Russia Invades and things look bleak

I said that I could just feel that the Russia-Ukraine situation was going to break one way or the other and did. Sadly, not in good way. Putin has basically said that Ukraine doesn't deserve to exist and it belongs to Russia. He made his resentment of the break up of the Soviet Union quite clear. People knew this but he's now acting on it. Oil has now spiked to $100. As I type this the market is attempting to recover from a gap down opening on the news overnight that Ukraine is being attacked on multiple fronts. There's  talk about how bottoms happen once an invasion has occurred. I'd much rather see signs of people fearing the worst  rather than say stuff like this because while it is true, in all those previous occasions you had capitulation.  I'm no so sure we have seen enough. NAAIM sentiment has declined to 44 which is bottom territory for run of the mill corrections/pullbacks but it seems to be declining grudgingly. I want to see this at 30 or less. Put/call ratios are high but could go higher although I wouldn't say they are a major holdout. Fund flows look poised to show a negative print this week...we'll see but there is still a ways to go before all the YTD flows get unwound. We saw the VIX spike to 38. High, but certainly can go higher during major panics/declines. AAII sentiment and Investor's Intelligence sentiment are the only indicators that are showing high enough extremes, but I place more emphasis on what people are doing with their money rather than what they are feeling. 

The potential silver lining is that the Fed may end up backing off from it's aggressive rate hike plans which is what they should have done in the first place. It is clear as day that inflation pressures are primarily due to supply issues which higher rates are not a cure for. The lesser evil is for rates to stay low and we live with higher inflation for a while. Perhaps this war will make for a good excuse for the Fed to adapt this narrative and do a dovish pivot. I will not hold my breath for this but it's definitely a possibility and it looks like the market is pricing that in to some degree as odds for a 50bps hike in March are now low. 

I keep thinking of all that diamond hand nonsense and retail mania last year at this time and it makes me think that this could be indeed the start of a major bear market because that's what often follows. Even if that's the case, I do know that you get interim rallies on the way down. The problem is that if you look at 2001 or 2008 the market basically slid for the first 3 months of the year before bottoming temporarily in late March. I get that there's different circumstances but it shows you how relentless the downside could be. 

It feels utterly hopeless. Thinking of the market makes me nauseated. It feels as if it's a sitting duck to get hammered relentlessly.  I know it's supposed to feel that way near a bottom, but again, I'm not holding my breath. I have no problem if this post ends up being the ultimate contrarian indicator and it makes me look like a goat.  I think I marked the bottom in March 2020 with a similar post but I don't think so this time. It seems things can and will get worse before it gets better. I'm sure people would like to think that it's all priced in now. Is it? Or is it just wishful thinking? Again, I defer to signs of capitulation. Can we see more of it which causes further downside? Absolutely. 

Update:

Fund flows were flat for the week. That doesn't take into account today's action but this is still very  disappointing. Huge reversal in the market today but this reminds me a lot of what I saw in October-November 2008.  Until I see proper capitulation  I will have my doubts that we are out of the woods.

Russia- Ukraine crisis is going to break one way or the other very soon

The tension of this crisis is reaching a crescendo. You can just feel that it's going to break one way or the other very soon. . Russia keeps insisting it won't invade but it keeps amassing troops, equipment and supplies - at least this is what we are being told. The West keeps threatening heavy sanctions and financial markets have responded in kind by punishing Russian stock market and the Russian Ruble which has lost 2/3 of its value in the past 10 years. The question you have to ask is this. Who has more to lose? It would clearly be Russia...so it seams. So, if you are Putin and you know you're in a weak position from the start, what would you do if you wanted to extract the most amount of demands? You would do exactly what he is doing now - make it look as if you are capable and willing to carry out your threats even if that means destroying yourself in the process.  Push things to the absolute brink in order to get maximum return.  If I'm wrong, then Putin has lost his mind and is going to go kamikaze. Now, put yourself in the shoes of the West. You have the superior economic and military advantage to not give in to all of Russia's demands. Russia has more to lose choosing war but you will still lose. You still want to avoid or minimize loss and so are willing to make some concessions but only if the threat is credible. The more immanent the threat appears to be, the more credible it is and the more likely you are to make concessions but since you're in a position of strength, there's only so far you will go.  

