Synthetic Systems Update
Synthetic Systems has been tracking well. For the third quarter, it had been predicting a up quarter for stocks, gold and copper, and we got that. It predicted a down quarter for bonds, and we certainly got that. Compare the Actual outcome in later charts with the Projected outcome for the same period in earlier charts to get a sense of its accuracy. The Synthetic Systems pages retain prior versions to facilitate this.
I don’t want to focus too much on quarterly performance though, because for its projections quarterly is near the upper limit of SS’s useful frequency range. SS is most useful for trends and cycles between about a quarter to about four years. Beyond those limits, we look to other tools.
Looking forward, SS sees stocks struggling in the fourth quarter. This is similar to what the last update forecast for this quarter. The degree of consistency between successive forecasts is an indicator of its confidence in its outlook.
Remember the charts focus on relative total returns, so that the relevant information content is in comparisons between the asset classes … a greater increase or lesser decrease in one plot indicates outperformance relative to another. So as it pertains to the next quarter, today’s update projects performance as gold>bonds>copper>stocks.
We’ll discuss the market outlook in general in the Comments.
Bonds continue to sell off this morning, with GOVT nearing its October 2023 all time weekly low close of $21.68. I’ve so far been wrong about a near term rally, but they’re deeply oversold and something’s gotta give. Stocks … ? …
With bonds yielding 5+% and stocks yielding barely 1.5% – and that’s the whole world market, not just the S&P – the valuation gap is in 1999 territory. Even allowing for
growthinflation, that’s a big divergence.The world market is inflated mostly by the presence of a few teracap stocks. Even as a percentage of the entire global stock market, the top five – Nvidia, Apple, Microsoft, Alphabet and Amazon, make up a total of 16.31%. While these stocks attained their multi-trillion-dollar status with strong, low debt balance sheets, that is no longer the case.
The increase in valuations coupled with a decline in quality makes for a risky mix.
What is the stock market? Here’s the one index fund I’d buy to beat it.
Is it just me? Or does this MSM article pull a brazen bait and switch? It begins with a comprehensive look at the world stock market, then, without any explanation, throws out everything outside the US as if it’s all that’s worthy of consideration.
Bonds & Stocks Are “Pricing A Fundamentally Different Macro Regime”
Don’t Own Bonds and be Cautious With Stocks
“Preserve and protect is my current investment motto.
Bill Gross“
I just want out: Billionaire investor Jeffrey Gundlach, who called the housing bust in 2007, says you should have almost nothing in AI stocks
The other bond king weighs in …
I’m more aligned with Gundlach at this point. I agree with Gross insofar as being long term bearish on bonds, but see them as a good value in today’s market as compared to stocks, and oversold to boot. Within stocks, I’ve also constructed a portfolio that does essentially what Gundlach outlines … maintain stock exposure at a distance from AI.
The big question:
When will Wile E Coyote look down?
He may have taken just a quick peek today, when the FT reported that OpenAI’s revenues fell about $20B short of previous expectations. OpenAI’s stock doesn’t publicly trade, but AI related stocks like Nvidia and Micron are down sharply.
Just for kicks, let’s try a little thought experiment. What if everybody followed Gundlach’s advice and trimmed their AI stock exposure to almost nothing?
The AI stocks would crash to almost nothing. Everybody can’t sell their AI stocks. Every share sold is a share bought. Unless the shares are retired, the only way their weight in the aggregate portfolio could fall would be for their values to fall.
So what if everybody followed Gross’s advice and sold all their bonds?
The housing market would crash as mortgages were called. Companies would go bankrupt. Governments would collapse. Civilization as we know it would end.
Jim Cramer spots something investors may be missing on Wall Street
“Major indexes keep closing at record highs even as Treasury yields climb to levels not seen in over two decades. That combination has traditionally meant trouble for expensive growth stocks, not fresh records.”
