Looking back and looking ahead

First off, I was wrong about the ST call I made in the previous post. Markets simply powered ahead rendering overbought conditions even more overbought as the Fed's pivot during the Dec 13th meeting caught literally everyone by surprise. With the market having already such a strong run going into that meeting everyone, including me, were expecting the Fed to push back on the market by talking tough as has been the case for well over a year. Instead, they pivoted penciling in 75 bps in cuts for next year. The market has now since pricing in twice as much. This pivot no doubt resulted in some forced buying by shorts and underinvested fund managers. So, now we have markets that are extremely overbought with some overbullish ST sentiment readings. More on that later. 

Looking back on 2023 I was spot on for the most part. I had pointed out from the start how expectations were quite low which underpinned my LT bullish posture. My ST calls were mostly right as well. Sure, I got this last one wrong but as I always say, calling the ST is tricky because the shorter the time frame the more randomness plays a factor.  There's been plenty of headlines pointing how the unanimous call for a recession in 2023 was wrong.  What's the mott of this blog again? For anyone reading this, and I'm not sure if anyone does, how many fucking times must I prove it you that the purpose of the market is to make fools of everyone? In other more kind words, the market will discount the popular narratives out there and so by the time you act on them it's too late. Now, you are hearing a lot of chatter about a soft landing. So, does this mean that this has been discounted and the market is vulnerable to downside surprises? I don't think so. Despite all the talk of a soft landing, it's not even close to being fully embraced. Yes, in the ST you have signs of froth, just was we did in July but then just like now, we aren't at the point where the fundamentalists type managers are fully committed to equities. I listened to several 2024 outlooks from fund companies/strategists and the message was the same for all: be cautious on equities and be overweight bonds vs equities. While there are less calls for a recession in 2024, you won't have a hard time finding them. Guys like Gundlach just keep moving the date forward. What a clown.

According to this set of  Wall Street Strategists, the average SPX price target for end of 2024 is 4861. That's a gain of only 2% from here! Last year at this time, the average target was for a 5% gain. So, if everyone is so bullish about a soft landing in 2024 why isn't the average price target  in 10-15%  range?  

Fund managers are less negative vs a year go but there's still a ways to go before they have fully embraced equities. 

The inverted yield curve is probably the main thing that's still keeping a lot of people still cautious. What does an inverted yield curve actually signal? It signals that the market is expecting short term rates to decline significantly.\This does NOT necessarily have to be the result of a recession, it can be the result of inflation normalizing now that we don't have dire supply chain issues and acute labour shortages. Yes, onshoring and the like could result in longer term inflation pressures, but inflation has clearly been on the downslope and since the Fed raised rates so aggressively to supposedly fight the inflaton (which it did not), then it follows that they will lower rates after it has been painfully clear that the inflation storm has passed. A 5.5% fed funds rate is simply not justified even if  inflation were to run at 2.5- 3% going forward rather than the 2% Fed target. Therefore, the inverted yield curve could possibly be signalling a recalibration  of ST interest rates is coming which doesn't necessarily mean recession. In prior instances when the yield curve went inverted, did it ever happen after a pandemic induced inflation episode?  No. Therefore, it would be naive to just blindly apply the inverted yield curve recession signal to our current situation. Yes, it was different this time! The pandemic induced inflation and labor shortage has also given false signals to other indictors like the SAHM rule and credit card delinquencies. I'm not going to go into details with these, all I will say is that look at what levels therese indicators are rising from....it was either at or close to historical lows and now look at at absolute levels. One word comes to mind:  normalization. 

So, bottom line is that the there is still plenty of room for the market to rise longer term before everyone is truly all in.  The ST is dicey however as once again the CTA types and other momentum based traders are pretty much all in. The tactical indicators are as stretched as there were in late July which as we know was followed by a 10% correction during the subsequent 3 months.  With the SPX flirting with all times high, don't be surprised to see it stay sticky until we surpass it but whether or not that happens, you will most likely get a better entry point if you remain patient. Never chase the market.  I've seen a few different momentum/breadth studies which have shown that when the market has been so strong as it has been, it's actually a strong bullish signal 12 months out with gains of 12-15%. in the offering. So keep that in mind if things get rough. I have some more things to say but I'll save it for a future post coming soon. 

Sentiment reset with some flies in the ointment in the ST

I've had a ST cautious tone on the market in general since mid July. Back then I warned that the market was showing signs of froth and advised against chasing. Symptoms of the froth were a string of very low daily put/call ratios, fear/greed index at 80+, NAAIM exposure 102 and AAII sentiment showing 2:1 bulls to bears. I mentioned how the market needed to shake out the Johnny come lately bulls such as the trend following CTA types who went from low market exposure at the beginning of the year to high exposure.   As the market rolled over I mentioned that signs to look for at a correction low would be Fear/greed index at sub 25, NAAIM at sub 40, AAII bears 2:1 - essentially the opposite of July conditions. Well, these things all happened at the late Oct low. We've also seen CTAs running for the exists at the fastest pace since the COVID crash of 2020 to the point where they were short the market on par with the 2016, 2018 and 2020 lows.  We have also seen the put/call ratio average about 1.05 for the past 3 months which is quite excessive. Even during this latest rebound, the put/call ratio has been constantly above  which usually results in further ST upside.

The other thing I had mentioned a few months back was that the signs of froth we were seeing had implications for the ST, not medium/longer term as there were still plenty of fundamentalist type investors who were still skeptical and underinvested. I referenced B of A bull/bear indicator which is effective in gauging sentiment from a medium term  perspective(1-2years). It had only reached a high of 4.5 in the summer which is only in  the neutral range. Historically, you didn't have to worry about an immanent bull market peak until there's reading close to or above 8, which implied that any subsequent market decline from 4.5 would only be correction.  At the recent market low the bull/bear indicator fell all the way back to 1.4, back into the buy zone, lower than it was to start the year. To sum up, the 10% decline in the market has resulted in a complete sentiment reset,which clears the way for the market to resume its bullish advance which began a little over a year ago. 

Since the October 27th low we've seen quite a rebound in the market. It was sparked by the notion that the Fed has given hints that it done hiking...or at least that was the impression given by a softer than expected tone by  Powel at the last Fed meeting. Jay tired to pour some cold water on that notion yesterday at the IMF meeting by stating there's still the possibility more rate hikes would be needed and is wary of disinflation head fakes. He also told somebody to shut the fucking door.  The market seems to have disregarded his comments for now at least. It's incredible and quite silly how much of a Fed obsession there is out there, as if they are the masters of the market universe; as if is monetary policy is by far the single most important variable of the stock market. As if the disinflation we’ve been seeing since June 2022 was largely due to monetary policy. Go back to my Inspector Gadget post from last year…it’s playing out just like I said it would.

There are some things that I don't like about this latest rebound.  First of all, it was initially driven by the "Fed is done" narrative, which runs the risk of being premature which would not the be first time this happens. The horribly lagging inflation data that the Fed tracks is still not sufficiently suggesting its a slam dunk by any means, however, next week's CPI report will show the impact of significantly lower month over month gas prices and lower used car prices as well.  Perhaps the market has front ran this already. Speaking of inflation, the 5 year breakeven spread is currently at 2.3% and has been more or less around this level for 8-9 months. The day to day readings can get jumpy at times such as when it had a little spike to 2.53 in October.  Fintwit was sure to point this out, implying that inflation was about to flare up again. Funny how fintwit is either quiet or in disbelief when the break-even spread had been hovering in the low 2's for several months. To me, it's not hard to see why this is so.  Shelter is the largest component of CPI comprising 30%  and 42% of headline and core figures respectively and it is baked in the cake for it to decline rapidly in the coming months.  Data used to calculate shelter is horribly lagged by about 12 months. The yoy inflation of market rents/leases have been steadily declining, hitting pre-COVID levels in June and in the past few months are now tracking BELOW  pre-COVID levels. So, it would appear that shelter CPI will be "normalized" by mid 2024 and onwards thereby putting downward pressure in the CPI for the next several months. It's probably likely that used car prices will also roll over significantly from here as well.  

I digress. The ST concerns I have at this point is that we are quite ST overbought now with some indicators of sentiment having rebounded very sharply in short period of time. AAII sentiment went from 2:1 bears to bulls (sufficient to mark a correction bottom) last week to 1.5 bulls to bears this week. That's probably the biggests reversal I have ever seen. NAAIM sentiment also went from 29  last week (another marker to suggest correction bottom)  to 62. 62 is not an extreme number but the huge jump is what's notable. This rally has also created 2 notable gaps in the charts. I fucking hate gaps like that as they tend to get filled, but not all do. The ones that don't, tend to happen at  major inflection points Some people I bet  are still waiting for the March 10, 2009 gap that kick started the bull market to get filled. The correction which started Aug 1 began with a gap down that did not get filled...at least not yet, but even if does eventually, you can see how it had staying power. I would expect the current gap from 4300-4330 will get filled at least. The one below that would require SPX 4220 to get filled. That one I am less sure of.. 

