This rally feels different

We've had a pretty good run in the market for the past month and a half.  We had similar good rebounds twice before this year - one in the spring and one in the summer both of which obviously failed. This time around the rally feels different in some respects. First of all, everyone is calling it a bear market bounce and I don't see any "is this the bottom?" queries. Some sectors like financial and biotech are exhibiting the hallmarks of a bull market advance, namely a strong, relentless low vol  move and they have just broken above the August peak although barely. The other thing to note is how the Fed's latest attempts at jawboning the market down is not having the same amount of bite. Monday's decline was driven by comments from Bullard who's saying the Fed funds rate needs to go to 5-7% to fight inflation. With the 10 year yield trending down and comfortably below 4%, the bond market is giving the middle finger to this tough guy stance these Fed guys have.  The Fed's "we don't see any meaningful signs of inflation easing"  rhetoric is a farce. Maybe part of this talking down the market tactic has to do with the idiotic perception that the wealth effect of a stock market rally would add to inflation pressures. I nailed it when I compared the Feds to inspector Gadget. On Monday oil prices hit an  11 month low and went briefly NEGATIVE YTD  yet  "we don't see any meaningful signs of inflation easing". 5 Year break even rates have been down trending big time since April and currently stands  at 2.29% This is the market's average CPI expectation for the next 5 years. Historically, this has been an accurate measure of what the CPI actually ends up averaging over the next 5 years.. Yet "we don't see any meaningful signs of inflation easing". Idiots. 

Getting back to market action. Did you know that despite all the horrific macro developments in Europe all year,  European stocks are down only about 9-10% YTD? I don't hear ANYONE mentioning this. Whenever the market is quietly going against the narrative you ought to pay special attention. On October 20th I read a market pundit make this comment "don't expect anything but a bear market rally until the Fed pivots, inflation eases and war in Ukraine is over". The problem with acting on this belief is that by the time those things happen the market will probably be at or close to new all time highs.  The markets will anticipate, they will price in information. That doesn't mean it gets it right all the time, but that's what it does. The more you wait for certainty, the higher the price you will have to pay for it i.e. lower the returns you will get.  I mentioned something similar in the summer of 2020 as the pandemic was raging. And think about how the markets behaved earlier this year. Stocks and bonds sold off hard from Jan-March well before the Fed did its first rate hike. Markets will anticipate/price in things.  It will probably do the same going the other way. 

The market is going to face an important test. The last 2 times we had a run like this where it became ST/IT overbought it ultimately fell apart. Can the market consolidate this time and not totally fall apart? From a market action and sentiment/indicator perspective the chances of this look better than before. But what about the inverted yield curve and other ominous macro signs like rising layoffs which suggest immanent recession? They are surely a concern, but if the market can consolidate here before moving higher again, it would suggest that the market is expecting that any recession would be mild and better times lie ahead. How long could such a consolidation phase last for? Typically they take 1-3 months but it's very difficult to predict these types of wiggles in the market. The best we can do is use tactical indicators to help navigate. By the way, I have never seen such a unanimous call for a recession as I do now. This is not to say that since everyone is calling for one it won't happen, but rather that a recession is very likely priced into the market to some degree. If the market can consolidate and break out above August highs it would suggest that  he market is looking past any recession or that there won't be one at all. If it's the former, it would suggest the recession will be mild without any financial crisis. There's some good reasons to expect this to be the case. More on that in a future post. 

Bottom line is that the latest market action is encouraging  but by no means an all clear signal. Let's see how it handles the looming overbought condition. 

Crypto rant

Anyone reading this blog knows I've been a crypto skeptic for some time. This post I made in Feb 2021 says it all. This year we have seen the unravelling of crypto with the latest being the FTX fiasco.  Due to the lack of regulation, there's a ton of scams and leverage underpinning the entire crypto space which is coming to light. I doubt this unwinding is over.  BTC in its current form will end up going to 0 in the long run because it's fundamentally worthless - you can actually make the case that it has negative worth given the environmental damage it creates. Eventually people are going to wake up and question the lunacy of BTC.  How the fuck can people not see how utterly asinine and wasteful the process of  "mining"  bitcoin is? Even if you believe in the possibility of crypto having a value, clearly there must be a much better way to manage/maintain it than to waste an astronomical amount of energy like BTC does.  BTC is the top crypto by "market cap" simply because it the was first crypto invented, nothing more.  Regardless of the system that is used to maintain any crypto, they are worthless unless they are backed by something of actual value. You can't just simply create a "coin" out of thin air and it expect it hold any value aside from greater fool buying which eventually peters out. Mind you, this greater fool effect can go on for quite some time as it did for crypto, but now the jig is up because the last and biggest batch of fools - institutional money - joined in just before the last peak and subsequent crash. In order to revive crypto aside from short term bounces, you are going to need a fresh batch of  greater fools bigger than the last cohort of bag holders and that  probably doesn't exist. 

After the GFC many people had  resentment towards the Fed and governments given how it was handled which very much persists to this day. So, some person or group invented  BTC and basically said "we  have come up with an alternative currency free from any meddling by governments."  Such an idea could garner a cult-like appeal from anti-establishment sympathizers which it did. The other main appeal was the clever blockchain tech that underpinned BTC. Regardless of the appeal, BTC was able to capture the imaginations of people on an incredibly wide scale. It had more than a few crashes and recoveries along the way all of which led to new highs, but the only reason why BTC was able to recover to new highs was because it was able to recruit a fresh batch of greater fools larger than the previous batch. The last run to $60K was the result of the last and biggest batch of greater fools - institutional money. The collapse of FTX exposed some of these institutional investors such as the Ontario Teachers Pension Plan. How embarrassed and ashamed must they be? This latest fallout all but assures that institutional money will be sellers, not buyers from this point on. 

The bitcoin rise and fall is very similar to that of dot com stocks in mid-late 1990s.  When dot com stocks first started turning heads it was driven primarily by retail. The internet was hyped to be the next big thing set to revolutionize the world and the way to profit from this was to invest in dot com stocks. It didn't matter that most of these companies had no earnings or real business plan, the fact that they had dot com after their name was good enough as it  symbolized that they were part of the internet revolution.  Dot com was initially scoffed at and dismissed by the so called institutional investors,  but many under-estimated how long and how intense the frenzy was going to be. Some of these skeptical institutional folks shorted the dot com stocks only to get badly burned. By the time the bubble hit its peak the institutional money had capitulated and jumped on board because they simply couldn't afford to miss out anymore. Then, just like what happened with BTC and other crypto, they had to come up with rationalizations to buy. At the end of the day, it was FOMO and greed that did them.  The crytpo Superbowl commercials this year marked the pinnacle of the euphoria just like the dot com Superbowl commercials in 2000. Crypto will survive, but the days of  creating coins backed by nothing and expecting success are over. 

I can sympathize with the Fed haters and the notion of seeking an alternative to fiat currency. However, you can't just come up with a coin and say "hey everyone, let's start using this instead of the US dollar as an expression of our hatred of the system" and expect it to work long term. This type of  "expressionist"  investing also underpinned meme stocks.  Such a thing can't work long term without anything of true value underpinning it.  The only thing underpinning it is inflows from the herd.  The herd is fickle, it's unreliable, it has no obligation to be loyal and when the inflows stop and the price starts sagging, it's just a question of when not if, the heard is going to stop supporting it and move on.  But wait, aren't fiat currencies backed by nothing? No. There's a central authority that enforces it; that deems it to be legal tender and the only way to transact, pay taxes and settle debts in the country it represents (many countries also do business in US dollars). Therefore you are essentially FORCED to use fiat currency of the country you reside in or do business with, the same way you are forced to abide by the laws and regulations of that country.  Nobody is forced to use a crypto coin in any way.  The herd can easily move on from whatever coin is popular at the time to another coin or get turned off completely by crypto. A central authority on the other hand, is always going to be there enforcing that same fiat currency. Do authorities  abuse or misuse their powers? Of course; some more than others, but they provide stability and assurance which is critical. Central authorities also enforce laws and regulations which is obviously critical. Again, the system is not perfect but it's necessary to have a government enforcing certain things otherwise we would be  living in a jungle of chaos. And yes, I know there are plenty of countries in this world that have oppressive governments. It should be obvious that I'm referring to democratic governments and not regimes like North Korea.  