Back on September 15 yours truly stuck out his metaphorical neck and predicted plunging bonds would soon put in a bottom and turn higher. That call was at least twenty days early, given that bonds have rallied only since hitting a low this Monday, October 5. There’s still no guarantee this week’s rally isn’t a dead cat bounce; its status remaining firmly in Erwin Schrödinger’s domain for now.
Being shy about putting one’s money where one’s mouth is, however, not my thing, so on September 24 I began bottom fishing in the bond market, buying bits of GOVT on each dip, gradually reducing my underweight position. Being as treasuries are the basis for pricing virtually every other dollar denominated asset though, this has implications far beyond bonds. Suggesting that investors may be gaining confidence in it, gold in particular has started to regain some of its mojo. REITs, which have been taken out and shot, may get caught in the updraft too.
An overweight position in COMT makes owning bonds and other rate sensitive assets a more palatable trade given that rising commodity prices are a big driver of falling bond prices.
In theory this extends to the tech-led stock market as well, but it may have been waiting for signs of bonds bottoming before even selling off, as few have the cajones to pull their money out of a winning asset class to push into a losing one, especially when they look to the recent past to define those terms. Stock investors these days tend to be a momentum oriented crowd.
It bears recalling though that the secular bear market for bonds remains in force. This is a purely cyclical call.
Setting aside for a moment its price behavior, GOVT sports an interesting dividend profile. Its trailing twelve months distributions per share total $0.833. Given its current price of $21.88, that works out to trailing yield of 3.81%.
That’s very competitive with dividend stock funds. On the same basis for example, the Vanguard High Dividend Yield fund VYM yields 2.32%. Over the past four years its dividends have grown at an annualized 3.40% rate. Being as stocks have the growth advantage though, this makes VYM’s lower yield potentially more attractive.
But wait … over the same past four years, GOVT’s distributions have grown at 25.7% annually.
That’s not a typo, as you can verify here. And as lower yielding securities are replaced by higher yielding securities, those distributions will continue to grow.
This would be nirvana for a dividend stock investor. The best of both worlds … not high yield or dividend growth but high yield and dividend growth.
As noted above, if interest rates and yields just stay the same, GOVT distributions will rise. If they rise, GOVT distributions will rise higher. If they fall, GOVT’s price will rise. It’s a compelling proposition for income investors looking to diversify dividend stock portfolios. Add gold and commodities to balance price behavior.
Ray Dalio warns the stock market’s cushion against rising bond yields is shrinking
‘Unholy developments’: Jim Cramer warns that interest rates are unlikely to drop — bolster your portfolio before the reckoning comes
The long term outlook for gold remains bright, but the near term not so much. Lower prices and higher yields for bonds, especially Treasuries, are attracting the marginal buyer. For example:
‘Single-asset portfolio’: Kazakhstan plans gold sales as holdings reach 78% of reserves
“Aliya Moldabekova, Deputy Governor of the National Bank of Kazakhstan, explained in a recent interview that the current multi-decade highs in Treasury yields make dollar assets very attractive.
“We haven’t seen levels like this in a long time,” Moldabekova said. “This makes the dollar an attractive option, thereby reducing the appeal of gold as an investment asset.””
Gold has been especially frustrating lately, neither gaining upside momentum nor falling enough to get excited about buying. I’d like to see dollar prices below $4000 first. There’s a fairly good chance of that happening before we close the books on 2026. Having reduced my position on the spike early this year, I’m waiting for more attractive prices before increasing it again. It’s possible we don’t get them, so I’m not selling either. Very near term, watch for the CPI tomorrow; a hot print is likely to cool gold while a cool print is likely to heat it up.
As we tipped late last year, broad commodities have been doing all the heavy lifting this year in the hard asset space. COMT just hit a new multi-year high and is up over 45% yoy. This in turn feeds into higher rates and yields, keeping pressure on gold. Because of the geopolitical inputs and their dependency on a few unpredictable decision makers, this is an especially unpredictable area. Until the picture becomes clearer, it’s prudent to remain diversified in not only gold but across the commodity asset class and in cash, treasuries and stocks.
