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.