The argument that crypto's value is a reflection of the blockchain technology or anything along those lines is pure nonsense. Once again, this is expressionist investing.  Think about the Microsoft Excel program which creates spreadsheets (loosely analogous to blockchain which creates crypto). Cleary, the excel program has a worth as it creates spreadsheets which can be used to keep records, make calculations, ect., but what is the value of the spreadsheets it creates? Zero...with the exception of when it contains information that a person or entity may value, but even in such cases, it's the info not the  spreadsheet itself , that has the value. If Microsoft were to announce that all their excel programs would only be able to generate a combined lifetime total of 21 Million spreadsheets, would that then give these spreadsheets value? No. Because there are other companies that can generate unlimited spreadsheets. So you see, there's nothing special about a spreadsheet. 

Face ripper

We had an absolute face ripper of a rally last Thursday thanks to a better than expected CPI report. SPX up 5%, Naz up 7%. with no mercy to the bears as the market gapped up huge. Coming into the report the market was sagging and looking bleak. Given the last 2 disappointing monthly CPI reports expectations must have been quite low and bears were pressing. Lot's of folks talking about how good this report was and how it bodes well for the future but lots of folks were also talking about how bad last month's report was and how it boded ill. Suffice to say that one shouldn't get too excited or depressed about a single month's worth of data. I've been saying for a while that pipeline inflation pressures are collapsing in general, sure, some components will be stickier than others but overall it's clear that the trend for inflation is down. A great way to distill this is to track 5 year break even rates which has been hovering at around 2.5% for the past 4 months. I really like this indicator because it distills all the nuances of the CPI providing an outlook GOING FOWARD of what the average CPI will be for the next 5 years.  Meanwhile the bumbling, fumbling Fed keeps looking in the rear view mirror saying how they don't see inflation subsiding much. I suspect at some point in the next year or 2 there is going to be an overhaul in the Fed with respect to how they make forecasts as they will once again be made to look foolish. Mark my words. 

The market is just punishing everyone, whipsawing the shit out of both bulls and bears. Once again, read the motto of this blog and don't you ever forget it. So, is this latest rally yet another head fake? Most likely, but it could very well be part of a base building process if the bull case is playing out. I had given a target of SPX 4000-4100 for which we have hit the lower end of this range. The market could be forming a W type bottom, similar to what we saw in 2002 and 2011...obviously too early to know if that's the case as can only know in hindsight if that actually transpires. Take a look at the biotech index ETF BBH. The W bottom is much more pronounced here. This sector is one to keep on eye on as it's showing relative strength and not being talked about much.  Bears can easily make a good case that this is just another dead cat bounce but the fact that the market is now flat for the last 6 months is a big achievement given what has been an absolutely brutal macro backdrop. Keep an open mind. Nasdaq is showing early signs of decoupling from BTC. To me this is an important thing that needs to happen to suggest a true bottom is in. The market needs to shake itself off from the speculative crap of yesteryear. Meme stocks are another thing that needs to die but they are still showing correlation to the Nasdaq although they have been pounded quite hard and are not nearly getting the spot light as they once did. I'm going to make a post discussing crypto shortly. 

Let's talk indicators. Prior to this surge there were some indicators showing some extreme bearish sentiment, namely, put/call ratios and DSI. One surprising development was how AAII equity allocation declined to 61.5% and cash is at 2.5 year high at 22.5% in October which means AAII members sold into strength. At 61.5%, exposure is about as low as it was at the end of 2018, shortly after the market had decline 20% from the peak. This is a good contrarian development but I still think think this needs to come down a bit more. Other indicators were neutral such as NAAIM. Fund flows had reversed course flipping to negative for the week but only after having been positive for the 3 weeks prior. These latter 2 are now poised to jump to excessive optimism territory when next Thursday's readings come out assuming the market doesn't totally far apart by then. 

Let's talk more about positioning. Throughout 2022 the strongest case for the bears in regards to sentiment is positioning from investors. AAII allocation surveys have pointed out all year that  they are feeling very bearish but they haven't actually positioned their portfolios to reflect it,  having only grudgingly decreasing equity exposure. Market watchers are saying that we can't bottom until we see more capitulation. Well, here's another possibility that nobody is considering. What if the market hits a bottom and Investors sell into the strength early in the new bull market? As mentioned, AAII did sell into strength in October. If the market keeps rising and they keep selling they could  end up capitulating into strength rather than into weakness like everyone is expecting. It should be noted that AAII members also sold into July's rally but then bought back in August. And so here lies the problem of these kinds of sentiment indicators - they can flip flop and whipsaw you. What I've learned through out the years is that when a lot of market watchers are focusing on a particular indictor or strategy it will end up becoming less effective. 

Let's talk about the Ukraine war. When this war started about about 9 months ago, who could have predicted that Ukraine would been preforming so well and Russia so poorly? Nobody.  I have heard that Ukraine has obtained more stranded Russian weapons/equipment than what they are getting from NATO. Who could have predicted when the war broke out that that the price of oil and wheat would end up being being about the same as it was pre-war in November? Nobody, not even the most rose-coloured glasses wearing optimist. Oil was supposed to be at $200 by now. Granted, natural gas prices are notably higher but have come down substantially since September.  The bottom line is that so far the world has been able to cope and adjust to the loss of Russian and Ukrainian commodities. Sure, that could change, but then again it would appear that Russia is in terrible shape. In regards to the war they are  running out of ammo and troop moral must be rock bottom  and it was probably never good to start with. Meanwhile Ukraine is getting more supplies by the day and moral must be sky high after taking back Kherson. Russia is isolated from most of the world and have a poorly educated workforce to pick up the slack from all the skilled foreigners who have left and closed shop. It's seems like the walls are closing in on Putin quite fast, but perhaps that means he is going to do something desperate as a last ditch attempt to turn the tide. I don't know. But let's say the Russian regime as we know it collapses, Putin is ousted and Russia withdraws from Ukraine. That's gong to create another face ripper of a market rally and tank commodities. This is just me thinking out loud here. I won't be holding my breath for such a scenario to play out, but it sure looks like Russia's war effort is collapsing. We can't however get complacent because Putin is known for cranking up the brutality when things aren't going his way. The problem this time around though is that the Russian economy is isolated and crumbling and patience must be running thin. If he orders a nuclear strike, his generals may very well turn on him as they know the repercussions will be so severe including a fear for their own lives The Russian military authorities know they are absolutely no match for NATO, the US in particular. Once you play the nuclear card that gives license for NATO to do a full assault on Russia as they will do it the name of saving the world from a madman. 

Bottom line is that although this bounce is good and there's promising signs that inflation is showing deceleration in the rear view mirror CPI reports, it's way too early for bulls to declare any kind of victory. How can you tell when a new bull market has been born? It will most likely show up as via a relentless 2-3 month rally. 

Fed fatigue and seasonality

I meant to post sooner but I was busy and then I caught COVID. It was another crazy month. We went from a horrific September to a blissful October.  After my last post the market dipped back down as once again, any notion of a Fed pivot got shot down. As were were drifting near 52 week lows the notion of no fed pivot kept getting hammered into everyone's brains to the point where I was sensing that maybe we are getting to the point of Fed Fatigue i.e. an acceptance of no pivot. So if that's the case, I thought that maybe the market would get tired of going down over the same thing. The so called next shoe to drop according to the bears is for earnings to collapse and layoffs to spike. As earnings started rolling in that was simply not the case. Sure, there were some disappointments including some of the big tech names, but overall it has been a rather benign earnings season. Even though the tech giants AMZN, GOOG and MSFT had disappointing results and/or outlook banks and other companies have had good or OK results. This less than disastrous earnings season coupled with the so called bullish seasonality of the mid-term election cycle started the rally and when big tech earning disappointments last week couldn't take down the market, a lot of bears who positioned for the kill shit themselves and covered adding fuel to the fire. 

So now what? We have the widely expected 75 bps hike this coming week. Bears are counting on the Fed to piss all over this rally again, but this time around the set up is different as the market has not been rising on hopes of a Fed pivot and so even if the Fed reiterates this, it may not amount to much aside from a knee-jerk reaction. If the market fails to show any sustainable downside, it's going to embolden the bulls more and make the bearish shit themselves yet again. I could see the market ultimately going as high as SPX 4000-4100 on this latest rally. We'll see. The Bank of Canada hiked by only 50 bps last week which was taken by some as a pivot which is a bit of a stretch in my opinion. A true pivot is a clear indication that rates are going to at least stop rising in my opinion. People have been so desperate for a pivot that they are willing to count this less than expected hike as some sort of a quasi pivot; that perhaps the end of the rate hike cycle for Canada is getting close. I believe this too may have contributed to the positive market tone last week but not much.  