The latest drama as I type this is Putin's decision to recognize separatist regions in Donbass as independent. If he does,  that would clearly be an escalation in the crisis as it shows a lack of good faith and opens the door for Russia to provide military support for the separatists in this region. There is also the prospect of a face to face summit between US,and  Russia. This crisis is going to break in one direction or the other in a major way quite soon, I would guess either this week or next. 

Obviously the market is fixated on the day to day drama of this crisis which will make for treacherous short term trading. The bears have overall control as the pressure is clearly on the downside. I'm seeing more signs of excessive pessimism. AAII sentiment is now clearly at historical extreme bearish territory. People have been piling aggressively into puts as the put/call ratio has been above 1 pretty much daily even when the market shows green. On the day when the market popped due news that Russia troops were being withdrawn the put/call ratio spiked to 1.3.  This shows that traders are now clearly favoring selling into strength. When bears press like this and get away with it, it's unusually late in the game for the downtrend more so in terms of time rather than price i.e. number of days left before things reverse. There has also been a major unwind in the excessive speculative behavior of traders in their use of leveraged ETFs and call options in 2021. The major missing piece of the puzzle is equity fund inflows which has been stubbornly positive YTD. I can see this week is poised for a negative inflow but we really need to see a capitulation here i.e. like $-20 M week.  NAAIM is back to 53 but again, need to see more capitulation here. With the market poised to retest or break the January lows, I think capitulation is coming. We'll see what the data shows Thursday. Until I see sufficient capitulation I will not attempt to bottom pick. 

The bottom line is that we are seeing signs of  excessive pessimism but there's holdouts, mind you, I find that there's always at least one holdout at a bottom as the indicators are rarely 100% in agreement. There's room for the market to have a breakdown lower given the precarious technical and fundamental condition of the market with the market in a ST downtrend threatening to break down to new lows and with bond yields and oil prices still near the highs.  Keep in mind, at market lows things look ugly and it feels like there's more pain in store. That's how lows get made. Overall though, the benefit of the doubt can't be given to the bulls at this point. The Russian stock market is getting destroyed today down 13% while US market is closed. Obviously this does not bode well. 

Update: Putin has declared the separatist regions of Donbass as independent which obviously is a negative towards finding a diplomatic resolution to this crisis. Futures were already in the red prior to this news and didn't change much but I can't see how the market doesn't gap down tomorrow. The only silver lining I see here is that this brings us closer to capitulation. In the long run this Russia-Ukraine situation is going to be trivial when it comes to the stock market since earnings are paramount to everything but it's certainly not going to help in the ST as the market was already dealing with jitters from higher expected interest rates due to inflation. At some point though, the narrative is going to get priced in because interest rate fears and Russia fears have been front and center stage for a while now. In my opinion, that pricing in requires capitulation from these stubborn BTFD buyers. I think we get that this week. The uber bear case is that the capitulation is just getting started. . I'm not so sure about that although like I said, I'm not giving the benefit of the doubt to the bulls. 

Can the market somehow keep it together this year?

It's becoming quite clear that the market is going to face a huge test this year. Bearish forces are clearly gathering. We know that from history, anytime we get a big flare up in inflation, at the very least it creates a multi-month period of market turbulence as the Fed raises rates and in often cases, it precedes a recession and bear market. January was a terrible month and in the heart of that decline I felt an anxiety that I haven't felt in very long time. I wasn't able to sleep well for a week. For clients that I knew would be especially vulnerable to a market crash I moved them to a safer allocation right at the bottom on Jan 24. Brutal timing, but I had a line in the sand that was crossed and I had to do it. Although there was some signs of extreme pessimism, there wasn't enough for me to delay pulling the trigger. I felt the risk of another December 2018 type meltdown was there and still is. Powel and the Fed not budging at all with their hawkish stance with oil and bond yields pilling on the pressure. The lack of  fund outflows is what's missing to signal the type of capitulation I want to see. We are seeing them now but they are modest relative the damage the recent big inflows that preceded them. Perhaps there will be selling into strength which did in fact occur last week as the market rebounded. Also, margin debt appears to be unwinding. The stats are always  delayed and so we will have to wait to see the end of January figure. Although AAII sentiment is in bearish extreme terrority, if you look as their actual positioning it has barely budged from the 70% equity exposure which is historically high. I just saw a chart of extreme buying of leveraged bear ETF which co-incided with prior lows. So, all in all, there is enough to suggest that a ST low could be in.  