When the market hit a low on Oct 3, most of the aforementioned indicators were signalling bottom ( AAII was the exception at 1.5 bears to bulls, not quite 2:1). Then we got a rally and a lot of folks flipped bullish quite easily as calls for a year end rally became prevalent. The rally turned out to be a nasty headfake to which sentiment became extremely bearish again at the Oct 27 low, more so than on Oct 3 . Now we are seeing similar bullish flipping happening with this rally. I see evidence of people too eagerly turning bullish for a year end rally again, however, the persistently elevated put/call ratio suggests the opposite. In fact, it suggests more upside.

On August 21, after the market had declined 5%  I wrote that the market was ST oversold and due for a bounce but not to expect that such a bounce would lead to a new leg higher. That turned out to be exactly what happened. I think we are in a similar situation but in reverse. The market is now ST overbought after having rebounded 7%.in a short period of time. It was achieved via 2 large unfilled gaps with bullish sentiment reversing very sharply, both of which are not constructive action. On the other hand, the put/call ratio had been stubbornly high all week which is contrary to the bullish sentiment and supportive for the market..That could turn on a dime but until it does it’s bullish and is arguably a more important indicator than sentiment surveys as it shows what people are actually doing with their money vs just feelings. So, It would not surprise me if the market goes higher still before peaking at some point mid or late next week and turns down but it shouldn't result in a lower low as medium term sentiment indicators have been fully reset. As usual I reserve the right to change this view as things unfold. 

This post was mainly a tactical discussion. In the next post I will discuss more about fundamentals and consensus views/expectations for 2024. . 

It's been a while

I've been busy lately and haven't had the time to properly sit down and do a post.  Man, a lot of things have happened since my last post. Obviously the war in Israel is the big one. I've always had a fascination with war history and so I did some research on this conflict and was intrigued.  I was going to give a long detailed take on this conflict but I'm only going to say a few tings. It's a sad situation which will be difficult to resolve because of the ingrained hatred on both sides which has only gotten worse now. Israel is entitled to a response and you can make the case that their response is largely disproportionate but such is war, especially when the weaker nation attacks the stronger one. With Israel being in the position of strength, it will dictate when this current war will end and set the terms for any cease fire or peace agreement; and given Israel's current right wing government, such terms will probably result in the Palestinians being  even worse off which means more resentment, more unrest in the long run. The issues that existed prior to this war will only grow worse. Israel's expansion of Jewish settlements in the West bank is an example of how their current government doesn't give a shit about the Palestinians and is only concerned about increasing Jewish interests at their expense. It's one thing to try to justify a heavy handed approach in Gaza in the name of security (which I believe is punitive) but there's no justification at all for the expansion of Jewish settlements in the West Bank which understandability fuels further Palestinian resentment and violence. For there to be any chance of peace in the long run, Israel has to have a more sympathetic government towards Palestinians. They need to encourage the Palestinians to reject Hamas and other terrorist groups  by offering them a way out and a better life in exchange. Israel needs to show the first act of good faith but that's going to be politically extremely difficult and it definitely won't be with this government. Israel is always critical of Arab countries who don't recognize their right to exist but yet they treat Palestinians with similar contempt. Yes, I get that Israelis will say that this is only because Palestinians/Arabs have always had contempt towards Jews. The cycle of hate and blame needs to stop and it can only happen when both sides agree to wipe the slate clean and have mutual respect for each other's existence and rights going forward. At this moment it seems like an impossible task.  

Next post will be a market update which will come shortly. 

  

  

 

Bearish undertones still there

We got the bounce I was expecting so now what? More on that later. Jackson hole proved to be a non-event as Jay Powel didn't say anything all that surprising. In a nutshell, he said that the Fed is still prepared to raise rates if needed and that inflation although falling is still too high. I'm not going to get into discussing how much of a bonehead Jay Powel and Fed buddies are. I'm not going to discuss how the recent fall in inflation was largely self-correcting and had little to do with rising interest rates. Ok I lied. When it comes to inflation pretty much everyone just focuses on the impact rising rates has on the consumer,, namely the demand to borrow money and the ability to service debts. Rising rates means less demand to borrow money and more income required to service debts, therefore less money to spend and therefore less inflation...at least that's the narrative. But hardly anyone mentions the impact rising rates has on the supply of money. Banks are more inclined to lend when rates go up as they make more profit  Rising rates also creates a fiscal impulse as higher interest payments are being issued on newly issued bonds and savings accounts. Higher rates also increases the cost of capital which can lead to higher prices being charged and raises the financing costs of expanding the supply of goods and services. These supply side impacts of rising rates are inherently INFLATIONARY. Even if you only focus on the naive, consumer only perspective, you have to take into account that the vast majority of  consumers in the US have locked in low rates on their mortgages for several years which has blunted the squeeze of higher interest payments on existing debts, however, there is a squeeze on auto loans and other non-secured debts but these are smaller relatively speaking. The bottom line is that impact of rising rates on inflation is complicated as there are offsetting factors.  If you look at anytime there was an inflation problem in any country it was mainly rooted in problems with the supply side of the equation. Demand for goods and services is generally steady and inelastic. We all need a consistent amount of food, shelter and energy, but the supply of these things are not always steady. Supply disruptions/shortages can happen for a number of reasons such as forces of nature (i.e. bad weather), political (such as embargos and nationalizations) and pandemics. Raising interest rates will do fuck all to stop the impact of a supply shock, if anything, it may exacerbate it as will be prohibitive to the financing of expanding supply which would be badly needed. We had a supply side shock in the form of a pandemic and now that the shock is normalizing inflation has come down with it, yet everyone is giving credit to the Fed for this. Bullishit. They might actually be hindering the disinflation.  I was right when I wrote last year that the Fed is like Inspector Gadget. But I digress....

Back to the markets.  NAAIM sentiment dropped to 34 on August 24th which was the lowest reading of the year.. That's quite a running for the hills for just a 5% pullback.  It did bounce back to 61 last week but that 34 reading  ticks the box for being at an extreme where solid, Intermediate term lows tend to be made. There have also been pretty notable equity fund outflows for the past 4 weeks totalling about $30 Billion  and  put/call ratios continue to be elevated and have been high enough to suggest an intermediate term low has been reached.. All in all, it didn't take much of a decline for  people to run for the exists and that's the kind of behavior you want to see if you're banking on the recent decline being a healthy bull market correction. Hedge fund positioning has backed off but I would like to see it back off a bit more, so it's not an all clear just yet. Am I being too cute? I could be.  It's a bit tricky now to call the ST. The easy money of the bounce has been made and of this bull run YTD as well.  I can see the market going either way from here this month but if we go higher it probably would not lead to a new leg higher. I still believe the likely path of the market for the next 1-3 months is sideways with the possibility of a slightly lower low. As usual, my outlook will adjust as things unfold. 

A couple of weeks back when NVIDA announced earnings after the close, I took a look at the messages being posted on the stocktwits message board.  Despite the fact that the company reported blow-out numbers, the vast majority of the messages posted were bearish.  It seems people were betting or hoping the stock would go down. Many people are calling NVIDA a bubble stock, yet you wouldn't see this kind of bearish posting back in the heyday of the tech bubble of the late 90s. You  would have seen everyone cheering and pumping the stock. Back then bears were an endangered species whereas now they are a dime a dozen. I'm not on expert of NVDA and I know the stock is not cheap using conventional valuation metrics but what I do know is that there is a bearish undertone to this market which has been in place for the most part since 2009. If you've been reading this blog over the years (I'm not even sure if anyone actually does) you will know that I have used the term permabear trading community to describe a large portion, if not the majority, of traders out there.  These folks became jaded and skeptics because of the crashes of 2000 and/or 2008 and I bet a good number of those who were posting bearish messages on NVIDA were tech bulls in 2000 lol.  When most people first start trading/investing they are inherently bullish looking to buy stocks they believe will go up. Very few, if any, start their foray into the markets as bears always on the look out for what could go wrong rather than what could go right. 