Despite all I've said, there's still problems with market action, namely, the fund flows continue to show FOMO. At the same time though, positioning from hedge funds and other measures like option activity shows bearish extremes that you see at major lows. I'm really struggling with these offsetting indicators. Therefore, I continue to believe that one be tactical. The tactical bullish call I made earlier this month is still in play although now the easy money has been made. If this rally ends up going to SPX 4000-4100 it will look a lot like a base-building bottoming scenario is in play. I would then expect more base building until March 2023. I'm clearly getting way ahead of myself but that's kind of how I see things unfolding IF the bull case is to play out.  By the way...Trader X once again mentioned earlier this month that it was not the time to start building long term positions.  Remember, he said the same thing in early July and in April 2000. Food for thought....

Critical Juncture

FYI most of this was written yesterday and an update to reflect today's action provided at the end. 

September was a brutal month with the SPX dropping 9%. Coming into Monday the market was in an acutely oversold condition with some notable extremes in pessimism. NAAIM for instance is at 13.6%. This is the lowest exposure since March 2020. DSI sentiment which is something I don't normally pay attention to unless it's an extreme  is currently single digits for both SPX and bonds. Over the weekend there was lots of chatter about an immanent major bank failure, Credit Suisse. in particular given the trading of their CDS swaps. The fear is that this will be the next Lehman moment. The US dollar strength has been a wrecking ball for global markets and you can just feel the global angst is reaching a crescendo. Surly the US Fed must now have some serious worries about this and are getting some pressure from foreign authorities to back down on their hawkish outlook

It looks like today's bounce is mainly a relief that the doomsday scenario did not pan out just yet, but obviously the market is still very much in a precarious position bouncing from a 52 week low. I've been saying  since July that if the bull case were to play out it would require base building. The other scenario obviously is the bear market still has a ways to go and it's quite conceivable this could be the case. Let's examine again the case for either side.  

Bull Case

We have seen multiple extremes in selling pressure and negative sentiment. Although there are some missing links, positioning shows extreme risk aversion that you typically see at major lows. The excesses of 2021 have been largely wiped out when you look at the unwinding of margin debt and the dearth of IPOs. Valuations although not historically cheap, are back to reasonable levels when you look at forward or trailing p/e.  The latest slide in the market has been largely self-inflicted by the Fed's unnecessary hawkish outlook which was been wrecking havoc on global financial markets given the parabolic rise in the US dollar. With pipeline inflation pressures collapsing and global stresses mounting, it gives the ability for the Fed to back down on their hawkishness at the very least. Doing so would bring much needed relief to the markets. Although earnings have been under pressure this year, they have not collapsed and since the main culprit of earnings pressure was inflation related, there will be relief when inflation pressures start subsiding which should happen soon although some sectors like retail might get hit because of inventory surpluses. The odds of Putin getting ousted are growing by day given the terrible results in the war and latest call for mobilization. The base case now is that we are in a recession and things are about to get worse. With expectations so low, it leaves the market ripe for an upward repricing. 

Bear Case

Although there are indicators showing extreme bearish sentiment and an unwinding of excesses, a very important holdout has been fund flows. We still have a long way to go to unwind all the inflows in 2021 which were still positive in the first couple of months of 2022. Fund flows were negative in September but only grudgingly so.  We have yet to have seen a 20+ billion weekly outflow.  AAII positioning also shows stubborn lack to capitulation with equity exposure at 63%. This should be at least in the mid 50's given all the damage. The crypto bubble has not been totally deflated as it still pretty much moves in lockstep with the Nasdaq. Bubble bursting typically result in 90%+ crashes. That implies BTC to $6000 as a long term target. Unlike in recent years, there is an alternative - TIAA.  Both short and long term GICs are providing rates not seen since 2000. We haven't felt the full impact of this interest rate shock as big hikes have only recently taken place and more is still to come and so even if we get a Fed pivot soon it will be too late. The yield curve inversion is quite entrenched and is set to go negative across all maturities if the Fed hikes another 75 bps in November. An inverted yield curve is a sign of immanent economic weakness, usually within the next 12 months. So even if we get a Fed pivot, at best it will result in only short to medium term relief. 

The Verdict

There's certainly enough evidence to suggest one be tactically bullish here, but nothing more. I'll repeat something that I've said a few times earlier in the year. For a bullish resolution to all this, we need to get to the point where the market sniffs out an end game to the rate hike cycle,  (i.e. the pivot) without there being too much damage to the economy. After the Fed's last meeting they poured cold water over any notion of a pivot coming any time soon however the subsequent market turmoil may have made them start to reconsider their hawkish plans. 

Update: 

The UN apparently has pleaded with the Fed to stop rate hikes given the havoc the strong US dollar is having on non-US economies. They confirmed the suspicions I had about the Fed coming under pressure from the global authorities to back down. Renewed Fed pivot hopes coupled with a still oversold market resulted in another strong bounce today. But even if we get a Fed pivot, will it be too late? And what kind of pivot, if any will it be? Any meaningful pivot would have to require the Fed to cancel any further hikes...at the very least one more hike and stopping. Bottom line is that the foundation for this bounce is shaky even though it has the potential to carry on longer. So long as we keep seeing crap like BTC, AMC, GME and BBBY surging every time the market is strong, it tells you that we haven't fully wrung out the excesses/stupidity of the prior cycle and so keep your guard up. More thoughts coming soon. 

Inspector Gadget Fed

No shortage of drama in this market. I called for a bounce in my last post which we got but it was very short lived and it's been nothing but pain since. The "poor" August inflation data was the trigger that started this latest shit show. The Fed's subsequent hike of 75 bps was expected, but it was the Fed's hawkish upward revision of rate hikes to 4.5-5% by March 2023 which cratered the markets. This outlook was no doubt fueled by the result of this single backward looking CPI report which is quite asinine. Meanwhile, the oil price, one of the main culprits of the inflation problem, has just about given up all its gains YTD.  Several other commodity prices and many other inflation pressure points have been abating since June as well.. One of the things the Fed cited as a concern was shelter costs but that too has rolled over, it just hasn't showed up in the data yet. The pipeline inflation pressures are clearly collapsing. 5 Year break even rates which is probably one of the best forward looking indicators peaked in April at 3.41%  and is making new lows almost  daily currently at 2.19%. back to normalized levels which is so significant but of course, the Fed doesn't seem to care. Instead they panicked over a single month's worth of rear view mirror inflation data. 

Here's the funny thing....interest policy won't do shit to move the needle in inflation the way most people seem to think it can. The obsession of the  Fed and interest rates reminds me of a cartoon I used to watch called Inspector Gadget who's job it was to thwart the evil schemes of the sinister Dr. Claw. When Gadget was assigned a case he was always accompanied by his niece Penny and her dog Brain. It was Penny and Brain secretly doing all the work to solve the case while Gadget was fumbling and bumbling chasing false clues often times interfering with the good work of  Penny and Brain. Near the end of each episode Gadget  just happens to be in the right place at the right time to get all the credit in foiling Dr. Claw when it was Penny and Brain all along who truly deserved the credit.  

Everyone seems to think that the Fed has the ability to reign in inflation via monetary policy because of the myth of how Paul Volker supposedly broke the back of inflation in 1982 by jacking up rates. I'd like to see how inflation would have  broke without the peak and subsequent long term decline in the oil price from 1982-1999 which was the result of the significant increase in the SUPPLY OF OIL spurred by significant new production from non-OPEC countries. Interest rates had fuck all to do with this. The mid-late 1940s had an episode of high inflation as a result of hampered supply which couldn't keep up with a surge in consumer spending post WW2. Sound familiar?  Inflation got as high as 18% in 1947. It eventually came down hard and by 1949 there was actually deflation of 2%. Surely the Fed had to jack up rates to break the back of this inflation right? Nope. Rates were rock bottom the whole time. T-bills were yielding less than 0.5% all through out the 1940s.   The economy eventually rebalanced on its own and perhaps was aided by government programs to restrict consumer borrowing which  directly targeted  demand for goods and supply of credit. Everyone points out the demand destruction that rate hikes can cause but nobody ever mentions or even realizes the impact to the supply side of the equation. Rate hikes increase the cost of capital which encourages prices hikes and makes capital investment to increase supply less attractive - both of which ADD to inflation pressures. 