We got pretty decent bounce since the low on Jan 25 but bond yields and oil prices keep creeping higher and until those 2 back off, it's going to at the very least keep a lid on the upside and at worst, put continued downward pressure on the market. Bearish sentiment as per AAII is hitting extremes and put/call ratios are high but NAAIM and fund flows are only showing mild-moderate pessimism given the damage that was done. Earnings seasons was a mindfield. Microsoft, Apple, Google and AZMN were good but Netflix and Facebook not and the later 2 got hammered. The first 4 are the true tech leaders of the FANGMAN complex and so it was critical that they did not disappoint or the market would have been smashed. Maybe they end up disappointing later this year. 

Tech sector has been woefully underperforming the broad market and value stocks, energy in particular, have been safe havens. Are we repeating the 2000 tech crash aftermath where value takes charge for the next several years?  There is clearly evidence to suggest this can be the case but there's also serious flies in the ointment. In the short term there is enough evidence to suggest the tech sector's relative underperformance is at an extreme and that chasing energy is late to the party behavior. The Russia situation is clearly keeping a bid under energy. If this situation can get resolved peacefully there should be a relief rally in the market followed by a shart retreat in oil and bond yields. I'm not going to hold my breath though. Putting yourself in the shoes of Russia, it would be foolish for them to start a war as it would be them against the world.

Getting back to the tech bubble analog of 2000 where value then took over for years. There's no shortage of people on twitter pointing this out. The bears have been squealing with delight during this decline as if they have claimed some sort of major victory. These miserable fucks have been decimated by the bull market for years on end and so they can claim zero victory even if we are indeed at the start of a new bear market. By the way, the talk that we are starting a new bear market is already out there, yet the market has dropped only about 10% from it's all time high at its lowest point.

The major problem I have with the tech bubble analog is that back in 2000 EVERYONE was euphoric about tech and valuations were higher. Aside from the fringe unicorn plays, broad based euphoria was missing. The leaders of the NASDAQ in 2000 were tied to the telecom cap ex boom related to the building out of the internet. This time around, the big tech leaders are not nearly as tied to each other and the valuations, although high are not nearly as nosebleed as the tech titans of 2000. On the value side back in 2000 energy had been a depressed sector for many years right at the time when China was on the cusp of a decade long boom  where they were buying up commodities like crazy.. That's not going to be the case this time. Although the energy sector was depressed since 2015 and rightfully deserved to have a big rebound because of underinvestment,  it doesn't appear to have the massive runway like it did at the start of 2000 and has to deal with electric vehicle sales eating away at demand. 

The bottom line is that the market will at best, face a multi-month period of consolation as it adjusts to the Fed tightening cycle and stimulus withdrawal. But there's no denying that something worse can indeed play out. Housing is another wild card. If home prices do more than just correct from these lofty levels, it could be the deciding factor that tips the economy into recession as most recessions tend to be housing led. There's clearly a lot that can go wrong this year and as such it's best to be tactical. If it is indeed a new bear market, then we are in early days and there should be a least one major rally to sell into which could perhaps begin from a lower low.  A peaceful diffusion of the Russia situation would be a great catalyst. It's really a tough call and dangerous on either side of the market, but the market is definitely starved for some good news on the macro front with respect to yields and oil pressures in particular. 

I'm still feeling anxious and nauseated when I think about the market and so that in itself should be indicator to buy.  