The CPI did print hot and gold did turn cold. September CPI +0.6% versus August. Gold down 1.87%.
As we would expect, treasuries sold off hard on the print, but oddly, recovered and at last check were posting gains on the day. This suggests that treasuries are being seen as attractive at these yields. At least someone besides me and the Kazakhstan National Bank must think so.
Just one more piece of evidence supporting my call for a bond rally, which appears now under way. It took a bit of patience, but the best gains on a trade are before it becomes obvious to all.
… and bonds continue their rally this morning, putting all our recent trades nicely in the green. This time, gold is entrained in the updraft, although it will be down tomorrow. Stocks, having been late to the selling party, still have some catching down to do first.
Wile E Coyote has been peeking down this week. Stocks broadly (VT) were down by 1.88%. More than all of that was concentrated in the most speculative and overvalued areas … our Model Portfolio dividend-quality-value allocation (VYM-VFMF-VYMI-VSS) was up 0.71% on the week.
So was its Treasury (GOVT) allocation (+0.91%). Gold (IAU) was down slightly (-0.67%) while broad commodities (COMT) were up stoutly by 3.07%.
Our friend Wile E took a good hard gander below this morning, and saw nothing but thin air for a few hundred feet. The skepticism we’ve expressed about the AI bubble seems to spreading to a wider audience. Stocks are getting hammered.
Bonds are providing much appreciated ballast. The rally that I called a few weeks ago is in full swing, with the ten year yield solidly back below the five handle to 4.95%, and the boring old widows and orphans UST index fund GOVT up a whopping 0.88% today alone. But the best part could already be behind us … the picture ahead is less clear. An argument can be made for further cyclical gains, but remember this is all in the context of a secular bear market.
It’s too bad they don’t include gold or other commodities. Fun fact: Over the past one year, gold (IAU) has returned -2.10%, the S&P 500 (VOO) 15.70%, and broad commodities (COMT) 55.85%. Commodities (COMT) have beat the S&P (VOO) over the past five years to date, +88.34% to 80.65%, with gold (IAU) returning 122.86% over the same time frame. Both commodities and gold beat the vaunted AI-pumped S&P over the last five years.
But you won’t hear this on CNBC!
Our gold and silver to energy and broad commodities trade from last year has been wildly successful. The rally in COMT began the day of posting, 2025 1217, and it is now up 59.66% from that day’s close of $24.54 to $39.18 at last check today. The same December day gold (IAU) closed at $81.76 and was last spotted at $75.15, for a return of -8.08%.
That trade is now mature. We went underweight gold and silver in January as gold spiked over $5000 a troy ounce. It’s traded today a bit below $4000. Relatively speaking, gold is now cheap and oil dear. It’s unlikely we will have nailed a turn to the exact day again … these trends could continue for a while … but it’s not too early to start unwinding the gold (IAU) underweight and trimming the broad commodities (COMT) overweight. I took a small first step in that direction today.
Our Model Portfolio stock ETFs have done well too. According to StockCharts.com, total returns over the past year were …
VYM +17.41%
VFMF +31.82%
VYMI +23.29%
VSS +7.39%
… so in the 3:1:3:1 MP proportions, this mix works out to a composite return of 20.16%. This compares to the supercap-heavy S&P (VOO) of 14.44% and to the world (VT) 13.70%. American investors following the ubiquitous media advice to just buy the S&P have been disserved. They have been both under-diversified and under-returned.
Disclaimer: This comment was produced without the aid of AI.
Investors should be on alert for a deflationary squall. The risk may seem remote, but deflation doesn’t happen by inflation drifting too low; it emerges from elevated inflation. The higher COMT goes the higher the risk. Readers may recall that crude oil hit its all time record of $147 a barrel in the middle of 2008 … shortly after which intense deflation sent asset prices into free fall and even slow-to-respond consumer prices to negative month over month prints by the fall. In addition to the above tactical leanings, I’m overweight TBills (SHV, TRSY).
… and here it is.