Let's revisit the credit restrictions enacted in the late 1940s. In the US it was required that consumers  put down at least 33% for the purchase of household appliances and autos and must repay the balance within 12 months. At the time interest rates were very low as mentioned. Now, let's say that there had been no such borrowing restrictions but instead, interest rates were jacked up by 10%. Which of these 2 measures would have been more restrictive for spending? It would still clearly be the original scenario.  With the higher interest rate scenario, it would be lucrative for lenders to offer consumers loans to purchase goods with  little or no money down with the option to pay back the balance over several years. There would no doubt be a greater pool of qualified and willing borrowers than the first scenario. That's the other things about higher rates - it makes bank lending more attractive and therefore can inflame inflation as there would be more willingness for banks  to lend. More loans = more money supply and therefore higher inflation pressures. Also, higher rates means higher interest payments on interest bearing securities, which increases money supply.  The credit restrictions used in the 1940s were draconian and anti-free market no doubt, but they were probably more effective than hiking rates would have been since it directly and specifically targeted demand by suppressing the supply of credit for the purchase of certain goods. So, the bottom line is that changes in interest rates have several offsetting impacts when it comes to inflation -it's not simply a case of demand destruction or creation. Hiking interest rates won't directly target the root causes of inflation unless it happens to be mainly related to housing.

During the pandemic there was a clear mismatch between demand and supply and prices surged....we all know why.  These problems got exacerbated once people realized the situation and start hoarding, triple ordering supplies and so forth.  Eventually, this will self correct once everyone has had their fill. This is the so called "transitory" inflation the Fed was expecting. It is indeed transitory but it took longer than the Fed had expected. The war and Chinese lockdowns obviously made things even worse. The Fed eventually caved into the narrative that they had to "do something" about all the inflation....as if the Fed is the master of the universe.  I mentioned in a prior post that I believe rate hikes were a good thing to cool off housing as prices were getting way out of whack which if left unchecked would likely result in even more pain down the road. Given the weakness we have seen in housing, the job has been done with regards to what  part of the inflation equation rate hikes actual have a direct impact on.  By insisting on higher rates the Fed is wrecking unnecessary havoc in the global economy and markets. In addition some aspects of rate hikes are actually inflationary as I have explained. The inflation problem will naturally correct itself but if authorities want to help speed up the process they need to target the root causes of the inflation, directly addressing them much as they can and stop with this myopic and misguided obsession that monetary policy is the answer. If we do get a recession and inflation drops as a result,  unless the root causes of high inflation have been addressed, it will come back quickly and could actually be worse due to the decline in capital spending you get in recessions, but it would appear that a lot of inflation pressures are naturally abating making a Fed induced recession unnecessary. 

Wow that was a long winded post.  I really wanted to get my thoughts off out my head and into the open. Next post will be about the current conditions of the markets. Obviously things are not looking good right now.  

Labor Day thoughts

Past couple of weeks have been pretty nasty in the markets. We are seeing the opposite of the action we saw in late June and July i.e. falling yields and tech leadership. July Job numbers released at month end were fairly robust. At first the market response was positive but by end of the day it was negative.  You always got to be careful to give too much credence in the market's reaction to a single data point. These types of headlines often create knee jerk, emotional type moves and a game of chicken element amongst traders who have made bets on either side of the market. One thing I noticed is that when the market had been up on the day the put/call ratio was high which says there was plenty of hedging/bearish betting going on which is contrarian bullish even though the market reversed course and closed in the red. Put/call ratios have rapidly risen during this market slide, fund flows have reverted back to negative and NAAIM exposure has retreated to 33% and is probably in the 20s right now as the latest figure was as of Wednesday's close. AAII sentiment last week had 50% bears vs 22% bulls. That's back to a lopsided 2:1 ratio you typically see at a market low. The market is also now ST oversold. All of this is suggesting that that the market is ripe for at least a strong bounce and supports the notion of a base building scenario unfolding rather than a market that is primed to make major lows....at least at this point right now.  AAII positioning showed a marginal uptick of equity exposure to 65.5% for end of August. That's disappointing if you're hoping for an eventual bullish resolution to this market. Once again, AAII is showing a clear disconnect of how they are feeling vs how they are positioned and suggests that if the bulls make some kind of stand here, we're not going to be out of the woods. Granted, this is just one indicator and you should never hang your hat on just one indicator. I've showed plenty of other positional indicators which suggest extremes in bearish positioning. Bottom line is that market action looks ugly but there's enough pessimism to suggest a bounce is immanent. At the very least, not an ideal time to be going short here.

There's this narrative that strong job data automatically equates for the need for higher rates. This is such naïve and dangerous thinking.  From 2010-2020 we had generally strong job creation with a fed Funds rate averaging sub 1%. Where was the hyper inflation that this should have created? Even when the labor market was considered tight in 2018 and 2019 inflation was tame. Low rates did however contribute to asset price inflation i.e. housing and equities but not in the CPI/PPI as many doomers were predicting. 

Inflation pressures have recently been generally abating despite the strong payroll numbers we've been seeing in recent months.. In Europe, not as much due to obvious reasons.  To try and kill the economy in order to reign in inflation  due to the external factors causing it is ludicrous. That's like cutting off a healthy foot  in order to deal with a mangled toe. If the Fed hikes rates high enough for long enough, that will probably induce a recession and the bankruptcies and liquidations which result will temporarily help suppress inflation but unless the fundamental factors which created the inflation in the first place aren't dealt with, it will come back with a vengeance. If while in recession the factors that actually created the high inflation are sorted out, it, then the Fed may end getting undeserved credit. That's what happened in the 80s when Paul Volker was given credit for "breaking the back of inflation" which is bullshit....that will be the topic for another day. All I have to say for now is look at the high inflation rates in countries like Turkey and Argentina and you will see how toothless high interest rates were in taming it. Alternatively, look at Japan which has struggled with deflation for decades with 0% interest rates. 

Powel pisses on the market

 I've been mentioning how Fed officials have been pissing on the market rally and so low and behold, Jay Powell the big dick, whips it out and pissed on it too during his Jackson Hole speech Friday. He had quite the hawkish tone downplaying the notion of any kind of pause in rate hikes. He used the word "pain" to describe what was in store and was rather dismissive of the recent rollover in inflation pressure. At last year's speech Powel was making the case about how inflation was transitory and therefore justifying keeping rates at 0. He eventually capitulated and gave up on the transitory thesis.. Now he's at the opposite end of the spectrum. He's worried about inflation staying persistent and is justifying further rate hikes despite the fact that forward and current readings of inflation pressures have clearly rolled over.  I'm betting Powell will end up eating his words again.   I believe Powell was correct about inflation being transitory, but he underestimated its duration. Granted, the Chinese lockdowns and Ukraine invasion inflamed inflation pressures and could not have been predicted, but Powel caved into the narrative that the Fed had to do something to fight inflation which was due to factors that are not related to low interest rates. The main thing rate hikes do is kill housing which in turn can lead to decrease in the pace of aggregate consumption. People were given free money in the pandemic while supply of many goods & services got stifled. That's what caused inflation to soar.  That was the case for transitory which is valid. The free money is now gone but supply side issues lingered. We need to address these factors directly as best as possible.  But you know what, I think it's good that the housing market cooled off as it was on an unsustainable path and I believe the rate hikes were justified for that purpose, but not to fight the inflation problems. Now that housing has notably  cooled down, the rate hikes should stop right now. They have done their job and further hikes raises the risks of going too far creating unnecessary damage. Aside from creating a housing induced recession,  rate hikes can actually exacerbate inflation as the cost of credit businesses have to incur gets passed on to consumers to some degree. It also makes financing investments to increase production of goods and services more expensive and therefore more prohibited which again actually exacerbates inflation. But I digress. We have to play the cards that are dealt and realize that the markets and powers that be don't give a rat's ass about what you think and the way things should be. If you have good reason to believe that the market will eventually see things your way, then that's another story; place your bets accordingly, but don't whine and complain if things don't turn out your way. This is how most of the dogmatic permabears operate. 

I had mentioned in my previous post that I had ST concerns about the market given the emergence of some froth i.e. cracks in the wall of worry. When you have such conditions, it doesn't take much for the market to have the type of decline we've seen since. I suspect that Friday's decline could start to rebuild that wall of worry. Coming into Friday NAAIM long exposure had already dropped to 55% and so it's probably even lower now. Near the peak of the rally in mid August Fund flows turned positive again after being negative for 5-6 weeks. I suspect that too will reverse course. Put/call ratios have spiked back up. The current reading of 1.22 as I type this is historically quite high. If the bull case is to play out, we will have a period of consolidation. That could either entail sideways action or a retest of the lows. We have September on deck, the historically worst month of the year. 