2022 the year of the hangover

Market's have gotten off to a rough start especially the tech sector. In a recent post I mentioned how it was suprsing to have seen the NASDAQ held up so well in 2021 despite the bloodletting in the speculative unicorn tech stocks which had paralells to the 2000 bubble bursting by which the NASDAQ eventually gave up the ghost in the last 3 months of 2000. Could it be that now we are seeing the same type of fallout happen in tech and that the 2000 paralell is actually still in tact? There's some strong evidence that suggests this could be the case but there's still some notable holdouts, the biggest one being that it was a collapse in tech earnings which ultimately did in the sector which was the result of over-investment in the telecom. If you look at the tech leaders of today , the FANGS, they each are dominant players in their respective spaces which aren't nearly as interconnectd as the tech leaders in 2000. The latest selloff in the tech space had been directly a result of the spike in longer term government bond yields thanks to a hawkish Fed pivot early in the year. This resulted  in rug pull which was amplifed because of of poor sentiment positioning conditions which I noted in my last post. There's some signs that sentiment positioning is improving however. According to BOA, global fund mangers have significatnly cut back on their tech exposure this month, in fact, they have the most underweight tech since Dec 2008! And what did they pile into? Financials of course, which has been the second strongest performer, energy being number 1. Financials too are now getting hit.   Now, it's one thing to dump tech because of poor fundamentals i.e. earnings but it's another to do so simply based on the yield of the 10 year s going from from 1.5% to 1.85% . Of course, the fear is that it's yields are going to go even higheer. At first this sell-off looked feels knee-jerk in nature and it so happened at time when the market was vulnerable in the ST due to poor positioning/sentiment. But now there's so much calls for the Fed to "do something" in order to stop inflation and that of course means aggresive rate hikes. No wonder the market is spooked. But the sad thing is, the Fed is not the main cause of inflation (aside from housing) and they can't fix it other than by creating a recession. The inflation is being caused by supply contraints and excessive government spending. Raising rates abruptly can tank the economy and therefore demand. Sure, that will curb inflation but not by addressing the actual underlying cause. That's like getting gangreen on your toe and cutting off your entire leg to treat it.  

On a bigger picture perspective, there's definatley things to be concerned about in 2022. We have a hawkish fed that will be raising rates sooner than what had been expected just a few weeks ago. One of the risks I mentioned earlier when discussing the expectations for 2022 was for a revising of rate hike expectations to the upside. The Fed is being hawkish at a time when some forward looking indicators of global growth and therefore inflation will be slowing.  That clearly puts the risk of a policy error much higher. The amount of fiscal stiumuls is also not going be as much as last year but it's not going to be abruptly taken away either, however, that's still an incremenatl detractor to growth. So it definatley feels like the market is walking on a tightrope here and 2022 could be a hangover hear as stimulus is being pulled back. Earnings ultimatley will be the deciding factor longer term but because valuations are historically so high, along with margin debt, it might only take an modest amount of monetary and fiscal tightening to create a big market decline. If earnings don't implode, once the market sniffs out the end game to the Fed's tightening, things will settle down and the bull market can resume. I can't give the bulls the benefit of the doubt on that. At best, it would appear that a drawn out trading range can hope for during the next 6-9 months. It seems probable we will see something worse. There was too much excesses last year, more so than I had orignally thought. This chart of global fund flows is scary. It seems unlikely this can be unwound without a major correction if not crash. Look at that last peak  in 2018 which was a bad year.  

The latest rotation of value into growth has been quite vicious lately. Last year we had a back and forth market between value and growth and they basically preformed the same. This year value is clearly ahead so far. Is the back and forth rotation from value to growth indicative of a changing of a the guard wherby value will become the dominant style? It sure that way. There's a lot of evidence that suggests it could be value's time to shine. For about the past 10 years growth has trounched value, with about double the peformance. The last time growth had such a dominance was in 1990s, from 1995-2000 in particular culminating in blow-off peak of the dot com mania. We very well could have whitnessed a blow-off COVID mania with disruptor/unicorn tech stocks and crypto being the bubble that burst. 

You can see that the recent value outpreformance last year was a headfake but now it's threatening to break out to the upside. You can also see how back in 2000 a similar pattern occured. Energy and commodities were the largest drivers of the value back then. Will they be again this time?  We know the narrative for Energy i.e. oil and gas has been one of secular decline due to the rise of electric veichles but we have shunned energy development for so long and now it's payback. In the ST however it does appear that chasing energy here is not prudent as others appear to be doing right now. Bullish sentiment on energy is quite high. DSI for crude is 92.  OPEC is expected to increase supply in Feburary and gas inventories are high. 

