Uneasy feelings

First let's talk about that Fed meeting last week. When I looked at what expectations were the day before the meeting, many folks were thinking that the Fed could blink in the opposite way I was suspecting - that the Fed was going to suggest hiking rates sooner than expected whereas I was thinking they would be even more dovish by suggesting they would cap long term rates. The end result was something in the middle. The Fed had mildly surprised the consensus by remaining steadfast on their "no hikes until 2023" stance but didn't go so far to suggest yield curve control. The bond market had a "meh" reaction while equities had a mild rally. Since then yields have cooled off due to declining oil and growth expectations as a result of new lockdowns in Europe and markets have rolled over a bit with vicious day to day rotations from growth to value and vice versa. 

Now I want to discuss what's been bothering me about market conditions. My posts as of late have had a pessimistic tone to them based on all the excesses I've been seeing.  Inflows have been surging at a time when supply of new stock via IPOs and secondaries have been spiking.  That's a bad combo. And  the silliness in meme stocks has not gone away as per the recent pops (and now fizzles) in GME and AMC and of course bitcoin.. Now, given the huge amount of stimulus that is forthcoming I get why animal spirts are elevated and I know one must be careful to not be contrarian just for contrarian's sake but I got to say that there is little in the way of a wall of worry right now for the market to climb on.

Something that could potentially be more ominous is how the recent carnage in the pure hype/momo stocks could be a parallel to the bursting of the tech bubble in March 2000. The carnage in 2000 first started with the dot com stocks which were pure hype garbage. Tech in general lagged the broader market for the next few months while the market overall held up OK  until one by one the bigger tech names started getting hit and eventually dragged down the entire market. By the end of 2000 the SPX  had clearly rolled over into a downtrend. However, there's some obvious major differences between that period and now. Back then interest rates and fiscal policy was notably tight whereas now it's notably accommodative if not off the charts accommodative. But you can't shake the parallels in the speculative excesses when you look at retail trading frenzy, bitcoin, NFTs, the issuance of IPOs/SPACs, ect.  I've been listening to the commentary of the "pros" i.e. fund managers and the consensus view by far is that there's going to be a huge acceleration of growth in the 2nd half of the year as COVID subsides. A  roaring 20's style boom is another thing I've been constantly hearing. As someone who is a contrarian at heart, all this talk makes me cringe. Now I get why there's such a bullish expectation given the stimulus that's going to be unleashed, but folks, it's all about expectations. Always remember the market has a way of making fools of as many people as possible. It seems to me that expectations are so high right now about a rosy outcome for the second half of the year. that there beckons to be some major disappointment in the pipeline.  Remember last year at this time? It was the complete opposite. Everyone's outlook was bleak including mine. Things looked really hopeless. 

Maybe I'm over-fretting here and the sentiment concerns I have will end up only being ST/medium term negative for the markets due to extremely accommodative monetary and fiscal conditions which will limit any downside to being just a sharp correction. But I just can't shake that uneasy feeling I have given the poor sentiment backdrop and excesses I'm seeing. Housing is another one which I will save for another post.  If we are at a major top right here or perhaps in a few months time,  could we look back a year from now and say that there were clear signs of irrational exuberance to have marked the top? The answer to that is a clear yes. The best thing for this bull market to continue would be for something to come along that cleanses the excesses and rebuilds the wall of worry. This would no doubt result in pain i.e. a 10-20%  decline. If not, we're probably just setting ourselves up for bigger pain down the road. 

Until sentiment conditions improve, I will continue to be very alert and practical sticking only with high conviction positions while keeping a healthy cash reserve.  

Will the Fed blink this week?

Immediately after I had warned about rising rates the market stumbled with tech stocks taking the brunt of the damage, especially the pure momo hype stocks like NIO, PLTR, TSLA and others. The Only places to hide were in value names. Did I happen to nail peak Cathy Wood and Elon Musk 3 weeks ago? Time will tell. ARKK and TSLA took a big hit.  I did see some Cathy Wood bashers come out of the woodwork and so maybe her time isn't up just yet.  We'll see. 