One thing that's quite troubling is the soaring electricity costs in Europe which is squarely the result of Russia turning off the taps. Again, how does interest rate hikes address this cause of inflation? It actually creates more costs for consumers in the form of higher interest payments on debts.  It's a game of chicken right now between Russia and Europe. I think it's fair to say that this war has been a disaster for Russia. Putin could not have expected it to go on for this long and for this degree of backlash from the global community. Their largest ally China, has its own issues too. How much longer can Russia maintain its current level of military persistence in Ukraine while being cut off from most of the world? At this point, Putin has gone all in. He's not going to back down until either Russia wins or he gets overthrown/killed. This is the other wildcard in the market. Imagine we wake up one day to hear news of a Russian coup. That's going to create the mother of all rallies in equities and decline in fossil fuel prices. On the flip side, if there's a collapse in the unity of the European countries to resist Putin that too could perversely have the same results in the short term but the fracturing of the West would be a long term negative. If the latter would take place I suspect it would have to be a point where there's more pain then what we are seeing right now in Europe. In North America, the situation is not nearly as dire. We are largely energy and food self-sufficient. The US could ban exports of oil if they chose to but that would be cruel. 

With all of these cross-currents out there how does one position him/herself in the market? For one to believe that a bullish resolution will take place, it requires quite a leap of faith that somehow things will get resolved or won't turn out to be as bad as feared. One of the benefits of posting to this blog is that it allows me to look back at previous times of turmoil to see what I was observing and how I was feeling. I was looking back at posts in 2011 whereby the market had been dealing with European bank and sovereign debt woes. Emerging markets were also struggling quite notably.  At the depths of the lows it looked ugly and hopeless. Then like now, calls for a recession were loud but somehow things turned out to be OK. The bottoming process took about 4 months. This is not to suggest that things will turn out to be OK or that if we did hit a low the bottoming process will take about 4 months. My point here is that when the market is near a major low things are bad and look like they will get worse, but that's also the point where expectations are very low and there's a lot of defensive positioning which sets the stage for either a major rally or new bull market rally on just a marginal improvement in fundamentals. If the fundamentals haven't turned up enough, we tend to get a major rally which will get given back to a certain degree as more time is needed before a new bull run is launched (base building).  In the 2002-2003 bottom it look 8 months of base building and triple bottom the first one being in July 2002, second one October 2002 and the last one in March 2003.  The 2008 bear market low also had a series of lows spanning 5 months but they were lower lows. The COVID low was a V bottom with no retest. Every market low is different which is why you should pay little attention of market analogs.

Let me say what's bothering me about the market from a market action perceptive, some of which is repetitive from prior weeks. The action in the meme and crypto space for one. These sectors are the epicenter of the speculative behavior of 2021 and I would much rather see them become a wasteland rather than still moving in tandem with the market to a high degree. The latest decline has washed away some of the recent froth but the connection is still there. Government bond yields have been rising and tech has lost its leadership which probably is a result of the former. 

In my opinion here's how to best generally operate in this type of market environment unless you're a ST trader.  If you see compelling buys, accumulate positions on weakness when there's clear signs of extreme pessimism leaving enough powder dry so that you will be able to be a strong holder should the market continue to go against you. Be willing to commit say 50-60% of your position this way or which ever exposure you can handle. Then commit the rest once there has been clearer evidence that the tide has turned. For me, that means 6 months without having made a new low. Using an all or nothing approach, especially chasing the market on strength, and then placing a stop is a sure fire way to get whipsawed as I'm sure most people are.  

If I had to guess, I would say that we are going to have  a choppy market for the next few months. While it's always difficult to make ST calls due to uncertainty,  right now it's especially difficult given the many cross-currents  which makes for a treacherous ST environment from either side of the market.  Be patient and pick your spots. Keep an eye for extremes in sentiment to fine tune entry/exist points. With  expectations reset due to the Powel non-pivot, it's tough to envision the market getting any escape velocity on any rally attempts unless we start seeing further drop in inflation pressures without it being accompanied by serious economic weakness. Some weakness would probably tolerated but not to the point which results in a vicious cycle of  big earnings misses and layoffs i.e.  a true recession. Admittedly, that's a tall order to ask. Bottom line is that if corporate earnings don't fall off a cliff, the market will be able to muddle through until the market sniffs an end game for the rate hikes. That could entail a sideways chop with a possible retest of the lows. I don't need to reiterate the bear case as it's self evident but that's what bulls like Ken Fisher will say is the reason to be bullish - by now the market has priced in these worries. Well, we shall soon see if that's true won't we? 

The main purpose of the stock market is to make fools of as many men (and women) as possible

This is the motto of my blog and for good reason. How many times have I cited this? The market has continued to advance since my last post as more evidence of inflation cooling has presented itself, i.e. the July CPI and PPI releases. Once again former and current Fed officials are trying desperately to piss all over this, hand wringing that the Fed funds rate must continue going up to fight inflation. They and others are pointing to the recently released strong payroll report. The market is so hyper focused on single data points, you can see the emotionally charged movements in the first hour of trading after such reports are released which more often than not is best to fade such moves intraday. 

There's no shortage of people calling this a bear market rally. We will only know so in hindsight but what I will say is that here's a tremendous amount of skepticism about this move, however, I believe the easy money has now been made. NAAIM sentiment jumped back to 71%. this week. Put/call ratios have shown flashes of complacency early in the morning on those emotionally charged moves only to ramp back up by the end of the day which shows people are still very eager to picks tops or hedge. Fund flows this week were only mildly positive but that could change by next week. 

The market this year has now punished just about everyone. The bulls in the first half of the year and the bears so far in the second half of the year. The gold bugs and commodity bulls (many of which are equity bears) got their punishment too.  What's the motto of this blog again?  There's this one guy on FinTwit (I won't name) who comes across as a very knowledgeable and sophisticated guy who for months has been explaining why it's best to remain bearish. Just the other day he admitted to getting stopped out of shorts on July 31. All his rants counted for nothing  because he couldn't take the pain of counter trend rallies as is the case with most shorts due to the unlimited loss potential of being short which makes them inherently weak holders. Therefore, when too many bears are positioned the same way they become their own worst enemies and their fundamental arguments won't be worth of shit as they won't be able to short and hold during a strong rally. All bull markets start with short covering rallies but all bear market rallies end with them. So, which one will it be? As I mentioned, there's a lot of skepticism about this rally and I get why, but as I stated before, the longer you wait for evidence that the worst is over, the higher the price level the market will be when you get it which at that point makes it difficult to pull trigger as you then may feel that you missed the boat or keep waiting for a big pullback that never happen. Having said this, I think there will be an opportunity at some point to get in at better prices if this is indeed a new bull run. 

I've been reading about the notion that this can't be a real rally because we didn't see true capitulation  as evident of retail fund flows. I have been harping on retail fund flows since January but there has been a notable shift in behavior which I have pointed out. Also, although retail didn't show true capitulation, the so called pros did as evident by the positioning of hedge funds and active managers which showed extreme risk aversion at the lows. So, it could very well end up being that it's the so called pros who are the contrary indicator because it's they who capitulated! These  pros are just as emotional as the retail investor, if not worse which is why they woefully underperform the market in the long run.  

The bottom line is this.  It's very difficult to distinguish a bear market rally from a new bull market rally as it can only be done in hindsight. However, there are some clues, one being the level of FOMO vs skepticism about the rally. There are some signs of both now which makes the short term dicey but there's still a very healthy amount of skittishness out there. 

On the negative side you have the big rally in meme stocks and crypto and  VIX sub 20 which is what we saw in early April marking a top.  On the plus side, credit spreads have contracted notably and fund flows are still showing caution on the margin (but that can change very quickly after today).  Positioning is also still very cautious from fund managers. Add this to the list of charts I've been showing since May showing extreme bearish sentiment on par to that of prior major lows. 

And here's the cincher. There's this trader (I will not name) who writes for an online publication and he's notorious for signaling tops and bottoms based upon the language he tends to use. Since July he's been saying that now's not the time to be building long term positions. When I saw him saying this I went back to the 2020 lows to see what he was saying back then and low and behold in April of 2000 he said the exact same thing! I will also point out myself as being a contrarian indicator. I too have been thinking that things are utterly hopeless as I have at prior market lows. I'm not ashamed to admit that. I have no ego when it comes to the market which allows me to quickly change my posture. 

