2022 the year of the hangover

Market's have gotten off to a rough start especially the tech sector. In a recent post I mentioned how it was suprsing to have seen the NASDAQ held up so well in 2021 despite the bloodletting in the speculative unicorn tech stocks which had paralells to the 2000 bubble bursting by which the NASDAQ eventually gave up the ghost in the last 3 months of 2000. Could it be that now we are seeing the same type of fallout happen in tech and that the 2000 paralell is actually still in tact? There's some strong evidence that suggests this could be the case but there's still some notable holdouts, the biggest one being that it was a collapse in tech earnings which ultimately did in the sector which was the result of over-investment in the telecom. If you look at the tech leaders of today , the FANGS, they each are dominant players in their respective spaces which aren't nearly as interconnectd as the tech leaders in 2000. The latest selloff in the tech space had been directly a result of the spike in longer term government bond yields thanks to a hawkish Fed pivot early in the year. This resulted  in rug pull which was amplifed because of of poor sentiment positioning conditions which I noted in my last post. There's some signs that sentiment positioning is improving however. According to BOA, global fund mangers have significatnly cut back on their tech exposure this month, in fact, they have the most underweight tech since Dec 2008! And what did they pile into? Financials of course, which has been the second strongest performer, energy being number 1. Financials too are now getting hit.   Now, it's one thing to dump tech because of poor fundamentals i.e. earnings but it's another to do so simply based on the yield of the 10 year s going from from 1.5% to 1.85% . Of course, the fear is that it's yields are going to go even higheer. At first this sell-off looked feels knee-jerk in nature and it so happened at time when the market was vulnerable in the ST due to poor positioning/sentiment. But now there's so much calls for the Fed to "do something" in order to stop inflation and that of course means aggresive rate hikes. No wonder the market is spooked. But the sad thing is, the Fed is not the main cause of inflation (aside from housing) and they can't fix it other than by creating a recession. The inflation is being caused by supply contraints and excessive government spending. Raising rates abruptly can tank the economy and therefore demand. Sure, that will curb inflation but not by addressing the actual underlying cause. That's like getting gangreen on your toe and cutting off your entire leg to treat it.  

On a bigger picture perspective, there's definatley things to be concerned about in 2022. We have a hawkish fed that will be raising rates sooner than what had been expected just a few weeks ago. One of the risks I mentioned earlier when discussing the expectations for 2022 was for a revising of rate hike expectations to the upside. The Fed is being hawkish at a time when some forward looking indicators of global growth and therefore inflation will be slowing.  That clearly puts the risk of a policy error much higher. The amount of fiscal stiumuls is also not going be as much as last year but it's not going to be abruptly taken away either, however, that's still an incremenatl detractor to growth. So it definatley feels like the market is walking on a tightrope here and 2022 could be a hangover hear as stimulus is being pulled back. Earnings ultimatley will be the deciding factor longer term but because valuations are historically so high, along with margin debt, it might only take an modest amount of monetary and fiscal tightening to create a big market decline. If earnings don't implode, once the market sniffs out the end game to the Fed's tightening, things will settle down and the bull market can resume. I can't give the bulls the benefit of the doubt on that. At best, it would appear that a drawn out trading range can hope for during the next 6-9 months. It seems probable we will see something worse. There was too much excesses last year, more so than I had orignally thought. This chart of global fund flows is scary. It seems unlikely this can be unwound without a major correction if not crash. Look at that last peak  in 2018 which was a bad year.  

The latest rotation of value into growth has been quite vicious lately. Last year we had a back and forth market between value and growth and they basically preformed the same. This year value is clearly ahead so far. Is the back and forth rotation from value to growth indicative of a changing of a the guard wherby value will become the dominant style? It sure that way. There's a lot of evidence that suggests it could be value's time to shine. For about the past 10 years growth has trounched value, with about double the peformance. The last time growth had such a dominance was in 1990s, from 1995-2000 in particular culminating in blow-off peak of the dot com mania. We very well could have whitnessed a blow-off COVID mania with disruptor/unicorn tech stocks and crypto being the bubble that burst. 

You can see that the recent value outpreformance last year was a headfake but now it's threatening to break out to the upside. You can also see how back in 2000 a similar pattern occured. Energy and commodities were the largest drivers of the value back then. Will they be again this time?  We know the narrative for Energy i.e. oil and gas has been one of secular decline due to the rise of electric veichles but we have shunned energy development for so long and now it's payback. In the ST however it does appear that chasing energy here is not prudent as others appear to be doing right now. Bullish sentiment on energy is quite high. DSI for crude is 92.  OPEC is expected to increase supply in Feburary and gas inventories are high. 

Bottom line is that I am officially market agnostic if not bearish for this year. I will not be giving the bulls the benefit of the doubt which means I will be tactical and not just stay the course when the market hits overbought conditons. The market sure looks sickly at this moment. Let's see if sentiment surveys and fund flows tommorow finally show signs of capitulation. Tech earnings are slated in the comming weeks. If we finally get some capitulation and energy prices back off we could get a nice snap back rally.  The only reason I'm not outright bearish is because we still did not get all the classic signs of a secular bull market top which is inverted yield curve, investor greed and rosy optimism in general. This makes me think that no matter how bad this year gets, it may be salvagable and just turn out to be another nasty correction in an ongoing bull market but I'm not holding my breath on that.  