During the market recovery of 2020 we saw the rise of newly minted young traders who piled into speculative tech, crypto and meme stocks. Now after getting burned, they too have probably joined the ranks of the permabear trading community while some are still delusional. I have a friend of mine who is also an experienced advisor.  He got balls deep into  the meme stock fever. He, like all other holders of AMC  was convinced that there was going to be a short squeeze of epic proportions and every time a rally would fall part he would blame it on manipulation by the powers that be and his negativity has coloured his outlook on the markets in general.  Anytime he discussed AMC with me and the grand conspiracies surrounding it  I didn't even bother trying to challenge him as there was no use. I would just nod along and wish him all the best. Now that AMC has been  decimated these past few weeks I'm sure he's more bitter than ever. We've been planning to meet up for some time and so I guess I'll know soon. 

Give it time and keep an open mind

I've been warning since mid July about the market getting overheated and now low and behold we've see the SPX drop about 5% from the recent peak. Rising bond yields appear to be the main culprit which I also warmed about. So now what?  Has the froth I warned about been unwound? Well, a good chunk of it has.  Put/call ratios have soared, NAAIM exposure is back to 60%., AAII sentiment is 1:1 bulls vs bears, Fear/Greed index back to 45 and the market is a quite oversold on a ST basis as per McClennan Oscillator.  Thus, there's  enough evidence to suggest a ST bounce is immanent but I suspect that if we get one, it won't signal the end of this corrective phase that we are in. I suspect at best the market goes sideways until end of October - mid November. A bounce followed by a lower low at some point is probably the more likely scenario but like I've always said, be careful trying to predict every wiggle in the market because it's often a fool's game. I will defer to the indicators. Right now they are oversold enough for a ST low to be immanent but they would need to be more oversold in order to provide a high conviction, longer term bottom signal. We're talking about AAII bears outnumbering bulls 2:1, NAAIM at sub 40 and Fear/Greed at sub 25. There's no guarantee of course that we will get these readings before hitting a low - the market may find a low well  before or well after such readings are hit. 

The Jackson hole speech this Friday will likely be a market mover. There's no denying the sell-off in LT bonds is hamstringing the market. I noticed a large outflow in TLT last week and it appears to be quite oversold as well at it re-tests the October low. So what's behind this bond rout? LT yields are theoretically supposed to reflect the average of what ST rates are expected to be over the duration of the bond plus a maturity premium. It's obviously not that simple as there are  buying and selling of government bonds as the result of changing needs/circumstances of its various holders in particular, the big boys which are foreign centrals banks like China and China has been selling US bonds significantly as of late. Of course, for every seller is a buyer, but as with any asset, if sellers are more urgent to sell than buyers are to buy at a given price, the clearing price will drop accordingly.  Despite the bond rout,  5 year break even spreads of TIPs have hardily budged and continue  to be subdued, hovering around 2.2% which suggests this rout does not appear to be driven by a repricing of higher inflation expectations which would truly lead to a higher for for longer Fed funds. Fed fund futures pricing also confirms this.

Bottom line is that although there's been a good amount of froth unwound in the market and a good bounce can materialize soon, I wouldn't get too excited about the prospects of the market until perhaps sometime in the fall. Could this be the start of something more than just a bull market correction? Of course, and we need to give that some consideration but as of now I don't see that being the case. If we see lot of people buying the dip and other signs of complacency that would make me change my mind.   

Wait and see

Some interesting things have happened since my last post. We had Fitch downgrade US debt and some notable bears like Mike Wilson from Morgan Stanley threw in the towel. As far as the debt downgrade goes, it's still clear to me that there's a continued misconception about the nature of government debt. Seems like these rating agencies didn't learn anything from S&P's downgrade in 2011...meanwhile these are the same jokers who slapped AAA ratings on subprime MBS. Wrong in both cases.  Unlike you or me, a  sovereign currency issuer like the US has the ability to literally print as much currency as it wants to pay its debts. If they held debt in another currency, that's another issue. But as we've seen earlier this year and in prior years, the US places a self-imposed constraint with the debt ceiling which ends up being an excuse for political gamesmanship So yes, technically the US can default but only if they deicide to shoot themselves in the head. As idiotic as many politicians are, they know that the consequences of a default are to be avoided and so it always will be.

Some of the extreme bearish positioning that has underpinned this bull run since October has been unwound along with a few bearish strategists  throwing in the towel for their recession calls in 2023. These developments are only natural after such a bullish move in the market. What we need to ask ourselves is have we used up all of the bear fuel? I don't believe we have from a longer term point of view but the ST does appear to be sketchy. I've seen quite a turnaround in the positioning in  hedge funds types to moderately overheated levels. These would appear to be trend following, CTA type funds whom I would classify as weak longs as they would no doubt bail once the momentum turns against them.  But if you look at the overall positioning crowd there is still plenty of fuel in the tank as there are plenty who position based upon their perceived notion of fundamentals and there's still plenty of skittish folks. Those bears who have capitulated are not exactly bullish, they are just admitting they were wrong with their timing. They still think recession risks are elevated for 2024 and are only grudgingly accepting the chance of a favorable outcome, but they want to see more proof. One of these capitulated bears is Morgan Stanley's Mike Wilson. I read this morning how he acknowledged strong fiscal spending as a supporter of the economy as part of the reason why his recession call did not come into fruition. He, like pretty much everyone else, was instead fixated on monetary policy. Maybe Mike finally discovered my blog lol  I've said it here more than once that robust deficit spending was supportive for the economy. Morgan Stanley wants to see "a broader swatch of economic indicators" turn up including  rate cuts before being comfortable with the economy being in an upturn. Again, as I've said ad nauseum, if you wait for the all clear before jumping back in, you will end up having to buy at all time highs and at that point, you will probably hesitate again to buy because prices and valuations will appear high - I'm already seeing plenty of people complaining about valuations now.  

Despite  a ST  overheated market, there's still ample fuel left for this bull run. Rising bond yields are not equities friendly and at some point will likely matter, but anything could be trigger for a correction/  consolidation. Bonds have hurt both bulls and bears this year. Coming into this year bulls figured the Fed was pretty much done and so even if rates just stayed on hold a sideways market for high quality bonds would yield a 5%+ annual return.  Meanwhile, most bears were penciling in a recession and therefore immanent rate cuts which meant bonds would be a source of  strong capital gains. Some of the bears who I follow on twitter openly mentioned a few months ago how they were long bonds and one guy was also short stocks too. Other bears I saw last year  got long vol as a way to express their bearish views which was a disaster of a trade. All these fintwit bears got slaughtered and I haven't heard a peep from them in about 2 months. Maybe this suggests the bears are due for a reprieve.  July CPI gets released in a few days which is typically a ST market mover. If it's market friendly do not be surprised if we get another run for the highs before the market finally rug pulls later on in the month  or in September. All of this is just guesswork of course and I don't like to fixate on the very ST which is usually too random to call. But the bottom line is that in the ST (1- 3 months), it's not a  good risk/reward set up on the long side.  

The one indicator that sums up where I think we are in this cycle longer term is the BOA bull bear indicator. It hit the max buy zone of 0 in mid June and hovered around there for several weeks. It currently stands at 4.1. In the past, anytime it hit 0 and rose from the ashes, it signaled a new bull cycle which was not in danger of a top or major decline until it rose to  8. This does not means corrections of 5-10% can't occur in the interim. I'm not necessarily expecting that deep of a correction...we'll see. The other thing that makes me believe we are perhaps in the mid innings of this run is the lack of IPOs. I read today how IPO issuance in Canada has been very weak, on pace to being the worst year on record. IPO weakness is also the case globally. Major market tops tend to-coincide with IPO frenzies and right now it's still in the doldrums close to where you see major bottoms not highs. That can change quickly of course but until it does, the bull run would appear to have ample fuel in the tank to go higher longer term as we continue the unwind of  pessimism/cautiousness  to optimism/complacency. 

Even the bulls have been caught off guard this year so far

It's been a while. I was in Korea throughout June, my third time visiting as this is where my wife's family resides. I always get a kick from the celebrity status I get over there being a white male.  I had visited a coffee shop to get a latte to go and the girl working there wrote a message on the lid in Korean which basically translated to "meeting you has made my day" lol.  The last time I was in Korea was the fall of 2014 which was when the Greenstar debacle had been unfolding. It certainly spoiled my trip. While I had been there the nail in the coffin was delivered when news was released that all the Canadian directors had resigned. I remember how my heart sunk after reading it but I hid my emotions from  my wife as I did not want to spoil her trip. Returning home from that trip was hard knowing what I had to face but looking back I give myself credit for my mental resiliency but I never want to be in that kind of a spot again. 