So, bottom line is that the weight of evidence suggests this is a new bull market rally however in the ST the easy money appears to have been made and the emergence of some froth suggests you not chase. If the market keeps going higher, so be it, but the risk/reward in the ST doesn't look appealing. I would suspect that any gains from here would be given back at some point but if we go by the Rev indicator, now would indeed be the time to be building long term positions!

Strong rebound with some notable wall of worry behavior but still some concerns

 July was a rip roaring month with the SPX gaining about 9%.  I pointed out last post that due to the acute pessimism that existed at the time, combined with reluctant longs on the sidelines, the market was ripe for a vicious rally.  I labeled such a rally as a counter trend rally i.e. bear market rally. Time will tell if that ends up being the case or if this is the start of a new bull market. I also suggested such a rally could take us to SPX 4000-4300. Well, here we are. How did we get here? It was primarily a function of lower long bond yields due to easing of inflation pressures and a quasi pivot from the Fed. Basically, the Fed suggested that they feel they have done most of the heavy lifting when it comes to hiking as they believe short rates are now at the long term neutral rate of 2.5% and going forward any future rate hikes will  "depend on the data" . This gave the market some relief that the Fed won't end up over tightening. Some Fed officials including former ones like Larry Summers are  trying to  piss all over this rally stating that the Fed is not even close to being done. Well, with the 10 year  bond yield at 2.7% it's saying otherwise. There's an abundance of indicators showing deceleration of inflation. Add this one to the list.

The market is still pricing in the Fed to continue to hike rates into December taking the fed funds to 3.25%.  I will take the under on that given falling inflation pressures and weakening economic data  with 10 year bond yield at 2.7% which is on the brink of inversion with the 90 day T-bill rate - this yield curve indicator has been  the most reliable of  the yield curve inversions when it comes to predicting recession. As I mentioned last post, we're in a technical recession which was officially confirmed last week. I don't give a rat's ass if this is considered a "real" recession or not. All I care about is what lies ahead....that's what always matters when it comes to the markets. Future looking indictors suggest at the very least, a major slowdown is ahead. Once again these hawkish Fed heads are going to look like idiots by failing to see the writing on the wall, preferring instead to look in the rear view mirror.  

Sentiment during this big July rebound was for the most part showing wall of worry behavior. Equity Fund flows were -$21 Billion for the month, NAAIM exposure was sub 50%, AAII sentiment continued to show more bears than bulls and put/call ratios were elevated. In prior failed rallies this year, fund flows and put/call ratios indicated FOMO. AAII equity exposure - one of things I have pointed out as a holdout - declined very modestly from 64.5% to 64%  in July despite the big rally. The fact that it didn't go up is bullish contrarian behavior, but I still want to see this exposure get down to about 60%. Earnings season was pretty good overall.  Tech has been showing relative strength and earnings misses have for the most part, been handled well by the market. All of this is a bullish change in character for the market, indicative of a wall of worry having taken shape. But there's some holdouts (there usually is). Bitcoin has rebounded pretty much in lock step with the market and the VIX is in the low 20s. Another thing that's a concern is China's economy. I've read how they are having to dealing with 2 debt crisis - one at home with real estate and one abroad with their belt and road plan. They have been showing economic weakness despite latest attempts to stimulate. There's been calls for a Chinese economic collapse for over a decade due to to overbuilding in real estate. If China collapses it would be massively bearish for commodities as they are the largest marginal buyer in a lot of cases. It would also no doubt create turmoil for global equity markets - at least temporarily.  In the long run however, it would make the US an even more dominant market force and US equity markets would benefit accordingly. I've never believed in the hype that China was going to be the next superpower overtaking the US because of their autocratic government and corruption.  How are they going to attract foreign investment flows with such a heavy handed autocratic government which is becoming increasingly heavy handed by the day it seems. They also have a huge demographic problem as does Europe. So, it seems to me that in the long run the US is going to continue to dominate markets...but I digress. The other major concern is the further inversion of yield curves across the board with the most reliable 10 year - 90 day just about set to invert and very likely would invert should expected rate hikes continue. This is suggesting recession. It would need to be a mild one for a happy ending to take place. 

So what do we do here now? Where do we go from here? In recent posts I showed charts and contrarian indicators that have shown we hit extremes which have marked major market lows in the past but I have also pointed out that certain things suggesting the bear market is not over yet. The action we have seen in July has been bull market-like action in that it has been largely not embraced  It has also been accompanied by declining energy prices and bond yields - the unwinding of  the 2 things that were responsible for the bear market starting in the first place. Obviously, this is only just a month's action and this bullish wall of worry behavior could crumble and turn to FOMO behavior quite quickly. I think it's probable that if the June low was THE low, we are going to have a trading range environment until the fall. The market is now ST overbought so let's see what happens in the next few weeks. If the market doesn't totally fall apart it would be yet another positive change in character. 

For the markets to have a happy ending it will have to look like this: The economy slows down or even mildly contracts in the coming months shy of the point of massive layoffs and sharply declining profits. This mild downturn creates enough disinflationary pressures to allow the Fed to call off future expected hikes - a true Fed pivot. Here's the deal though...the market will probably sniff out this happy ending  before it actually happens just like it always does. The longer you wait for confirmation, the higher the price you will have to pay to get in the market. It's quite conceivable the July rally is the beginning stages of the market starting to sniff out the end game for this Fed rate hike cycle with a positive resolution. Bears will vehemently dismiss this is nonsense and claim this is just an oversold bear market rally. The bearish narrative is that profit contraction and layoffs are the next shoes to drop. We shall see how this plays out. Keep an open mind and let the market do the talking. I will say this...despite some holdouts we have seen enough pessimism to suggest a major low may have been put in but it's tenuous at this point - we need to continue to see fund flows stay negative or flat and I would like to see bitcoin decouple. Let's assume for a moment  that we're in a new bull market. There's a few ways this could play out. The rally continues in a V shaped fashion like it did at the Covid lows or we have a drawn out base building period like we saw in the lows of 2011, 2002-2003. I think it's likely that we will get such a base building period if the bull case is to playout. 

Worst start since 1970

In January I made a post titled "2022 the year of the hangover". It's the worst start to a year since 1970. Only 2 other years, 1962 and 1932 have been worse (and basically a tie with 1940). Bonds have also had the worst start to a year ever.  It's been an utter shit show.  There was only one sector you could have hid in this year which was commodities and that too now has been taken to the woodshed in a major way the past couple of months with respective equities down 30-50% from their peaks. You can see that the damage is across the entire spectrum of commodities including wheat which is supposed to be in short supply due to the war (I read that Australia and Brazil are going to have big harvests this year though). 

Meanwhile, inflation expectations implied by the bond market have dropped sharply as per the 5 year break even spreads. The market is now pricing in an average inflation rate of 2.7% over the next 5 years. 

The evidence is certainly mounting that inflation has peaked. So, is the Fed going to take any of this into account or will they carry on looking in the rear view mirror with their ridiculous plan of hikes to infinity? The fact that the Fed under Powel provides on open book with expected rate decisions for the next 6-12 months is comical. The Fed has a poor track record of predicting inflation as the future often proves to be too uncertain to make accurate predictions. The Fed thinks that by keeping an open playbook it will create less market uncertainty but I believe doing this creates a false sense of certainty which leads to upheaval if the Fed realizes they blundered and have to rapidly change course which is often the case. Last year at around this time the Fed said they weren't going to raise rates until the latter part of 2022 and it would only be small. You can see how such an expectation can lead to complacency with businesses and consumers when in comes to their borrowing and spending decisions. Instead what the Fed needs to do is stop being so explicit and open with their intentions and admit that they can't make long term forecasts accurately enough. Keep the market guessing and on guard to a certain a degree so that expectations don't get too extreme one way or the other.  Powel's Fed has been terrible at setting rates. The only glimmer of hope I see that they don't fuck up yet again is that so many people are concerned that they will fuck up that Powell and the Fed are well aware of this. Maybe that will make them more cognizant of the forward looking indicators I posted and they will announce some sort of pivot in July. 

If a Fed pivot does happen, it would result in a relief rally but is it too late now to save the economy from going into a deep recession? We are no doubt in a recession right now in the technical sense.  The damage of this rising rate environment may have been too been much even if rates have peaked. It could very well be the case that too many dominoes have already fallen. And it's not all just interest rate issues. The deficit has been shrinking which is a detractor for economic growth. At the end of the day the market cares about earnings and if they are slated to contract in a major way, forget about it. We will see SPX 3000 before all is said and done. 

