Since my last post some notable things have happened. It's clear the Russian war hasn't gone nearly as smoothly as Russia would have hoped for. Low troop morale and poor execution appear to be hampering the Russians while the opposite has been the case for the Ukrainians. But if history is any guide, Putin will resort to increased brutality and force. The war resulted in a further flare up of inflation as oil, agriculture and fertilizer prices have spiked. Some of these spikes have subsided but they are still elevated and relief appears to be bleak unless a peace agreement is reached soon which doesn't appear to be case. In mid-late March there appeared to be a breakthrough in negotiations which have now all but disappeared especially after the brutalities of the Russians have been discovered. The 2 week rally from Mid March to early April appeared to be at least partially due to peace hopes and we have seen the market give back quite a bit of those gains. I would say the thing that is hamstringing the market the most is the blistering rise in bond yields.
Some interesting things are happening from a sentiment perspective. We are seeing historical extremes in AAII sentiment. The most recent readings are pretty much as bearish as it could be with a 3:1 ratio of bears to bulls last week which I think was a record. AAII sentiment has been persistently bearish for 3 months. II sentiment is also confirming the message of AAII. However, if you look at how retail investors are behaving with their portfolios it does not jive with how they are feeling. With AAII members, they have only reduced their equity exposure modestly to 68% from the peak of 71.4% in November. This exposure needs to come down further to confirm the bearish sentiment readings. The other indicator showing stubborn/reluctant capitulation is equity fund flows which up until the last couple weeks has been positive. The past 2 weeks has shown a $25B outflow however, which is a good and necessary blood letting. This needs to continue. NAAIM sentiment continues to show stubborn bullishness for the most part. It got as low as 30 near the market lows in March but then rebounded to 82 in early April. It dipped back to down to 63 but this week back to 74. Not good and I'm not surprised to see the market sell off today.
There are some other indicators worth noting. The BOA bull/bear indicator is at 2 which is in solid buy zone. It was at 0 during the depths of the COVID crash mind you, but that's after a 35% decline in the SPX. The fact that it's at 2 with the market only having had a moderate correction is encouraging. I've also seen a chart showing that hedge funds have reduced their tech exposure by the most amount in 10 years. This also confirms another survey of fund managers I saw recently which showed a massive reduction in tech exposure. Meanwhile bond sentiment is at historical bearish extremes with prices being extremely oversold. It's obvious as to why this has been the case with everyone expecting the Fed to hike rates to infinity. On top of this you got Fed rhetoric adding fuel to the fire such as Bullard suggesting that that the Fed could raise 75 bps if need be.
Given how tied the tech sell off has been to the surge in bond yields it would appear that the tech space is a coiled spring the moment we get any kind of relief in bond yields. If you look at recent used car prices and shipping costs it would appear that inflation pressures are abating but the China lockdowns may have thrown a monkey wrench into this development. Inflation expectations are already very high. All it would take is just a modest surprise to the downside and there would be a violent reaction in bond yields to the downside.
Netflix got smoked again after reporting disappointing results and this is giving people jitters about other growth names which aren't even in the same sector, but it's understandable. It easy to have doubts about holding high multiple stocks because the risk/reward doesn't appear favorable. If you disappoint you get slaughtered and if you don't you survive but then have to deal with the headwind of rising rates which is capping upside.
On an anecdotal basis, the doom and gloom is quite thick. Nothing but ominous posts on fintwit. There's no shortage of people who are worried about a Fed policy error, recession or what have you. Bulls like Fisher say that all of this doom and gloom is good because that means it's priced into the market. Perhaps so, but it could also just be the case that the market is in denial and is only slowly coming to grips with reality. How can rising rates be priced in if bond yields keep making new highs?
With the prospect of 50bps rate hikes for at least the next 2 Fed meetings and signs of slowing growth ahead, it's easy to see why market sentiment is gloomy and the market trades so poorly. So far it hasn't fallen apart and the degree of damage doesn't match the level of negativity out there. If you take a step back and look at a long term chart, this downturn doesn't look bad at all....at least for now. It would appear that the best thing the bulls would be able to achieve is for the market to go sideways and work though the 2021 hangover with a headache as opposed to a coma and hospitalization. We have definitely seen an unwind in the excesses of early 2021. IPOs are essentially nil and unprofitable pipe dream tech stocks have been wiped out. Margin debt has also unwound quite a bit. Back in 2000 the telecom/internet boom and bust was tied to the majority of tech names, both unprofitable and the profitable leaders like CISCO and Intel. That wasn't the case this time around. Today's tech leaders are in separate silos and are tied more to the general economy. So, is the economy strong enough to sustain this adjustment phase of higher interest rates? Depends on how high they will go. Government spending although lower this year is still historically robust. There are reasons to keep an open mind that we can get through this year without entering recession. I'll discuss indicators forecasting recession in a future post. Suffice to say that there's not enough evidence to suggest one is immanent.
Bottom line is that this is still a treacherous market but it's not all that bad just yet with the market off less than 10% from all time highs. For the bulls, the best thing they can hope to see is a sideways market for the next several weeks or even months, probably until we can see the end game for all the expected rate hikes. Although we are finally getting retail capitulation, NAAIM sentiment needs to back the fuck off as it shows that too many people are eager to chase rallies. I personally still continue to feel like shit when I think about the market and I too can't help to have a hopeless feeling about how things will turn out this year. Perhaps that's a contrary indicator suggesting somehow we will get through this without serious damage but I will not hold my breath. The burden of proof is on the bulls.
