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.