This latest surge in rates may have very well pierced the tech bubble in the purest of momo names, but if rates can find a way to stabilize and retreat from here, we could see a stabilization and resurgence in tech names...at least for a while.  During the depths on the recent pullback we didn't see the typical run for the exists type sentiment that we normally see except for the NAAIM indicator and a couple of other shorter term indicators. Fund flows and AAII sentiment didn't budge and is still showing elevated bullish behavior. Also look at how muted the VIX spike relative to other recent pullbacks. Thanks to the resurgence in value names the SPX and especially the DOW have recovered from the pullback while the NASDAQ is still well off the highs. We are seeing crazy day to day rotation in and out of growth and value names. 

So, the narrative as to why growth has been getting hit is because rising rates have a  negative impact on the valuation of secular cash flow generators given the higher discount rate applied to cashflows. At the same time rising rates have steepened the yield curve which supposedly makes financials more attractive and so you get this massive rotation from growth to value happening. Growth over value has dominated for years and really accelerated during COVID but for the past 5-6 months this trend has reversed sharply. So, is this the beginning of the long awaited value over growth cycle turn? For that to happen I believe you would need to see earnings disappointments or some other negative shock to the tech bellwethers i.e. the FAANGS. This is what kick started the last major value cycle from 2000-2007.  If earnings from the tech giants and growth plays in general don't come under threat then this value upturn will probably end up being a short lived affair.

In the short term the value rotation looks overbought here. All the Fed has to do is just hint that they are ready to step in to cap the yield in long bonds and this trade would reverse hard in the short term.  At some point the Fed has to step in. If yields keep climbing it will undermine the massive $1.9T stimulus bill. Remember, it wasn't too long ago that the Fed was urging politicians to play their part in supporting the economy by passing a major stimulus bill. Well, they did just that and so now the ball is back in the Fed's court.  Given the passing of this stimulus and Fed's accommodative stance towards the economy, It would be asinine if the Fed just sits on their hands and continues to just watch this surge in long bond yields. Mortgage rates are already ticking higher. What's the Fed's uncle point?  Is it 1.75%, is it 2% on the 10 year?  The Fed meeting this week will be a big one. If they don't hint strongly towards doing some sort of yield curve control we will probably see yields on the 10 year make a run for 2%. That's going to cause more pain for the market, tech in particular. And then what....the Fed is going to capitulate a few days later and announce something? They need to say something at this meeting or they will risk looking like fools like they did in late 2018 when they stubbornly took too long to respond to changing market conditions. Maybe Powel learned something from this. Maybe he didn't.  The last time Powel spoke he didn't suggest any changes to Fed policy and the market sold off  and yields took off notably. All he said was the rising yields had "caught his eye".  It appears that most market players are expecting more disappointment from Powel again,  but given how bond yields keep making fresh highs I think there's a much better chance this time for a positive outcome.

Back in late 2018 the bond market bullied the Fed into doing a complete 180 turn from their rate hike campaign. The tail wagged the dog. They are now bullying the Fed again. The Fed has to realize that they are the dog. If the Fed wanted to, they could  rip out the throats of the bond bears for they have literally unlimited buying power.  Right now there's a lot of speculative trend following shorts in the bonds. It's ripe for a squeeze and the Fed probably won't even need to do a lot of heavy lifting. Just them announcing that they will backstop bonds would send yields sharply lower on their own. If the Fed does this  you're going to hear it from the permabears and self righteous market purists as they cry foul about such manipulation. But guess what? Manipulation is here to stay. The Fed stepped in to backstop corporate bonds last year and it worked. You're never going to have markets be totally free, nor would that even be desirable. If markets were totally free,  manipulation would be worse.  Those with the largest pools of capital would be in position of power and would manipulate markets with no mercy in order satisfy their self interests at the expense of everyone else.  Due to the madness of crowds psychology, unfettered free markets would likely result in more frequent bigger boom and bust cycles as well. The truth is, you need regulations and you need central authorities to keep "the children" in check. It's arguable as to how to organize and run such overseers and no doubt they have been less than perfect and have abused their powers at times,  but we need them to prevent the larger abuses and instability of purely free markets.  Anyhow, I digress.

It will be interesting to see how things play out here. If the Fed says the right things this week and the markets end up making new highs with NASDAQ making a comeback to take back leadership, it will probably result in one last hurrah before something else eventually comes along to make the market stumble. The reason I say this is because sentiment conditions are already bullishly elevated for the most part and therefore not providing a wall of worry backdrop at the moment aside from a couple of shorter term indicators. It wouldn't be long before we see bullish sentiment turn to euphoric bullish  and bad things tend to happen when we get that.