Tomorrow’s Fed announcement is as much about signaling as it is about substance. CME futures put about 10% odds of a rate hike and I don’t disagree, but there’s hope. If the Fed whiffs, it takes some of the oomph out of its tough talk; if it hikes, it’s saying hey, we really are serious about this inflation thing.
That would likely spur a selloff in gold and its elementary commodity kin, and likely stocks too. It could very well prompt a bond rally, as some of the inflation premium comes out of bond yields. In any case, a hold could have the opposite effects, although milder in intensity.
It’s what can happen when someone even in the mainstream financial media starts with journalistic integrity and rubs some functioning brain cells together. MarketWatch’s Brett Arends calls out the ubiquitous articles (Motley Fool, are you listening?) warning of risks to the stock market yet exhorting investors to keep buying no matter what. Because past performance assures future results.
You can’t rely on the S&P 500 as much as you may think
Arends systematically dismembers such simplistic pap. He cites TIPS as an alternative, and in fairness doesn’t claim they’re the answer, but plain old diversification itself is a huge improvement. Value stocks, smaller stocks, foreign stocks, bonds and commodities are all ways to diversify away from the concentrated bet in a handful of supercaps the S&P represents these days.
The Art of Not Being Stupid
“During World War II, a young Army Air Corps weather officer sat in a hangar at night and asked himself one question: How could I kill these pilots?”
AI is being taken out and shot this morning as investors increasingly question the questionable decisions to borrow to the hilt to invest in trendy tech. In a deflationary dustup prompted by belatedly elevated official inflation stats the baby is being thrown out with the bath water as gold is also being hustled out behind the barn.
Treasuries are not, however, having fallen too far too fast over recent weeks and bottomed 1005. GOVT and REET have been benefitting nicely as well as COMT with rising commodity prices. We’re gradually reducing our overweight in COMT and our underweight in IAU … as noted above the trend isn’t over yet but is increasingly water under the bridge.
All Hell is starting here, Gold/Silver massive sell off………i think we about to see a Bloodbath very shortly!
A gift to buyers. Gold may have more downside side near term but any price with a three handle is a long term bargain. We’re in a deflationary mode and at some point they will print.
IAU -3.46% since yesterday’s close.
Definitely in “bloodbath” territory.
Still a better place to be about now than crypto or AI😳
They print like bastards!
Brent @ $115…………………………something coming?
Counterintuitive as it may seem, soaring oil prices are deflationary.
If ever there were a sign that physical commodities are the new thing, the latest precious resource is … sand?
Illegal sand trade may be worth up to $350 billion a year, and people are being killed over it
Ok, as i see it:-
AI blow out, but more likely to deflate 1st.
No one in their right mind will loan any more cash.
Without more cash the AI coms can NOT finish their build outs
Unable to complete their build out means they no income to service debts
BOOM!
You betcha. The bond market (Mr Spock) was already pulling back. Even the more emotional equity market (Dr McCoy) is getting skittish. Markets have been skeptical about stock prices versus plausible returns for a while, but Big Tech crossed a line when it went from funding its adventures from business cash flow to borrowing. Much of its valuations depended on strong balance sheets, which are no longer so strong.
Higher energy prices also figure in because it means higher inflation stats which translates into tighter monetary policy than would otherwise be the case. The Fed will be behind the curve in easing as it was in tightening (just less so because of its asymmetric reaction function). Inflation (and deflation) happen first in asset markets, while the Fed mostly follows lagging consumer prices.
The timeline is the hard part. The denouement could be 6-12 months away (we’ve seen false starts before) or … it could be starting now.
MDFE post in World affairs
👍
https://financology.net/2026/10/03/world-affairs-2/#comment-11020
I didn’t want to say anything earlier so as not to jinx it;-), but I was watching for follow through today. As expected, we got a morning rebound … but it didn’t hold … faded as the trading session wore on. After previous false starts, this is encouraging … the sooner this bubble deflates the better.
