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.