Bottom line is that I am officially market agnostic if not bearish for this year. I will not be giving the bulls the benefit of the doubt which means I will be tactical and not just stay the course when the market hits overbought conditons. The market sure looks sickly at this moment. Let's see if sentiment surveys and fund flows tommorow finally show signs of capitulation. Tech earnings are slated in the comming weeks. If we finally get some capitulation and energy prices back off we could get a nice snap back rally.  The only reason I'm not outright bearish is because we still did not get all the classic signs of a secular bull market top which is inverted yield curve, investor greed and rosy optimism in general. This makes me think that no matter how bad this year gets, it may be salvagable and just turn out to be another nasty correction in an ongoing bull market but I'm not holding my breath on that.  

Poor sentiment positioning hampering the market. Expecting more ST downside

Comming into the end of the year there was a massive $25Bweekly inflow into equity funds. After this week's decline you would figure that sentiment would have turned negative, but no. Another weekly inflow. Not as big but a solid $9B. This is not good. It shows too much hope. NAAIM is another indicator showing way too much bullishness given the poor market action. I also was expecting it to go down this week but instread climbed to 89% long. That made me cringe. Only AAII sentiment ticked down. Put/call ratio is also starting to perk up but all in all, there's not enough pessimism to mark a low here in my opinon. 

Expecations are tempered for 2022

The market was able to shake off Omicron and inflation fears in December and closed a little bit off all time highs. It was a strong showing in 2021 being one of the lowest volatity years on record. Pullbacks were all shallow being no more than 5%. 1995 was the closest resemblance. Earlier in the year I was getting concerned with the speculative fevor going on in certain parts of the market namely in the unprofitable/unicorn tech space aka the ARRK stocks and meme stocks. These were signs of euphoria which is what you see near major market peaks. The bitcoin frenzy was also a sign.  In March I made the comparison of the run up leading to the dot com mania peak and what we were seeing at the time. There were clearly some notable similiaries but differences as well. The bears were only focusing on the former of course. But the market did something that was rather remarkable.The undoing of the eurphoria in the speculative sections of the market did not spill over to the broad market. By mid year the high flying tech space tanked with a vengence while the board market simply carried on making new highs. The NASDAQ did lag slighly but not even the biggest bulls out there like Tom Lee expected the NASDAQ to have held up so well. .Throughtout 2021 New covid waves,  inflation fears, Fed tapering and tighting have all put a damper on sentiment. The strong US dollar was also a surprise to many but not to me as I pointed out in early 2021 how bearish sentiment towards the dollar was extreme. 2021 was also characterized by vicious rotations from growth the value and vice versa. Lots of active managers/traders got chewed up by this and so even though 2021 was a bengin year when it came to volatility, that was only the case if you did nothing but held the market index the entire way...and as often  is the case, that's the best way to go in a bull market. Hedge funds and active manages as a whole once again underpformed the SPX. Think about all the stress, time and effort that goes into managing a hedge fund only to realize that come the end of the year you did worse than a lay investor who simply bought the market and did nothing else. 

Comming into 2022 expecations are clearly tempered with the Fed set to taper and raise rates 3 times and fiscal stimulus set to downshift. There's also a lot of complaining/worry about how the breadth of the market is poor. I'm not going to go into great detail but suffice to say that not all measures of breadth are poor such as the equal weighted SPX which returned just about the same as the cap weighted SPX. It surely feels like investors have their guard up. "How long can these good times in the market continue?" is the question that's on everyone's mind including mine. But you see, this is why the market continues to surprise people on the upside - low expecations. It's been this way for the most part since the bull market began in 2009. Along the way there were a few times where expecations becaome too complacent which then led to corrections and these corrections ended up re-reseting expecations quickly back to pessimistic again thus allowing the bull market to resume. I believe the reason why expectations are so easily able to revert back to pessimsism is because there is an ingrained disbelief in the bull market and/or a fear another a major crash like 2008. Many of today's investors have scars from 2008 and 2000. We can now add the Covid crash of 2020 to this list.  I also get the sense that even most of those who have generally been bullish have a sort of "one foot out the door" type mentality. I include myself as one of these people. I'm sure more investrors are asking themsleves "how long can this go on for"" as opposed to "I wonder how much money am I going to make this year".  