A global perspective from Martin Hutchinson:
The Bear’s Lair: The Shrinking Investible World
I don’t believe the UK is uninvestable or falling apart. Quite the opposite,I believe it has more or less bottomed. As long as the Labour and Conservatives keep a lid on migration and can ignore the siren calls of business looking for cheap labour solutions the future is looking up.
As for Martin Hutchinson defending Tommy Robinson, absolutely ridiculous.
He is a 5 time convicted criminal and was found guilty by a jury of 12 of his peers for intimidating journalists.
This is sign of a country ruled by law rather than intimidation.
FWIW I agree with you insofar as I’d say the UK is more investable than the US with its bubble valuations, especially given the caveats you cite. I suspect even Hutchinson might with those caveats. I would add one more, and that’s that it resists calls to undo Brexit.
A Mushy, Wormy AAPL
I’ve written before on the overvaluation of the S&P 500, but haven’t cited this aspect. It called to mind some famous comments by Scott McNeely, which the article quotes.
“So 51% of the S&P 500 trades at more than a 10x price-to-sales ratio. This is not normal, or healthy.
A 10x sales multiple is extreme. When you buy a mature stock at a valuation like this, be prepared for disappointment unless everything goes perfectly.”
It’s hard for any investor to avoid the S&P … it makes up roughly half the world stock market cap.
I didn’t expect such immediate gratification, but my observations about the gold and silver versus broad commodities trade have already begun to be borne out. COMT (including oil) so far has topped on the date of the above comment (1023) and has since reversed sharply lower, while IAU (gold) bottomed a week later (1030) and has exploded higher. Be wary that trends don’t generally move in straight lines, but it’s possible the peak COMT/IAU has been passed.
Stocks as an asset class, in dollar terms, topped out on August 13, and have been working their way down since. This is a quintessential bear market. We define a bear market in the traditional sense as any meaningful decline extended over time. Financial media lite have attempted to redefine it in purely magnitude terms (a 20% decline), but that merely serves to delay a declaration of a bear market until large losses have already been incurred. Wouldn’t you rather not wait until you’ve lost 20% for a bear market alert?
Media are also attempting to chalk up today’s crash to the mid term vote, alleging that Democrats will be less friendly to building AI data centers. This is typically amnesiac media obsession with tying all major market moves with the latest headlines. Not that there isn’t an element of truth to it, but it’s hard to turn that into a retroactive explanation for all the declines that came before. In fact the bigger problem is more fundamental; Big Tech moved from financing its investments with business cash flow to financing them with huge amounts of debt and the stocks were overvalued to begin with. Shifting the blame to politics conveniently exculpates Big Tech from its own excess and media for its pumping stocks regardless of valuation.
The world stock market closed today down 6.78% from its August 13 closing high. This is hardly a market apocalypse, except maybe for those who have never invested during a real bear market before and have been conditioned to expect uninterrupted gains. The core explanation for most plunges in stock prices, including this one, is that they were too high to begin with. Nothing has to ‘go wrong’ when you’re priced for an unrealistically rosy future; you only need the real one to arrive. Bubbles burst.
Gold and Treasuries meanwhile are doing their job of providing ballast today, both up smartly.
As they often do following outsized moves, markets are reversing a bit of yesterday’s. It’s entirely possible that the prevailing direction for stocks the next few weeks is up.
Seasonality is mildly favorable. Prior to the selloff, financial media were busy plugging the notion that the six months after the midterms are historically the strongest period of the four year cycle. The day after rally may have reflected efforts to take advantage. What most media didn’t mention though is that this strong period was typically a rebound following deep declines. Pre-election declines this cycle were however very mild … there just wasn’t much to rebound from.
(This btw would be double counting if viewed as an additional factor to Synthetic Systems; seasonality is a one of the factors it already captures well. In fact SS anticipated both weakness into mid November and strength thereafter. This also doesn’t mean a larger bear market isn’t still in effect, to resurface later.)
It might be a stretch to say this was a deliberate effort by Wall Street to dump what it wanted to sell to its despised “retail” investors, but that’s just about how it would have worked out if it had been.