Bear markets will not make it easy for pessimists to make money. There are vicious counter trend rallies within them to shake them out and suck in hopeful longs and they usually happen when negativity becomes acute and lots of bearish bets are being made at a time when many would be longs are on the sidelines too scared to jump in. I believe we are in a such a condition. All it takes is a spark to light the fuse unless the wheels simply start falling off fast and furiously before it can happen. 

Let's now talk about sentiment and more about what I believe are missing links to declare that we have seen true capitulation. Positioning in AAII investors is the first one. This has proven to be the best indication of lack of capitulation from day 1.  The recent allocation was released today and it shows that equity exposure dropped down only to 64.65%.  At the peak of the market in Nov 2021 exposure was at 71.4%. Given that this has been one of the worst years in history YTD, the  behavior of AAII investors continue to show, as has been the case all year,  only a grudging amount of  retreat from the market which is indicative of a bear market that has not run its course. Back at peak of the market in 2018 exposure was at 72%, and by the end of year whereby the market had declined 20% from the peak, exposure dropped to 62.4%. At the very least I'm expecting exposure to get to 60% for me to have any confidence that the worst may be over, but that's only in the event that what we seeing this year will turn out to be a mild bear market year as was the case in 2018 and 2011. If we are in a major bear market then there's a long way to go before we have seen true capitulation. At the lows of 2003 and 2009 equity exposure was 46% and 41% respectively. 

The other major concern I have is fund flows which like AAII, continues to show only grudging amounts of capitulation. In recent weeks we've seen what I would characterize as mild to moderate outflows given the damage done to the markets. We have seen $30 Billion outflow in the past 3 weeks which is good but not enough to signal an all clear from a LT perspective especially give all the inflows earlier this year. One thing I did notice though is that there was a outflow last week when the market had a rally and so that's actually a positive from a contrarian perspective in the ST. 

Other concerns I have which suggest this bear market has not run its full course is bitcoin still at 20K.  When bubbles burst, its pretty much a lock to see a 90%+ collapse from the peak. BTC was the biggest bubble I've seen since the dot com days. The hysteria, the scams, the leverage, the amount of dumb money retail and institutional participation, the super bowl indicator - all of this says that 90% + drop is inevitable. Now, it's possible that the market and BTC decouple like it did after it collapsed in 2018 but its less likely given how widespread its reach was this time around. For me, BTC and the meme stocks are barometers  of speculation and although they have come off a lot from heir highs, they still show signs of life anytime the markets do and they certainly can and likely will go a lot lower in due time. It can take a long time for traders/investors to move on from the types of stocks that worked well in the previous cycle. This was the case after the tech bubble bursting as well and so many of the junk stocks that eventually crashed  90% + many of which going to 0.  It took years for traders to give up playing them. Look at weed stocks for a modern day example as to what crypto and meme stocks will end up looking like in the long term. 

Finally, the last thing bothering me is the low VIX and the lack of capitulation its signaling. I've heard it may be due to its "microstructure" as I've seen someone put it., but I'm not trusting that.  

So, all in all you can make the case that although we have seen excesses having been purged from the market, its still not enough. That does not mean the market can't have a strong rebound for several weeks. SPX 4000-4200 is quite doable if a bear market rally takes hold due to a Fed pivot or whatever.  

I sincerely hope that my longer term negativity will prove to be misplaced. I really hope we can somehow muddle through this year.  Like I said, many times,  I am trying to keep an open mind but I have to say that deep down I feel that we're fucked. 

Weekend thoughts

 Since my last post we've had a market bounce and there's been some notable developments.  Commodity stocks have sold off hard. XLE, this year's top sector YTD has taken quite a tumble. A lot of hot money had been piling into this sector. Prior to this tumble, the monthly BOA global fund manager positioning report was showing a massive overweight in commodities and respective underweight in tech. Cash was also massively overweight. Obviously this was a wrong way bet for the ST at least. I've been noting evidence of the rapid shift out of tech for months now. We could very well be at the point where its washed out on a medium term basis and perhaps long term basis. There has been a complete unwind of once high flying stocks like SHOP and ZM as they have gone so far as to  hit COVID bear market lows. That would appear to be a big overshoot to the downside. For about a month or so, these types of stocks a.k.a the unprofitable/high p/e tech stocks,  have quietly been showing relatively strength. It's still far too early to declare a change in trend but if it continues, it would be encouraging as these type of stocks were the first to go down. Probably the main reason these stocks are showing some signs of life is the recent decline in commodity prices and other inflation pressures. Chinese freight rates for instance, have rolled over. Housing prices have rolled over. It's too early to declare the decline in commodity prices as a major rollover just yet. It could very well just be a pullback due to over-crowded longs getting rug pulled. I suspect the Fed will probably not make much of these emerging signs of cooling inflation just yet and hike again in July, but they need to signal that they are aware of them and will not simply react to lagging indicators. 

The above was published mid June. When you see such things on the front page of a mainstream newspaper it's a strong contrarian signal. At the very least it suggested a ST market rebound as sentiment is extremely negative. The University of Michigan consumer confidence index just registered an all time record low - even worse that than during 2008 financial crisis. Again, such an indicator has strong contrarian implications as it signals extreme pessimism and history shows future longer terms returns to be strong. The one time it didn't work so well was in 2008 when it hit an extreme in June of that year of 56, rebounded to 70 by September only before tanking again to 55 in November for obvious reasons. The current reading is 50 which as previously mentioned, is a record low. Taking this into account along with other indicators both anecdotal and quantifiable such as the BOA bull bear indictor, it's signaling that at least a ST market bottom is immanent or has been put in. Of course, there's good reasons to believe that that we aren't near a LT bottom but we need to keep an open mind.  I was looking back at the 2011 bear market lows and at the time there were recession fears and major concerns about a European debt crisis which was going to lead us to the next phase of the financial crisis. Things certainly looked dire but that's why it's hard to buy at bottoms because it always feels that things will only get worse. 

 In recent years bulls were able to make the case of TINA - there is no alternative. Well, now there is. GIC rates in Canada have not been this good since 2000! You can get a 5 year GIC today at 5%. That's pretty damn good. Yes, this is a negative real return at the moment but you would expect inflation to subside in the years ahead. Even if it averages 3% for the next 5 years that's still a pretty good return for a 100% risk free investment. How much of a deterrent is this to equity markets? It's got to count for something. The only way I see a bullish resolution to this is if GIC rates peak and start coming down notably but that's not happening as they keep climbing making fresh highs daily. It's hard to get bullish on the market longer term when risk free alternatives are now attractive and getting more attractive by the day. The high interest rate environment for me, is the biggest bearish factor for the market - whether it be high mortgage rates\choking off housing or high GIC rates providing an attractive alternative. If the market sniffs out that rates are peaking at a point where it's not too late (we avoid a painful recession) we can get a bullish resolution and we'll look back to this period as a major growth scare with a healthy cleansing of excesses. That's certainly not a given by any means. There were enough signals and red flags to suggest that a major bear market has began. But again, that's not a lock either. I'm trying my best to keep an open mind as to how this is going to turn out. I think though that if there's going to be a bullish resolution to this, the market is not simply going to do a V shape upwards move from here. It would likely chop for several weeks.  As usual, I will take my cues from the market and the indicators and adjust my outlook accordingly.  As of now, I suspect it will be treacherous trading for both bulls and bears. The easy money of last week's bounce has been made. With bond yields and oil prices rebounding as I type this, it's going to serve as a headwind again. 

Miserable market

I wanted to make this post sooner but I've been busy. In my previous post I ended off by saying that the market was ST overbought and to watch and see if the market could manage to find a way to not fall apart as it did prior times this year when in a similar condition. Well, it failed the test miserably. A hotter than expected CPI report sent the market on its way to new lows and sealed the deal for a 75bps hike. There's clear signs of slowing growth ahead and we now run the high risk of the Fed hiking rates by looking in the rear view mirror rather than what lies ahead. Clearly they must be seeing that housing has stopped dead in its tracks and that's the main thing that Fed rate hikes will impact. They've done enough. Yet the rhetoric from the Fed is that they will continue to raise rates throughout the remainder of the year, yet they say they are not trying to create a recession. That's exactly what they will do if they continue on this path and it may already be too late.  There needs to be a pivot soon. After the July meeting they should announce that they may stop further hikes as there are clear  signs of cooling in the economy. They should  say "we don't want to make our decision on interest rate policy entirely based on the latest rear view mirror CPI data while there are clear signs of economic cooling and therefore abating inflation pressures ahead". Don't hold your breath for this because the Fed does in fact have the reputation of making decisions by acting upon rear view mirror data which means they are only gong to pivot when it's too late and the economy is well on its way heading towards the shitter. Could it be different this time? Could they see the writing on the wall and be proactive rather than reactive?  The Fed did say that that they don't want to induce a recession but that's only going to happen if they look at forward looking data.  I won't give Powell the benefit of the doubt. With the mid term election coming you would expect some sort of policy responses to fight inflation whether it be a gas tax holiday, removal of Chinese tariffs, US oil export ban and/or incentivizing more US drilling for oil. These measures may turn out to be fruitless but it could spark a temporary rally. 

