation optimism is misguided, and the recent data and a hawkish FOMC have suppressed investor sentiment.

Please see below:

To explain, the red and green bars above track the NASDAQ 100’s December performance from 2000 until now. If you analyze the right side of the chart, you can see that the index is on track for its “biggest December drop since 2002.” As a result, the liquidity beneficiates have been taken to the woodshed.

More importantly, while the stock market bulls highlight how down years often don’t repeat (which is true), periods with major fundamental imbalances (like this one) don’t follow that roadmap.

Please see below:

To explain, the charts above show how consecutive years of negative S&P 500 returns are rare but highly damaging. If you analyze the chart at the bottom left, 1973-1974 rivals the current environment because the fundamental backdrops are so similar. 

With unanchored inflation forcing the FFR much higher in 1973-1974 (and it was still rising during the recession), the S&P 500 declined dramatically before a sustainable rally unfolded; and with the Fed far from solving its inflation conundrum, strength should be sold until the S&P 500 reflects its fundamental value. 

To that point, billionaire hedge fund manager David Tepper said on Dec. 22:

I’m leaning short on the equity markets. I think the upside/downside just doesn’t make sense to me when I have so many central banks telling me what they are going to do. This is a tough level [for the S&P 500] to talk about robust returns.”

He added:

“Why are we still putting these high multiples like when we had 1% rates? I have to put multiples that are realistic to the market.”

Furthermore, while we’ve warned that the FFR should continue its ascent in the months ahead, Tepper said, “I think [the Fed is] worried about that inflation rate that’s going to be stubborn at 3.5%, 3.75%, 4%.”

As such, he also expects higher short-term interest rates in 2023.

Please see below:

Source: CNBC

So, while the white metal has dismissed many of these issues, the fundamental problems that confront the S&P 500 should come for silver in 2023: higher interest rates, QT and a likely recession that has Morgan Stanley predicting a ~20% drop in S&P 500 earnings per share (EPS) are highly bearish for silver. Remember, financial markets are interconnected, and tremors in one market often shake others. 

Therefore, with little economic damage unfolding in 2022, outside of lower commodity prices and a weaker U.S. housing market, we believe risk assets have a lot more downside in 2023 before their final lows are reached.

Alex Demolitor
Precious Metals Strategist