 Ok, so let's talk markets. There's been a notable shift since my last post. Some of the market skeptics have thrown in the towel or at least have given the bull market case some respect. The employment report released back in May started this shift because it indicated that the recession by end of q2 call was dead in the water. Last year at around this time you had Jamie Dimon calling for an economic hurricane, Elon Musk saying that he had a super bad feeling about the economy and Jay Powell saying that we need to see economic pain to get inflation down. Well, here we are a year later with economy still in tact and inflation pressures significantly on the decline. This week's inflation reports have made this really obvious and at the same time BOC hiked rates by another .25 and stated something along the lines that the downward momentum in disinflation may not last. What a crock of shit. This sounds the opposite of the "inflation is transitory" narrative they were echoing from Jay Powel 2 years ago. They are just trying to save face for what will turn out to be yet another idiotic and unnecessary rate hike. Like  I've been saying for a long time here, central bankers are largely clueless when it comes to forecasting the economy as are most economists. I've been saying here since at least last fall that inflation pressures are set to drop significantly by looking at forward looking data and at history. The most similar comparison to our inflation episode is the 1940's post World War 2 spike, not the 1970s like how most people think. This thinking is a classic case of  recency bias. Although the 70s weren't all that recent in regular speaking terms, it was the most recent period in which we had a major inflation problem.  It's becoming painfully obvious that our inflation problem was in fact primarily due to COVID supply chain disruptions. Yes, there are some long term structural issues like early retirements and re-shoring that may end up making it difficult to sustain a 2% inflation target long term but the truth is this inflation episode was indeed largely transitory, it just took longer than what the Fed heads had hoped for or expected. Prior to COVID inflation was not a problem and so I never bought into the 1970's inflation narrative. My go to  forward looking indicator of inflation is the 5 year break-even spread. It has been hovering around 2.15% for the past 2 months which means the bond market is forecasting the CPI to average 2.15 %  or so over the next 5 years from this day. If that turns out to be the case, short term interest rates are too high right now. The break even rate has a very good track record of being proven accurate with its implied inflation forecast. With that in mind,  it should be notable to realize that it peaked March 25th of last year at 3.59% and has been in a downtrend ever since signaling that future inflation rates were set to fall significantly for which it did. 

At the beginning of the year I had made the following observations about the consensus calls for 2023

• Bad first half, good second half with lower low in market
• value over growth
• underweight tech
• higher for longer
• recession evident before end of year
• flat to modest gain in the market

What's the motto of my blog again? Lol. The market has not only badly foiled the consensus, but it even did better than what the minority optimists were expecting. More people are finally starting to realize that the economy has been resistant to higher interest rates because the vast majority of consumers and businesses had locked in rates back in 2020-2021 and both have notably lower leverage compared to 2007. I hear chatter  about excess COVID savings keeping people afloat but I hardly hear anyone giving any credit to fiscal flows as a major supporter of the economy. Although well off the COVID highs, the deficit as a percentage of GDP is still a robust 5.5%. People tend to obsess over interest rate policy while paying little attention to fiscal flows. Interest rate policy is highly overrated, while fiscal policy is highly underrated with respect to its impact on the economy because fiscal policy has an immediate and significant impact on the economy while monetary policy has an ambiguous effect at best. I already discussed this is a previous post. 

So, where do we go from here?  With the SPX up 18% YTD and the market having gapped up in recent sessions, not to mention NAAIM at 93%, a low string of put/call ratios and fear/greed index at 80, this is not an ideal time to be entering new long positions unless you have high conviction on a certain individual name that's relatively non-correlated to the market. Recent action looks like a ST blow-off type move here. If you missed the boat you have to wait for the next one. If the market just keeps rising from here so be it - you just have to be patient as it most likely would give back any gains  But, I do believe that the market will hit all time highs by year end or early next year.  With the market only about 6% away from all time highs and given that there's still quite a bit of defensive positioning this looks like an inevitable outcome, but we will probably see a shakeout of the Johnny come latelys first. 

Despite ST overheated markets, the medium-long term still looks good from a contrarian point of view. BOA bull-bear indicator is only at 3.5. Remember in June I had posted this indicator had hit literal rock bottom of 0. At 3.5 it's not even at a neutral reading. The average Wallstreet Strategist price target for the end of year is about 9% lower than where the market is right now. Such a bearish outlook especially in the face of such bullish market action YTD gives a strong contrarian bull signal. The average posture of fund managers as per BOA survey continues to be risk adverse. I get why there's still all this cautiousness. The fundamentals appear to be shaky at best, whether  because of high rates, shoes that are sure to drop or whatever, but this was also the case in the second half of 2009 and 2020. I've said this before many times, if you're waiting for all the fundamentals to look good again, the market will be at all time highs.  History suggests that the length and magnitude of this rally is signaling better times ahead and that any of the negatives you are seeing either will be fleeting, won't matter or at least won't matter for some time. "Oh please, the market is being driven by 7 stocks" would be a common bearish retort Well, what if we start seeing the smaller stocks take the baton and lead again as they did from October-February? In fact, from June up until now small cap stocks have been quietly outperforming large cap. Quite early to suggest a trend, but if we did end up seeing better participation from small cap, what excuse will the bears come up with then? I'll tell you what the ultimate/default excuse will be - high valuations. When the doomsday macro calls don't come to fruition the bears always defer to high valuations.

The fuse is burning

I love this time of the year. I get this cozy, content feeling as flowers bloom and the weather warms up, knowing that a lot more good weather is still to come.  Last week was my birthday. When you're very young you can't wait for your birthday to come but that changes when you get older. When I hit  my mid 20s I started dreading my birthday, because it was a reminder that I had not had a successful life both from a personal and career standpoint. I was falling behind in life. I felt as if I was still at the starting line while friends and family were so far ahead of me. Every so often I would get an intense feeling of anxiety or  sadness as I reflected upon my life thinking that I've failed to live up to my potential, but I wouldn't dwell on these negative emotions for long. I never fell into a depression or felt sorry for myself. I would always pick myself back up knowing deep down that I had what it took to be successful in all aspects of life and I still had time on my side to make things right. I knew that the correct approach to get to where I wanted to be was to stay positive and take action, doing things that are in my control which would increase my chances of success. I was able to get my life back on track through persistence, skill and a large heaping of luck. It wasn't a smooth path to recovery by any means. The last 2 major setbacks I had to endure was the Greenstar debacle in 2014 and me getting fired from a job in 2018 (which I saw coming and was a relief). Ironically, both of these setbacks were part of a chain of events which led to me where I am today. I ended up landing a great position working with a great team of people with an amazing pipeline of opportunities. I also recovered all my losses from Greenstar. I could not have asked for a better situation to be in. Prior to Greenstar I was managing my own money and that of a few personal friends/acquaintances via an informal, good faith arrangement.. Now, I have a "real job" as an advisor and only personally manage my own money. My advisory role allows me to earn a solid income relieving any pressure for me to have to perform with my personal money. I have a really good foundation in place to have a lot of financial success  As I mentioned prior, a big part of being in the situation I am in right now was due to luck - perhaps it was the biggest factor, it definitely was not the smallest. If you look at successful people, luck is often a key contributor to their success. Yes, skill, working hard, and having a positive attitude are critical,  but non-controlling factors such as your parents,  being born at a particular point in time,  growing up in a certain country, coming into contract with certain people by chance are things that you can't control yet they are often crucial in providing the opportunities for your skills,  hard work and positive attitude to bear fruit. I for one will not be complacent about the situation I am in now. If anything, I get overly worried that something could derail me once again. Last year I had some sleepless nights because of the market even though I had properly positioned clients and myself.. I couldn't help but fear that my career and financial well being would take a major turn for the worse. I knew deep down it was an irrational fear but I couldn't help it. I've weathered the market storm quite well but by no means do I get an all clear feeling. I, like most people, am bracing for more upheaval and that's probably a good sign.   