Poor sentiment positioning hampering the market. Expecting more ST downside

Comming into the end of the year there was a massive $25Bweekly inflow into equity funds. After this week's decline you would figure that sentiment would have turned negative, but no. Another weekly inflow. Not as big but a solid $9B. This is not good. It shows too much hope. NAAIM is another indicator showing way too much bullishness given the poor market action. I also was expecting it to go down this week but instread climbed to 89% long. That made me cringe. Only AAII sentiment ticked down. Put/call ratio is also starting to perk up but all in all, there's not enough pessimism to mark a low here in my opinon. 

Expecations are tempered for 2022

The market was able to shake off Omicron and inflation fears in December and closed a little bit off all time highs. It was a strong showing in 2021 being one of the lowest volatity years on record. Pullbacks were all shallow being no more than 5%. 1995 was the closest resemblance. Earlier in the year I was getting concerned with the speculative fevor going on in certain parts of the market namely in the unprofitable/unicorn tech space aka the ARRK stocks and meme stocks. These were signs of euphoria which is what you see near major market peaks. The bitcoin frenzy was also a sign.  In March I made the comparison of the run up leading to the dot com mania peak and what we were seeing at the time. There were clearly some notable similiaries but differences as well. The bears were only focusing on the former of course. But the market did something that was rather remarkable.The undoing of the eurphoria in the speculative sections of the market did not spill over to the broad market. By mid year the high flying tech space tanked with a vengence while the board market simply carried on making new highs. The NASDAQ did lag slighly but not even the biggest bulls out there like Tom Lee expected the NASDAQ to have held up so well. .Throughtout 2021 New covid waves,  inflation fears, Fed tapering and tighting have all put a damper on sentiment. The strong US dollar was also a surprise to many but not to me as I pointed out in early 2021 how bearish sentiment towards the dollar was extreme. 2021 was also characterized by vicious rotations from growth the value and vice versa. Lots of active managers/traders got chewed up by this and so even though 2021 was a bengin year when it came to volatility, that was only the case if you did nothing but held the market index the entire way...and as often  is the case, that's the best way to go in a bull market. Hedge funds and active manages as a whole once again underpformed the SPX. Think about all the stress, time and effort that goes into managing a hedge fund only to realize that come the end of the year you did worse than a lay investor who simply bought the market and did nothing else. 

Comming into 2022 expecations are clearly tempered with the Fed set to taper and raise rates 3 times and fiscal stimulus set to downshift. There's also a lot of complaining/worry about how the breadth of the market is poor. I'm not going to go into great detail but suffice to say that not all measures of breadth are poor such as the equal weighted SPX which returned just about the same as the cap weighted SPX. It surely feels like investors have their guard up. "How long can these good times in the market continue?" is the question that's on everyone's mind including mine. But you see, this is why the market continues to surprise people on the upside - low expecations. It's been this way for the most part since the bull market began in 2009. Along the way there were a few times where expecations becaome too complacent which then led to corrections and these corrections ended up re-reseting expecations quickly back to pessimistic again thus allowing the bull market to resume. I believe the reason why expectations are so easily able to revert back to pessimsism is because there is an ingrained disbelief in the bull market and/or a fear another a major crash like 2008. Many of today's investors have scars from 2008 and 2000. We can now add the Covid crash of 2020 to this list.  I also get the sense that even most of those who have generally been bullish have a sort of "one foot out the door" type mentality. I include myself as one of these people. I'm sure more investrors are asking themsleves "how long can this go on for"" as opposed to "I wonder how much money am I going to make this year".  

We know from history that the stock market doesn't get into big trouble untill monetary and fiscal condtions get tight while co-inciding with historically optimistic sentiment or at the very least complacency.  We are going to enter a period where monentary and fiscal are going to get tighter but would still be classified as easy. Everyone is expecting these tightenings and so there's no suprise factor here unless the tigheninings become greater than what's expected. Lots of people are also concerned about a possible policy error. Therefore, all of this "taking away of the punch bowl"  should be priced in and it would appear to me that the market is more inclined to  re-rate bullishly rather than bearishly. So long as interest rates across the board are historically low and corporate earnings solider on, the market should remain generally boyant. Dips/corrections will happen no dobut, but they should be just noise unless there's a major negative surprise. Inflation is poised to decelerate this year simply due to base effects alone but also due to declining commodity prices and hopefully this latest Covid wave will be last major one. It appears that it could be the case given the weaker strain of Omnicrom. It's also encouraing that most governments around the world are finally accepting the notion that Covid is something that we may have to live with forever and that draconian lockdowns and quarentines are not the solution. This should lead to less workforce shortages going forward which was a major contributing factor to inflaiton in certain goods and services. 

A potential achiles heel for the market at some point could be the crypto space which hardly anyone expects to be a risk for the broader economy. I continue to be a skeptic and the question I'm asking myself is how much of a misalloaction of captial has gone towards this space and how bad will the fallout be now that instituional money has gotten involved? The dot com implosion ultimatley led to a reccession in the economy. Has cyrpto infected the broader economy large enough to take it down should it implode? This is an important question I need an answer to because I believe the jig may be up for crypto.