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.