I also mentioned last post lingering doubts I had about the market. Despite indicators showing that there's a extreme amount of pessimism there are some holdouts which suggests otherwise. First off is  fund flows. It continues to show lack of capitulation and FOMO anytime the market stages a rally. Last week there was a $16 Billion outflow which is good (to signal pessimism) but given the damage of the market year to date we should be seeing far greater outflows. Another lack of capitulation indicator is positioning from AAII. Although they have been showing record bearish sentiment, it's not being reflected in how they are positioned as they are 67% in equities which is still high. It needs to drop off the low 60's at the very least which is what it did at the end of 2018 after the market had dropped 20% from it's peak. .At the COVID low it got to 55% however, that was after a 35% one month drop in the market and so 55% shouldn't be a target.  Let's see how that changes when their positioning is released at end of month. The other thing that's bothering me is bitcoin. The fact that it was still lingering at 30K told me the excesses and silliness of 2021 are not fully washed out yet. It has since tanked getting as low as about $17.6K  and now back above $20K. All the shenanigans and leverage that have underpinned cyrpto are unravelling. From a pure ST trading perspective, there was enough negativity and extreme selling pressure to warrant a bounce but there's still no shortage of people out there like that smug self-righteous clown Kevin O'Leary and that idiot President of El Salvador who are claiming what a great opportunity it is to buy more. I remember back in 2017 when bitcoin was under $5K how people were talking about it. That's were its ultimately heading and then lower still. Just look at the weed stock mania and the dot com mania to see where bitcoin is ultimately heading. There will be interim rallies no doubt, some of which could be quite vicious.  Just how much is the market and/or economy tied to crypto? There has been a pretty strong correlation of crypto and the NASDAQ for quite some time now but in the last few weeks has decoupled. That's a market positive, but have we really felt the fallout from crypto yet? I don't think we have. Layoffs in the crypto space have been announced. There's got to be quite a few hedge funds that invest in crypto which also invest in equities.

Switching back to market sentiment. That BOA bull-bear indicator I showed before hit 0. That's literally as low at it gets. I remember seeing it at 0 in April 2020, however, I'm not sure if it was 0 in the midst of the carnage in March 2020 and hence early, but even if it was, it was a great long term buy signal . In hindsight we can say that the COVID crash was a major correction in a bull market just like the 1987 crash as it was rather short lived. Until proven otherwise, we have to operate in bear market parameters given that the market has been in a downtrend for several months. In a bear market, negative sentiment can be tolerated for quite some time before resulting in an upside corrective move, just like how in bull markets bullish sentiment can be tolerated for quite some time before a downside correction happens. This is why a lot of the contrary indicators haven't worked as well as before. Only when you get prolonged extremes will it work and it may only result in a ST corrective move. That's where we could be right now. There's enough negativity to suggest a multi-week rally is in the cards.  Bulls  will say that that so much negativity is priced into the market and so we must be near the ultimate bottom. We've been hearing the "it's all price in" argument all year. It's been more wishful thinking than anything. Certainly, there's a high degree of negativity priced in and we are at a point now where just the slightest glimmer of good new could spark a major rebound but as I've been saying all year, you can't give the benefit of the doubt to the bulls just yet. Although there's high negativity, its justified. The spike in interest rates and inflation have resulted in economic damage that we have still not yet fully felt. Again, I understand that the market has priced in this to a certain degree but we were just at 52 week lows last week. That disproves that all the bad new is priced in. One thing I've noticed which is showing a glimmer of hope is how the NASDAQ's advance/decline ratio did not make a lower low last week and is showing positive  divergence.  The NASDAQ was the leader on the downside and it needs to show leadership to the upside. Meanwhile the energy sector has gotten hammered recently. The market desperately needs energy prices and rates to cool off. Oil may have made a double top. The bearish interpretation of this is that it indicates significant slowing global growth which is going to accelerate. The bullish interpretation is that this could signal a much needed relief in  inflation and perhaps the the oil market is becoming better supplied which would give the Fed more impetus to back off should energy prices continue to slide. I admit it's way too early and perhaps naïve to suggest this could be the case.

The bottom line here is this. There's enough to be worried about if you're either bullish or bearish in the ST. In the ST the market is once again oversold and sentiment is quite negative (with some holdouts)  however the bears have macro on their side. Things are incrementally going to get worse economically before they get better. Fundamentals trump sentiment in the medium and long term and there's a real risk that the wheels can fall off quickly because of some sort of blow up.  If that happens we see can see mounting layoffs and collapsing earnings resulting in much lower lows for the market. The word "recession" is on everyone's lips and quite frankly, for good reason.  For the market to start looking beyond the valley and ignore any upcoming bad news it needs to sense an endgame to this rising rate cycle at a point where it's not too late for us to avoid a painful recession. It's possible we can get a technical recession without the accompanying layoffs and earning collapse but do you want to hold your breath for that? I don't. That's not the norm. 

Is it possible for us to look back at this point one year from now and say "that was the bottom""? Yes it is, but it's also just as possible for us to look back to say that we were at a point where things were about to get really bad, maybe not tomorrow but by the end of summer or early fall.  There's definitely the potential for this when you look at the excesses of housing which right now is hurting. 

Everyone is calling this a bear market

We've had a good bounce since late May as I suspected could happen. I mentioned that in the 2001 and 2008 bear market years there was a spring/summer rally which was the last hurrah before the most damaging leg of the bear market took place later on in the fall. Is this what we are setting up for? My last post was titled "too many indicators suggest major bear market". The following are some reasons why this may be the wrong assessment. Typically, big bear markets start off as slowly trending down for several weeks and it's in the final stages when things really accelerate to the downside and you can get 3%+ gut wrenching daily declines. We've seen that type of scary downside action take place which would suggest that this "bear market" is close to its end not its beginning. Everyone is pretty much calling this a bear market now and many are bracing for a recession. Elon Musk today said he has a "super bad feeling about the economy". There's plenty of obvious reasons for concern, but could it be now that it's too obvious and that expectations now are too low?  Just prior to the low analysts and strategists were tripping over themselves to lower price targets and earnings expectations.  Low expectations are the bricks that can create a wall of worry. I'm not sure expectations have been lowered enough but they are heading in the right direction to create conditions for upside surprises later on.  

The following charts are contrary sentiment indicators which all suggest that this "bear market" could actually turn out to be a major correction and that it's now over or close to being over. 

Now, I know it seems hard to fathom that the market could have hit a major bottom but you know what? That's what a bottom usually entails. At a bottom things look ugly and hopeless. Someone who's bearish would probably respond by saying "you think this is ugly? Wait until you see what's coming!" To that I would say fair point. Things could indeed get a lot uglier, but they could also get better...or at the very least not be as bad as what everyone's bracing for and that would be good enough for the market to go up. Take a look back at the lows of  2011, 2016, 2018 and 2020. Most people were expecting lower lows. The charts I posted above all indicate expectations/sentiment is at a pessimistic extreme. I love that chart about bear market rally articles. It proves that pretty much everyone is calling this a bear market and that's a strong contrary indicator.  At the very least, these charts support the notion of a multi-week counter trend rally, and at face value it supports the notion of a major bottom. Does that last statement make you hot under the collar?  Did you shout "no fucking way" If you did then maybe I'm on to something. I'll say this...if I just woke up from a 3 year coma and was given those 5 charts I would characterize the market as a table pounding buy. But of course, I like everyone else am cringing about record high gasoline prices, sharply rising interest rates and war fears. 

Let's see how this is going to play out. In the ST the market is overbought but ST sentiment indicators, NAAIM  in particular, has lots of room to rise before getting overheated. If the market can manage to not fall apart while ST overbought it will have been the first time this has happened all year and would set the stage for at least a multi-week IT rally and possibly something more. 

Despite all the contrary indicators suggesting a low has been put in, I have some lingering doubts aside from the obvious ones (inflation, rising rates, war) which I''ll discuss in an upcoming post shortly.