We know from history that the stock market doesn't get into big trouble untill monetary and fiscal condtions get tight while co-inciding with historically optimistic sentiment or at the very least complacency.  We are going to enter a period where monentary and fiscal are going to get tighter but would still be classified as easy. Everyone is expecting these tightenings and so there's no suprise factor here unless the tigheninings become greater than what's expected. Lots of people are also concerned about a possible policy error. Therefore, all of this "taking away of the punch bowl"  should be priced in and it would appear to me that the market is more inclined to  re-rate bullishly rather than bearishly. So long as interest rates across the board are historically low and corporate earnings solider on, the market should remain generally boyant. Dips/corrections will happen no dobut, but they should be just noise unless there's a major negative surprise. Inflation is poised to decelerate this year simply due to base effects alone but also due to declining commodity prices and hopefully this latest Covid wave will be last major one. It appears that it could be the case given the weaker strain of Omnicrom. It's also encouraing that most governments around the world are finally accepting the notion that Covid is something that we may have to live with forever and that draconian lockdowns and quarentines are not the solution. This should lead to less workforce shortages going forward which was a major contributing factor to inflaiton in certain goods and services. 

A potential achiles heel for the market at some point could be the crypto space which hardly anyone expects to be a risk for the broader economy. I continue to be a skeptic and the question I'm asking myself is how much of a misalloaction of captial has gone towards this space and how bad will the fallout be now that instituional money has gotten involved? The dot com implosion ultimatley led to a reccession in the economy. Has cyrpto infected the broader economy large enough to take it down should it implode? This is an important question I need an answer to because I believe the jig may be up for crypto. 

Market destroys bears....again

It's been a relentless rise as the market keeps making fresh all time high after all time high. In my last post I suggested that pullbacks would be shallow...what pullbacks? It's been nothing but pain for bears who got trapped shorting that first big rally from the bottom in early October. So now what? Well, pretty much all short term indicators are redlining here which suggests at the very least that the market is due for an immanent rest but I suspect that rest will be relatively shallow and short lived and we close out the year at a high. We'll see. I reserve the right to change my mind if evidence suggests doing so. I've sold almost all my energy holdings at this point. We'll see if I end up regretting that. 

So what's causing this rip higher in the market? I think the market is sensing peak inflation here. Remember, inflation scares are what caused bond yields and energy prices to spike and markets to sell-off in September. Now we've recovered all those losses and then some. Freight rates have rolled over energy prices have stabilized and are are possibly rolling over,  and there are early indications that some supply chain bottlenecks are starting to subside. I read how Ford and some others have reported that chip shortages are easing.  The big bad tapering event this week turned out to be a non-event which caused further FOMO capitulation. 

The key to this market all year has been to avoid chasing/embracing the narrative of the day. In my last post I mentioned how financials and energy were being chased and therefore due to underperform. That has certainty been the case. Growth and US stocks have resumed their dominance since mid May. For many months Ken Fisher has suggested that the COVID decline was a large correction in the bull market that started in 2009 and therefore the sectors/factors that were leading prior to COVID should eventually resume their leadership. It looks like he's going to be proven right especially if inflation pressures subside and we get back to low but stead growth in the coming months which seems poised to happen. The huge fiscal boost we've gotten during the past 2 years is set to subside significantly next year. 

So, the big question is, how does this all end? When will the next big bad bear market happen? What we've been missing is the full embracing of the bull market at a time when monetary and fiscal conditions are unfavorable. We've seen some instances over the years where froth was apparent like earlier this year, but then we would get a shakeout that washed out the froth and revert it back to pessimism/skepticism. I don't know what it will take for us to get the ultimate peak but there's certainly some late bull market stage indicators out there. Margin debt levels, the  high level of quit rates for example. Will next year's fiscal drag be the trigger to cause a bear market or at the very least a 20%+ correction?  Stay tuned ad stay vigilant...