 In my last post about a month ago I suggested ST caution. The market didn't really go anywhere afterwards until last week when it made a marginal breakout. Since my last post the Fed hiked by .25 and strongly suggested  that future rate hikes are unlikely but that rate cuts are also unlikely .Markets meanwhile have been pricing in  about a 1% rate cut by the end of the year and about another 1.5% cut by the end of 2024. When I see the market pricing in such a radical difference from the present like this, I pay special attention and I tend to believe what the market is signaling about the future because I have found that the market gets proven right. For instance, when oil was  trading sub $30 in 2020, futures were in a steep contango, correctly forecasting that oil prices were poised to rise significantly in the months ahead.  The opposite happened in the spring of 2022 when oil prices were north of $100. Futures were in deep backwardation signaling lower prices in the months ahead. I saw similar signaling behavior in the futures market for iron ore. So, if we are to believe that the futures market will be right about the Fed cutting rates it must mean that inflation is going to drop significantly from here. That can happen either in a bad way or a good way. The bad way is that we have a recession and/or  financial crisis. In the good scenario, it will be the result of inflation subsiding back to 2-3% without a nasty downturn, (perhaps only a slowdown) as COVID induced inflation pressures are largely wrung out. The vast majority are clearly bracing for the former, not the latter, yet so far the evidence is suggesting the latter is playing out. Remember, at the end of Q1 when a recession didn't materialize, bears simply scoffed and moved their call to June. Well, June is just around the corner and still no signs of a recession, meanwhile the market is hanging tough, grudgingly at the high for the year., up about 10% YTD.

Over the past few weeks there has been 2 major concerns about the markets. One of them is the dreaded debt ceiling, the other is poor market breadth. All the talk and worry about the debt ceiling  reminds me of  Y2K fears people had about computers shutting down at the turn of the millennium.  I see people pointing out how the market reacted badly in 2011 when there was a debt ceiling impasse which resulted in the credit downgrade of the US debt (which was so silly) which resulted in stock market turmoil - ironically US treasuries rallied HARD on this "downgrade". The big difference between then and now is that there's no surprise factor this time around. All of today's worries actually increase the chances of there not being another crisis this time ,because since authorities are so well aware of what can go wrong, they are motivated to do what's necessary to avert/solve/mitigate any crisis before it can happen.  If someone tells you I'm going to punch you in face in 5 seconds, you would probably put your guard up or be ready to duck. Quite a difference compared to if someone cold cocks you. This analogy applies to the markets in general. Major moves in the market happen as a result of surprises -  things that are not expected or priced in. Think about what expectations were coming into 2022. The consensus forecast by the  "experts" was for rates to remain ultra low for the entire year with only modest hikes penciled in by the end of the year at most. The negative surprise of rapid rate hikes along with the Ukraine War resulted in a significant resetting of expectations lower hence lower stock and bond prices. Coming into 2022 I'm sure there were also plenty of folks thinking "With the Fed fund rates at 0%, I don't have to worry about a bear market on the horizon - that's never happened. I'll have time to get out once rates have risen significantly." The market obviously front ran the Fed in 2022 leaving people in disbelief and slow to react for the first 6 months of the year. 

Now we have a situation that's the  complete opposite in many ways.. Higher for longer  has replaced lower for longer as the consensus view.  "There's no way the market can be in bull mode with rates this high" is what a lot of people are thinking I'm sure.  Yet, here we are with it been 7 months since the market has made its low, up about 20% since that point and now higher than it was 1 year ago. That's simply not how bear markets behave. Oh but it's only a handful of tech stocks driving the market. Yes, that's true. Since the banking crisis in March, the small cap stocks have not recovered all that much. But remember coming into this year, nobody wanted to touch tech stocks and nobody was pointing out (except for me and few others) that the average stock was performing well with several sub sectors looking much better than the overall SPX. Nope. Instead people were complaining and warning about lagging tech. Then things changed. Now, it's the opposite situation. People are complaining about how it's only tech holding up the market. It would not surprise me now if we see small cap start beating tech in the coming weeks just to stick to the herd once again which has been relentlessly bearish in general. The market doesn't make things so neat and obvious otherwise most people would correctly be buying at lows and selling at highs. 

The bottom line is that despite the market's good performance YTD,  market expectations in general  are still quite low in my opinion, as there still a large cohort of investors/traders who remain defensively positioned and have been skeptical about the market for several months. I read from a bearishly inclined money manager how the average household is still holing a historically high equity allocation, yet they never mentioned once over the last several months how money managers and retail trader types have been very defensively positioned, overweight bonds and cash vs stocks which obviously has been the wrong posture.  The ST is often tricky and right now at this point the indicators are a mixed bag. A bit of a shakeout would make the market more primed to make a sustainable breakout later in my opinion.  What  I'm more certain of is that there's a  powder keg of buying power out there and as each week goes by where there's no dreaded recession or financial upheaval, the fuse keeps burning, getting closer to the point where this powder keg could explode. 

ST caution is warranted

There's some shorter term indicators which are suggesting caution is warranted. NAAIM exposure is at 78. which is close to or at where prior market rallies in recent months have stalled. Fear/greed got as high as 70, and there's some other indicators which are suggesting the market could be running on fumes in the ST, but I wouldn't rule out a quick pop higher before finally peaking in the ST. However, medium/LT sentiment indicators are far from suggesting that the market is too bullish, quite the contrary. When the market is vulnerable to a pullback, pretty much any excuse will do. We have big tech earnings this week. We could possible  see a sell-off sparked by disappointing results and/or guidance or perhaps even none of the above - a sell on the news reaction could end up being be the narrative....like I said, any excuse will do. 

It should be noted that when the market is in full bull mode and we get one of those strong, relentless rallies, these ST indicators I mentioned will get even more elevated and stay elevated for some time without the market pulling back meaningfully. That's because in bull markets, high optimism/bullishness is natural and therefore can be tolerated whereas in bear markets or sideways markets it is not. So, unless the market is ready to break out in a major way (which I don't think it is), the ST bullish sentiment we're seeing now should serve to indicate a ST peak is immanent. So, what would be the catalyst that makes the market break out in a major way? I would say once there is enough evidence to confirm that interest rates have peaked AND that any downturn would be mild enough for the market to look past the valley on to better times next year. If that's going to be the case, I would think that it happens in late May- first half of June. Obviously, this is largely guesswork and as usual I will defer to the indictors.

Switching gears now, I want to talk a bit about perspectives. The majority of the commentaries/analysis of others that I come across have clear biases. People with bearishly inclined biases will present mainly bearish evidence while those with bullish biases will focus on the bullish evidence. It's difficult to find analysis that is objective. Now, this is not to say you should always be 50% bull, 50% bear. You have to pick a side - the side that's going to win and that requires taking both points of view into consideration and the willingness to switch sides when required. You also need to be aware of which indicators actually work in providing predictive power and whether too many people are using it, hence the risk of it losing its effectiveness as it will be priced in already. I've noticed some people pointing out a rise in bankruptcies and tightening lending standards suggesting this is going to be bad for the market, but if you look at history it shows that this may not necessarily be the case as such indictors tend to be lagging or co-incident. For instance after the GFC bankruptcies in the US didn't peak until Jan 2010, yet the market bottomed in March 2009. 

One thing I have noticed over the years is that when someone get burned, typically during big bear markets, they can easily become embittered and overly cynical for a long time and perhaps forever.  It leads them to seek out doomer propaganda and it essentially brainwashes them. This no doubt results in either further losses by playing the short side on market recoveries or in being overly cautious sitting in cash. Since 2000 we''ve had 2, 50%  bear markets, one 35% bear market and 3, 20-25% bear markets and so I can get why one can get jaded, but if you look at those who made the most money through thick and thin, it was the optimists - those who focused on identifying longer term themes/tends, focusing on what could go right.  Take Apple for instance. If back in January 2008 if you were convinced that smart phones would be a mega trend for the next 10+ years and bought shares of Apple, you would have been down about 60%  in the subsequent 12 months but if you remained steadfast in your conviction and held, you would up about 60 X today.  Yes, I know hindsight is 20/20 but to be a successful  investor I believe you should have a certain disposition and if you typically find yourself to be a doomer, I doubt you will be successful or if you have some success,  leave lots of money on the table.  I'm sure there are exceptions to this. I'm sure there are some people who have had success with ST trading focusing on the short side but that's the very small minority. Guys like Schiff, Roubini, Rosenburg,  did you ever see them provide information about their LT performance? No, because it's horrific. All they can do is peddle doom. Even if these doomers get it right this time and the end of the world is nigh, it does not make up for their horrific calls and performance up until now. 

 

End of first quarter comments

As usual, some sort of crisis happens anytime I'm on holiday in March which prevents me from truly relaxing.  I mentioned in early January that expectations this year were very low which had bullish implications for 2023. I also mentioned this:

Coming into the year, the following was the consensus thinking. 

• Bad first half, good second half with lower low in market
• value over growth
• underweight tech
• higher for longer
• recession evident before end of year
• flat to modest gain in the market

As per usual, the market has foiled the consensus so far. What's the motto of this blog again? The growth over value trade may be overheating now in the ST but there's still plenty of doubters out there. The acute underweight of tech stocks I had mentioned in early January is probably not as acute but we're far from the "pros"" being overweight tech from what I can gather. It will be interesting to see the latest positioning stats of money managers. 

