April was horrific and May so far hasn't been much better as the market has been down 6 weeks in a row. At its lowest point last week the SPX was down 20% YTD and we are off to the worst start in market history. Just brutal. Volatility studies are showing that the action in the market we have been seeing was what we saw in 2001 and 2008 which were terrible years, indicative of a big bear market and recession. Sentiment is negative enough and the market is oversold enough to get some short term relief but the macro situation is firmly bearish with no hope unless there is some miracle in Ukraine. Some measures of inflation appear to be peaking but energy prices have not. Gas prices hit over $2/liter this past weekend and it's going to go up even more. The sharp spike in LT interest rates have resulted in LT mortgage rates spiking in kind and this has stopped housing dead in its tracks. I live in the GTA and prices have declined at least 10% from the peak. The Fed is determined to stop inflation by targeting demand even though they admit that the main causes of inflation have been supply shocks due to lockdowns and the war. It would appear that they are OK with creating a recession to achieve their goal. Rising energy costs and slumping housing must at some point create a softening of consumption right at the point where companies have rebuilt inventories for a lot of goods. That could end up being a toxic situation and by the end of the year we could end up being worried about DEFLATION rather than inflation.
The whole "the market has priced in the negatives" argument has turned out to be bogus otherwise we would not be trading near 52 week lows YTD and the damage would have been less. In 2001 and in 2008 the market was able to stage a multi-week rally in the spring/summer. That was the last chance to get out before the serious damage was about the begin, when earnings were heading sharply lower and ensuing massive lay-offs began. Are we going to get that one last rebound or are we simply going to keep sliding? Again, there's enough indicators that suggest bears are pressing a lot and so we could get the former but that's certainly not a given.
So how bad could it possibly get? Really bad. We could end up seeing SPX 3000. Look at how much LT bond yields have risen. I've always said that major market declines were preceded by a major rise in bond yields. I've always said that a bull market will die when there is euphoria coupled with tight monetary policy. The euphoria part is debatable as there was euphoria/greed in certain segments of the market i.e. unicorn tech and crypto along with housing, but not broad based euphoria. Tight monetary policy is there with the long end of bond market but not yet on the short end, but that's going to change very soon as the fed hikes rates by 1% in the next couple of months.
The crypto meltdown is yet another negative shock to the market because unlike in 2018 when it last crashed, this time around a lot more institutional money got in creating more linkages to the broad economy either directly or indirectly, the degree to which I'm not sure of. Crypto commercials during the super bowl was akin to the dotcom commercials in super bowl 2000 which by the way was won by the LA RAMs as well.
Let's discuss sentiment for a bit. While there are certain measures of sentiment which suggest too much bearishness in the ST, the one measure that continues to be lacking of capitulation is fund flows. Although they have turned negative in the tune of $-44 Billion these past 5 weeks, they have done so rather grudgingly and there have been many instances which showed people buying dip on days when the market got slammed rather than running for the exists. I was hoping to see one week where we would get a $20B+ outflow. Never happened. The Recent NAAIM exposure came in at 24 last Thursday which is low. It can and has gone lower in the past but that's not the ideal situation to initiate a bearish bet. The CNN fear/greed index is also extremely low and hit single digits last week. That's at a level which suggests a low is or is close to at hand. Only when you have major meltdowns like in late 2018 and March 2020 will these indicators won't work. Could that happen now? Sure can, so you must be mindful of that. The NASDAQ continues to be the weakest index which is NOT good for the overall market.
Bottom line is this. Enough conditions are in place for a major bear market for which it looks like we are in the first leg of. If history is a guide there will be one last major rally before the most devastating phase of the bear market plays out. There is of course, no assurance that such a rally will happen. Even if I am wrong and this turns out to be a major correction like in 2011 or 2018, it's likely the market will go sideways for some time. Earlier this year I saw some warning signs which I didn't heed as much as I should have. For instance, on Linked In I saw some guy who recently passed his level 3 CFA exam say something like "now all I need is for my stonks to go back up". And he said the word stonks, a word often used back in the early 2021 unicorn stock bubble which is reminiscent of the dot com bubble of 2000. The crypto superbowl add was another red flag which also reminiscent of 2000. I know so many crypto bagholders. High energy and housing prices are reminiscent of 2007-2008 and so here now we have the worst of 2000 and 2008 in 2022. It would be naïve at this point to think that we could unwind the excesses without a major downturn like what happened in 2018. This time the excesses were higher and would appear to be too great for the soft landing scenario to play out. I will always keep an open mind how this will play out but as I've been saying for some time now, the benefit of the doubt can't be given to the bulls.