The banking crisis in March was quite short lived as the Fed heads in the US and Europe stepped in aggressively. This is what the Feds are best at - providing emergency liquidity to prevent a contagion. 

What the Feds are not good at is managing or forecasting the economy as it pertains to monetary policy. Credit spreads barely budged during the banking crisis and the equity markets recovered all the losses and then some. That should be making bears shit their pants, but rather what I see from them is more hand wringing and snark. Instead of capitulation, they are digging in their heels. Comments I hear from them are "This is just the beginning of an even bigger banking crisis down the road". There's been no recession in Q1 as many were expecting but again, instead of capitulation and admission of being wrong, economists and bears are digging in their heels by simply moving their recession calls to June. With this banking crisis, we are surely to get a recession now they claim, because banks will be more focused on shoring up their balances sheets rather than lending. Maybe, We'll just have to see about that. All I can say is that this banking crisis just serves to lower already low expectations even lower. 

I try my best to be a pragmatist. I adhere to the motto of this blog because it works, it's a money maker.  One of my favorite things to do is to figure out what the average person's view of the market is going forward and then fading that view if it's showing an extreme and especially when it's contrary to what market action has been. Why is it that the motto of this blog works so well? It's because the market is a reflection of everyone's expectations and so chances are if there's a widely held concern or belief about something it's already being reflected in prices. There's a bit of an art to this because sometimes it takes a while for the herd to fully express such views as they may have been anchored to an opposing one for such a long time. The higher for longer narrative is a good example of something that probably took several months for the majority to embrace. In the first few months of 2022 a lot of people were shell- shocked by the abrupt change in the interest rate environment as we were in an ultra low rate environment for several years, but by the fall pretty much everyone had adjusted their view and accepted the notion that high interest rates are hear to stay which is why hawkish Fed comments have been losing their bite in recent months. Sure, you  still get knee-jerk reactions but Fed hawkishness is like beating a dead horse - it's old news unless the Fed funds rate would be poised to go to 7%.. What moves the needle in financial markets are surprises. What would be the biggest surprise this year? Cleary it would be if we don't get a recession or even if we do, a mild one would still be considered a surprise. To move the needle on the downside I suspect we would need to get a severe recession. 

I mentioned in January there were very low expectations coming into 2023. With the market up a solid 8% at end of Q1 has this view changed? It doesn't appear so according to This recent CNBC poll which took forecasts from over 400 so called "pros".  Only 16% believe we are beginning to rally, 16% believe we are close to a bottom and 68% expect more room to fall (in other words expect new lows).  So, despite the market being up notably for the past 3, 6 and 9 months there's very few believers of this market. It's still a bear market according to most.  Probably the number one thing that is keeping people bearish is the inverted yield curve which has everyone bracing for a recession. "The Fed will raise rates until something brakes" is a common bear mantra.  In 2008 the mortgage market broke in the US because there was a lot of bad lending and significant ARMS exposure. Less likely to happen this time around given that 99% of US mortgage borrowers have locked in rates at much lower levels and have 15-30 year terms. Corporations have also locked in low rates as well. You can argue that the small banks "broke" with the recent crisis but the Feds fixed this instantly by allowing banks to effectively cash in their underwater bonds at book value.  But there will be other shoes to drop as a result of this the bears say. Lending will surely contract. Maybe, we'll see. But what if inflation pressures continue to fall and the economy slows down but doesn't crash which then gives the Fed cover to adjust rates lower? People seem to believe that the only way inflation pressures are going to drop significantly is if we get a recession. What if that's simply not true? 5 year break even inflation rates have been averaging about 2.5% since July and have been gradually on the decline for 1 year as inflation pressures have been NATURALY abating despite the fact that consumer spending has not let up at all since then. 

We've been in a rather choppy market for the past 9 months which to me looks like a base.  Bears of course are going to say it looks like a bear flag, but I will say this. If I woke up from a 5 year coma and the first thing I did was look at 5 year chart of the market, I'm pretty sure I would say that it looks like the market is consolidating gains from recent years and is forming a base which will lead to an upside breakout at some point.  That would be an objective viewpoint based solely on market action without any biases or influences from news flow, economists, pundits and what have you. 

Moment of truth coming up

The market has cooled off since my last post as I expected. The main narrative as to why is because of hotter than expected inflation numbers which was also something I said to look out for. With the market having been overbought with ST sentiment indicators in nosebleed territory it was no surprise to me that the market has since pulled back. I'm not going to get into to weeds too much about why inflation numbers came in hot. One explanation was that due to unusually warm weather created a surge in spending that would have not otherwise happened. I don't care if that's the case or not. Making a big fuss over one's month's worth of data is not wise. I will take my cue from the 5 year breakeven CPI rate currently at 2.47% which is still suggesting disinflation lies ahead. If we start to see this trending up then I will become concerned that inflation is not going to come down sufficiently in the near future. 

So far we have seen a significant retreat in the tactical indicators which had redlined. NAIIM exposure dropped back to 57%. This was coming into Thursday and so it's likely that number got even lower since.  The bullish pop in AAII sentiment from a couple weeks ago got sharply reversed and bears are once again are notably outnumbering bulls about 1.8 to 1. Fund flows, which were flat going into this decline,  showed a moderate outflow. Put/call ratios are also turning up sharply. If the bull thesis is in tact, we should have seen the bulk of the decline for this pullback and the market will consolidate and turn back up at some point in March. I would caution on being too cute with market wiggles though. The shorter the time frame, the more randomness plays a factor. 

Due to the hot inflation numbers, expectations for higher terminal Fed funds rate has increased and the "higher for longer" narrative got strengthened. But notice how the market's reaction to higher interest rates is becoming more muted since the fall while any hint of interest rate expectations being revised lower is met with a much stronger positive response. That's because this "higher for longer" narrative has been already been drilled into everyone's brain for so long. I hate to use the words "priced in" because these words were often said in vain last year by bulls, so perhaps "hawkish Fed fatigue" is better. 

I'm always trying to get a sense of what expectations are because I adhere to the motto of this blog. I've read the bullish and bearish arguments and the latter tends to seems to be the most convincing in general, especially now given the macro backdrop. But you always have to keep in mind that the market is a forward looking discounting mechanism. Bears are pointing out how earnings are set to decline this year, hence the market is poised to go down, yet they fail to mention that the market has already had a significant decline. They fail to acknowledge the forward looking nature of the market and that history shows that the market can go up strongly when earnings have been trending down and down strongly when earnings have been trending up. Yes, there are also times when the market goes up or down in the same direction as earnings as well. Markets, like most women, are not straight forward. If they were every trader would be rich. They can act a certain way in response to a certain set of circumstances one day but then react in the complete opposite way with the same set of circumstances the next day leaving men scratching their heads

Look at how the market declined in the first half of 2022. By mid June, the Fed funds rate was still at 1.50-1.75% yet the market had dropped over 20%. Now the Fed funds rate is 4.5- 4.75% yet the market has been up as much as 13% since then. Of course, time will tell if all of this is simply a counter trend rally that will fail or if the market is looking ahead to better times,  but to ignore the forward looking/discounting nature of the market is a huge blunder and in my opinion, there's enough evidence to suggest that you at least respect  that the bull case can play out. 

Despite what the bears are trying to convince you about, it's undeniable that there is a large cohort of fund managers and traders who are underexposed to equites because of interest rate and recession fears. This is indicative of low expectations and represents a powder keg of buying power should the aforementioned, widely held fears were to abate making the market vulnerable to a melt-up scenario.

The burden of proof

Meant to post sooner but I've been busy. The market has gotten off to a blistering start with the SPX up about 7% YTD. It was up 9% until the recent pullback. Aside from the squeeze action in BTC, meme, shitco stocks, I like the action in the market as it resembles what you see in early in a bull market  given how it managed to advance despite overbought readings. The advance has also been broad based. If you look at the equal weighted SPX, ticker RSP you will see that the average stock in the SPX is well off its lows and only 8-9% away from reaching an all time high. We are now however at a point where the market has likely entered  a consolidation phase at the least as most of the tactical indicators are redlining. Last week's  spike looked like a ST blow off move. We have NAAIM at 82% long and fear/greed index had hit 80 last week. For the first time in over 60 weeks AAII showed more bulls than bears. Bears are pointing out the contrarian implications of this but it's important to have some perspective here. When sentiment has been so negative for so long, the spring gets coiled tight and in the first phase of a new bull run it's typical to get a bullish burst like this. Fund flows have been flat and so there's no FOMO there. What I don't like is the action in the meme and shitco stocks but that appears to already be quickly unwinding as I type this. Apparently the move there has been almost entirely short covering and notice how those stocks are still well bellow where they were just a few months ago whereas the broad markets have faired much better. 

There's been a lot of hand wringing with the rally. "This is going to end badly" "Earnings are only going to get worse" and a "recession is immanent" are comments I've been seeing. Meanwhile the Fed continues to dig in their heels although they were forced to soften their tone a bit as they mentioned the word ""disinflationary" about 15 times during their last presser whereas in December presser they mentioned that word 0 times when it was already clear back then and earlier that disinflation had arrived. So much for the "we see no evidence of inflation subsiding" rhetoric just a couple of months ago.  Such a joke these guys are. Once again, the Fed had to capitulate with their backward looking stance because the evidence was so painfully obvious, but by no means have they pivoted even though the bond market continues to slap the Fed in the face, with the steep inversion of the curve and the pricing in of rate cuts by November-December. 5-year breakeven  rates continue to suggest normalized inflation is in the cards however it has recently ticked up a bit to  2.45%.  Imagine if the Fed had stuck to their transitory stance; they no doubt would be saying "see, we told you so!" but because they flip flopped and became peak hawkish at the worst possible time, they have to point out things like  low unemployment rates and other excuses to justify their hawkish tone. The next CPI report comes out next week. At some point, maybe with this next report, we may get a report that comes in hotter than expected and this may cause the market to freak out temporarily as everyone is still apprehensive and  high strung on monetary policy. But it's pretty clear to me that the majority of the evidence points towards normalizing inflation. Just because you get a warm week in the winter doesn't mean spring is coming early. 

Getting back to market psychology. It's a fascinating situation. Yes, we did not get retail capitulation in the classical sense of extreme panic selling, but we sure did get institutional capitulation as evident with the chart and others like it. 

And make not mistake about it, these so called "sophisticated" big investors are just as bad if not worse than retail. I mentioned in an earlier post that expectations coming into the year were very low. Well, right now the market is already above the 4050 average price target of WallStreet strategists. The odds are growing  that at some point this year there's going to be a massive buy side capitulation from these "smart folks"". You can feel the pressure already mounting on them as they are being left behind for being underexposed to equities.   

One bear argument I hear is this. "This can't be a bull market because we didn't get the washout in valuations that you typically got on prior bear markets". This is true, but only if you're assuming that the bear market we've experienced is going to be one that is accompanied by a significant recession and financial upheaval. The skeptics are not considering this alternative: What if what we've seen last year was something along the lines of 1994 or 2004 where it just a consolidation of the prior bull market advance? In 1994 and 2004  the Fed was also normalizing interest rates, hiking from relative rock bottom levels. Given that this hiking cycle was much sharper than in those 2 prior episodes and there were more excesses this time around, we experienced greater turbulence. Also think about this. At the peak of the market in late 2021 interest rates were at 0%. Big bear markets have always started after a significant periods of rising interest rates, not at 0%. So, I'm more open minded of last year being a hangover year clearing out the excesses rather that it being the beginning of Armageddon, There are also studies which show that the 3rd year of a presidential cycle is historically the strongest with an even stronger signal if the 2nd year was negative. I won't hang my hat on such studies though but it's another feather to the bullish cap. 

A read 2 articles recently which surveyed expectations from common people about the equity markets for 2023. A survey was done on about 1500 Canadians at year end and the result was this ""Sixty-eight per cent said they were unlikely to invest in financial markets “because now is not a good time to do so,”"".  In the US a similar poll was done on 1000 Americans in  January and the result was this  "A record-setting 48% of Americans told Gallup that, over the next six months, the stock market will go down. 18% said stocks will remain the same, while 31% said they will go up."  When it comes to polls like this, it's almost always best to fade them especially when the market action has been doing the opposite of they are expecting. Once again, another clue that we may be early in a new bull market advance. 

Right now it takes a leap of faith to be positive about the market in 2023 because we haven't seen  a clear turn around in the fundamentals. Meanwhile you got the dreaded inverted yield curve which is suggesting immanent recession....or so that's what everyone seem to believe. As I stated before, the yield curve inversion is suggesting that future Fed fund rates are set to go lower but that doesn't necessarily have to suggest a recession will be the cause of it. Another possibility is that it can signal a recalibration of rates lower as a result of normalizing inflation. Corporate yield spreads typically start blowing out just prior or during a recession. We have not seen that happening. 99% of mortgages in the US are Fixed with long terms. This is not like the situation was in early 2008. Deficit spending in the US is also still robust even though it's well off the COVID highs. At 5.4% of GDP, net government spending is still supportive of the economy whereas just prior to previous recessions the % had been notably lower.  In Canada, the situation is indeed much more precarious on the mortgage front. I have a client couple who own 2 Investment properties with a variable rate mortgage. Because of the rising rates, they now losing $3000/ month as rents are no longer sufficient to cover mortgage and maintenances fees. I digress. 

When the market is doing the opposite of what you think it should be doing like it is now you ought to take a step back and consider the possibility that it's looking ahead to better times. Do you remember how you felt in summer of 2009 and 2020? I do. It certainty did not feel right that the market was behaving bullishly. There were still plenty of things to worry about, plenty of calls for more shoes to drop. But here's the thing...the longer you wait for proof that all is better, the higher the price you are going to have pay to get in, hence the burden of proof.  Let's say by year end we end up realizing that a recession didn't materialize or was quite shallow and inflation had normalized. Where do you think the market going to be? Not at 4050 but at 5050+.  But please don't get me wrong here. I don't want to come off as sounding like a cocky bull. I do realize that bear market rallies can make it look like things appear to be all good again and the difficulty in discerning them from the real thing until after the fact.  Is it wise to chase the market after it surged 9% in the first 4 weeks of the year? No it's not. Is the bull case a slam dunk? Absolutely not. This is why right now will be a really important test for the market. Can it work off the ST excesses I pointed out without major damage?  If the answer is no then it suggests we are still in a base building phase or still in a bear market. If the answer is yes, then the bull case in mostly likely in play. From a pure sentiment/expectations perceptive looking out one year, the market in a position to have a strong year given how low dour the outlook most people have is. The runway is clear for there to be a take off although that doesn't necessarily mean there will be one.  

Inverse of 2022 so far

The market has has gotten off to a strong start. It's been the complete opposite of last year. Tech has leading the charge and the bond market is defiantly telling the Fed that it's going the wrong way. Last year at this time the market led by Tech sold off hard as the bond market front ran the Fed's rate hikes and sold off hard too. At this time last year, the Fed had acknowledged that it had to start raising rates, but it was slow in doing so. This time around they are digging in their heels with their "higher for longer" rhetoric. The bond market is signaling that it's just a question of when not if, the Fed is going to cut rates. The inverted yield curve has been a harbinger of a recession because it signals that interest rates are set to come down notably in the not too distant future due to sharply falling inflation which always happens as a result of a recession. But that doesn't necessarily have to be the outcome this time .given the unique circumstances of the inflation we've experienced. We can very well see inflation fall sharply not due to a recession but rather due to the subsiding of  one-off pandemic causes of inflation. Prior to the pandemic we didn't have an inflation problem and so we should go back to how it was prior to it. Now I do acknowledge  the pandemic did result in a surge of early retirements and disenfranchised workers and that may result in some structural inflation pressures longer term and so it won't be entirely the same as before, but overall it's looking pretty clear that the pandemic inflation was indeed largely transitory, it just simply lasted longer than the Fed thought it would and they capitulated on this view just prior to the worst of it. 

Coming into the year, the following was the consensus thinking. 

• Bad first half, good second half with lower low in market
• value over growth
• underweight tech
• higher for longer
• recession evident before end of year
• flat to modest gain in the market

I know it's very early but so far a lot of the consensus thinking is getting it wrong. There's an interesting breadth trust study making the rounds on twitter. It's called the Walter Deemer Breadth Thrust indictor which is flashing new bull market is underway. The last time this indicator gave a buy signal was in April 2020. It has a very impressive track record going back to the 1940s. The spring and summer rallies of last year produced false buy signals with other types of thrust/momentum indicators and so there's some skepticism about this WDB indicator, however, the WDB did not flash a buy in those 2 rallies. I believe a key reason why it's flashing buy this time is because we've seen a broad based participation in the upside this time around. I mentioned in my previous post that the charts of a lot of sub sectors were looking much better than what the major indexes were showing - the SPX and NAZ in particular. Would I hang my hat on this buy signal? No, but it's yet another clue to me that the bull case for 2023 is making sense. The WDB signal is coming at a time when we got very low expectations and much better market action than we've seen in quite a while. That's fertile conditions for a scalable wall of worry.  The market is now once again ST overbought though. If the bull market is truly underway, then any pullbacks from here should be shallow and the market will advance despite overbought conditions. That's typically what you see in the first leg of a new bull market. I will be watching closely to see if FOMO takes hold from the usual suspects. If so, then the buy signal, even if it does work eventually, may not work initially. 

Expectations are very low for 2023

Before I discuss 2023 outlook, let's talk tactical. In my previous post I mentioned how the market was ST/IT overbought and would now face an important test. Would it consolidate or would it just fall apart again as it did after the April and August peaks? The assessment depends on what index you are looking at.  If you look at the Dow which has low tech exposure, the pullback we've seen has been mild and looks healthy whereas the action in the tech heavy NASDAQ looks dreadful while the action in the SPX is somewhere in the middle. There are several sub indices such as equal weighted SPX, financials, biotech and even homebuilders (big surprise) which look healthy. In fact, if you look at  a one year chart of an index which has little/no large cap tech, they appear to be forming a base. Here's a fact I'm sure you haven't heard: 93% of the 2022 decline in the SPX occurred from Jan 1- June 15 which means we have basically gone sideways for 6 months. I said back in the summer that if the bull case was going to take shape it would likely require a base building phase. Obviously, only in hindsight will we will see if this a base or simply a bear market breather. The longer this sideways action goes on, the weaker the bear case will be. 

I've always believed that tech leads the market and so it does bother me to see it lag like this. Now mind you, when we had the summer rally, tech was leading which by my logic, was a good sign but it turned out that it wasn't and so who's to say that tech can't play catch up this time. Right now there's an acute underweight in tech by the so called "pros". Cramer recently mentioned how he hates tech, meanwhile he loved coinbase at $400 last year. and all the other crap. So, is there a contrarian play here to buy tech? I believe there may be but we need to see more evidence of it. By the way, Cramer is bullish on energy this year and other value plays. He has been a great contrarian indicator as of late, so much that there is an inverse Cramer ETF being considered lol. 

Currently, it's a mixed bag with respect to key tactical indicators. NAAIM exposure hit a high of 70% at the recent peak of the market in mid December and since then has pulled back, currently at 38%.  There has been significant fund outflows for the past 5-6 weeks which is what bulls want to see. Last year at this time I was cringing at the big inflows despite the market weakness, But on negative side, AAII positioning showed an uptick in equity exposure at end of December, currently at 63% which means they bought the dip.  NAAIM and AAII have been the whipping boys of late always doing the wrong. thing.  So all in all, the tactical indicators suggest the market is not ready for a sustainable breakout just yet

So, what were the headlines/narratives that have been responsible for the pullback since mid December? Once again, the Fed which despite painfully obvious signs of cooling inflation, gave no indication whatsoever that they were going to change their hawkish narrative.  At the peak you had on overbought market with evidence of some FOMO in trader types as per the 70% NAAIM exposure.  The Fed mentioned how they want unemployment to go higher to help with inflation pressures. It just goes to show you how clueless and idiotic these guys are. If they want job losses so bad, then I say to the Fed lay off 20% of the Fed heads and practice what you preach. You would think that after all the blunders and flip flops Jay Powel's Fed have made in forecasting interest rates and inflation since 2018 that they would would be more humble and flexible with their approach. You would think that they would say to themselves "maybe we aren't approaching this the right way". But no. I say they are going to look like complete idiots once again in 2023. So what does that mean? It means inflation is going to drop like a rock far faster than they expect and will be forced to pivot. Either this happens in a bad way i.e. sharp economic contraction or a good way, normalization of inflation which was indeed largely transitory. Every day it seems, there is more and more evidence of falling inflation pressures. Natural gas prices have now collapsed back to Dec 2021 levels.  Wage growth has been clearly decelerating, real time rents had another negative print, which makes it 4 months in a row. All of the evidence suggests for the Fed to stop hiking at the very least. But they continue to act in Inspector Gadget like fashion chasing false clues and narratives. They are stubbornly digging in their heels  just like when they were digging in their heels with their transitory stance in 2021. I still stand by notion that inflation pressures are subsiding naturally for the most part but because the market is so Fed obsessed, it will likely remain in jail until it truly sniffs out a change in the Fed's posture. Meanwhile, the Fed is still afraid to even do a minor pivot to a no more rate hike stance because they idiotically fear that if they do, it would inflame inflation pressures due to the wealth effect of a stock market rally. But if the trend of inflation data continues on this path, it's just a matter of when, no if, they will pivot.

Switching gears, let's talk more longer term. Early last year I predicted 2022 would be the year of the hangover which it was indeed.  2022 has washed away a lot of the excesses of 2021 namely the frenzy in non-profitable tech, meme stocks and crypto - all of the "assets" for lack of  better words, which had little to no substance. We also saw significant retrenchment in margin debt and crickets in the IPO market. All of this was a necessary purge to lay the foundation for any recovery. But is it enough? Bears will say we need to see more bloodletting and point out that at recent lows the market was not on par with previous bear market lows with respect to valuation and other factors. But making this assertion assumes that this is one of those big bear markets like in 1974, 2000 or 2008 which was accompanied by a significant recession and the financial upheaval.  What if that turns out to not be the case? What if all we get is a significant slowdown like in 2011 or 2016 or just a mild recession and no major upheaval? If that's the case, a 25% decline in the market is indeed enough of a bloodletting and what we've been seeing is just a consolidation of the big gains made from 2019-2021. I'm keeping an open mind. Expectations are quite low for 2023.  I recently read that the average price target from top market strategists is 4030 which is about 5% from current levels....we were at 4030 just a few week ago lol. Also, there has never been a more unanimous consensus from economists calling for a recession. With expectations this low it would appear that the market is vulnerable to UPSIDE surprises more than downside surprises. Now, one must be careful in trying to play the clever contrarian because even though expectations are low, it's not low to the point where people are bracing for a  financial crisis. Coming into 2008 I clearly remember recession chatter and so taking a bullish contrarian stance to that obviously did not work. But this time around the recession chatter is much louder. Meanwhile, households and corporations in the US are in  much better shape relative to 2008 as debt burdens are low given the vast majority locked in low rates from a couple of years ago. So, rising rates are primarily impacting new borrowers not existing borrowers. Here in Canada it's a different story. There's a significant amount of variable rate mortgage holders, I believe about 1/3 of all mortgages of variable and about 55% of new mortgages issued in the last 2 years were variable which means there's a lot of new home owners who are probably at or close to being in a  negative equity position with homes and face a painful higher re-adjustment of their mortgage as their current payments are not even covering the interest on the principle anymore. I know of one such person who bought a home in late 2021 with a $500K mortgage currently paying $2550/M. He will now have to pay an extra $4050/M come January. That's a kick to the balls. He barely has any surplus savings as it is. The BOC knows that there's a significant number of Canadians who are in this type of situation and they have already hinted that they can't raise rates much more. They are idiots too. Them, just like all the other Fed heads last year at this time were basically saying "don't worry, rates are going to stay low for at least another 2 years" and no doubt encouraged people to borrow and go variable.  This is why these Fed heads ought to just shut the fuck up when it comes to making forecasts. They are terrible at it. 

I've seen bullish narratives pointing out the high odds of the market bouncing back following such bad year and that the 3rd year of the presidential cycle is the most historically bullish. I place little weight in such narratives. Same goes with seasonality. They have little substance in my opinion. What matters most is expectations and positioning. Never forget the motto of this blog. Bottom line is that I see some encouraging signs out there, namely, how the average stock has been acting, the very low expectations and painfully obvious declining inflation pressures which at some point is going to make the Fed pivot.  However, I don't think the market is ready for any major breakout just yet as per the NAAIM and AAII positioning and the likelihood that the Fed is going to continue to talk tough in in the near term. This suggests more sideways/down action in the short term but unlike last year at this time, I can see the case for a bull market advance in 2023....the window is open.  But  I can also see how the bear case can come to fruition as well. I've never been so torn as I am now about the market which is why I will continue to be tactical until I my conviction level rises. I will say this though....if by April the market hasn't made a new low it's quite likely the bear market is over. What's also sticking in my mind is how trader X pointed out how it was not a good time to build long term positions in July and again in  October of last year. He said the same thing in April 2020. This to me says that somehow, some way the bulls are going to win this year and if they do, it will likely be in a big way. I know how unlikely that seems but it should feel that way if it is to actually happen.