All eyes on Jackass Hole

Yes, I said Jackass Hole...more on that later. First off, so much for the yen carry trade meltdown. I thought the yen carry trade was such a big driver of US stocks for the past x number of years? Hyperbole just like I said. The market has recovered all the losses from a couple weeks ago and is closing in on the previous all time high. At the lows we saw excesses get purged as I had pointed out. Sentiment had been sufficiently reset for a solid low,  but now with this V shaped move, some excesses have quickly built up again. Put/call ratio these past few days have collapsed back to the complacent levels seen at the July peak. Apparently the CTAs are slated to be buyers over the next few weeks whatever the market does lol. There's guys are hilarious. They puked everything near the bottom and now buying it back 10% higher. AAII sentiment released this morning shows 2:1 bull to bear ratio, the same as where it was in mid July. NAAIM exposure which had dipped back to 56 last week is back up to 75% - not extreme but notably higher. So, all in all, the ST condition of the market is now stretched. However, having said that, there are some ST-medium term sentiment resets which still have ample room to unwind further. Fear/Greed index sits only at 54 for one. Hedge fund and mutual fund positioning had a significant unwind in tech stocks which is still in place.  I read an article on marketwatch which says tech stocks make up 16% of hedge funds portfolio. Compare that to the S&P 500 which has a 30% weight, it seems modest. Apples to oranges you might say. Fair enough, but what about this:  According to Goldman, US mutual funds are the most underweight tech stocks in 10 years. When the Mag 7 were getting hit a few weeks back, I saw a lot of chatter about how the AI bubble may have popped citing the same concerns I had listed in my July post.  That to me is a sign that such concerns will end up being premature at the least or wrong at the most. You see, when a bubble truly bursts you tend not to see major bubble-pop proclaiming come out until after major damage had been done i.e. 40-50% type damage. I had estimated in July that we could have up to another 9 months before the AI party would be over. As I had mentioned, the major thing missing to flag a major peak in AI is a flurry of IPOs. It would appear that the recent rout in tech was simply a reset from a very overbought condition. We shall see...

So, the main event at Jackass Hole is tomorrow. Expectations appear to be high for Powel to deliver a dovish message. The market is clearly expecting rate cuts to start in Sept which is pretty much a lock. So, what's the expectation? Are we primed for a sell the news reaction if Powel hints that only a 25 bps cut is in the cards? I know there's folks out there who want to hear that Powell is willing to consider 50 bp rate cut. The futures markets is currently pricing in only about a 30% chance of this happening but futures markets can be fickle. A couple of weeks ago I believe this percentage was around 80% but don't quote me on that. Given the ST overbought conditions of the market, ir would not surprise me to see a knee jerk decline post Jackass Hole, especially if Powell delivers only a mildly dovish tone.  

The obsession with the Fed dates back to at least 1998 when they did emergergy rate cuts in response to the LTCM debacle. Given all the crises that we've seen since then, the Fed has been viewed as this omnipotent force that pulls all the strings of the market. "Don't fight the Fed" is a mantra that's ingrained into everyone's psyche. Well, if you look at history there's times when this has turned out to be true and other times where is hasn't. 2023 was a great example of how fighting the Fed by being bullish was the right move as they were still hiking rates. 2001-2002 was another time when fighting the Fed was the right move by being bearish as they cut rates aggressively. Never blindly follow popular Wall Street adages. Context matters and markets are not meant to be so obvious otherwise we would see a far greater percentage of active managers beat the market. I clearly remember in Jan 2001 how CNBC was celebrating the Fed's first rate cut which was 50bps. They showed a statistic that the market was always higher 1 year following such a rate cut except for 1929. At that time I was a bear and I remember thinking "and what happened in 1929? It was the bursting of a stock market bubble, the same was this time!"

So, what is the context of rate cuts this time? I know there are some people hopeful about it but I also  see plenty of people showing an ominous chart of when rate cuts have started from elevated levels like this i.e. 2001 and 2008. Once again, people are just blindly adhering to analogs without taking context into consideration. The rate cuts in 2001 and 2008 were a response to a clear deterioration in the economy. This time around, the rate cuts are slated to be in response to clear deuteriation in the rate of inflation - an inflation episode which had been the result of a pandemic rather than structural issues. The economy, while having slowed is still healthy. Of course, this can certainly take a turn for the worse but as it stands now you can't argue that the US economy is showing deterioration comparable to that of early 2001 and early 2008. You can't argue that the consumers and/or businesses are as levered as they were back then either...not even close. You can't argue that credit spreads were blowing out as they were back then either. Again, I'm aware that things can change rather quickly but as it stands now, the situation we are in is not comparable to 2001 or 2008. The one thing you can argue is that valuations are historically high on some traditional measures, but that in of itself is not a predictor of major market peaks. But isn't the Fed behind the curve? Yes they are, but it doesn't matter as much as people are making it out to be. The bond market is doing some of the heavy lifting of the Fed already as long rates have declined notably in anticipation of lower short rates.  

Inflation subsided naturally, not because of the Fed. I've stated this ad nauseum for the past 2 years that this would be the case. As I predicted in my Inspector Gadget Fed post back in 2022, everyone is giving praise to the Fed for squashing inflation when in reality it was natural market forces that did the heavy lifting. In the US, rate hikes took place at a time when a lot of debt was termed out and generally speaking rate hikes can have conflicting effects on inflation because on the one hand it can crimp loan demand but on the other hand it can stifle supply as it raises the cost of capital, which in turn can raise the cost of goods and services and it also creates more money in the form of higher interest payments to savers. Since the inflation episode we had was largely due to a supply shock I would argue that hiking rates probably did more harm than good when it came of fighting inflation given its impact on supply side of the equation. I have argued that consumption is stable and generally inelastic and so hiking rates would have limited impact on it,. I was correct and yet it was the consumer that the Fed was targeting with their hikes. Deep down they were thinking "hopefully the rate hikes will create some unemployment which would cool off inflation".  A naive and hopeless notion, which did nothing to address the actual cause of the inflation which was the supply side shock. Anyhow I digress. 

Bottom line here is that this market is likely going to be in highly emotional state for the next few months given the inflection point in monetary policy. The narrative can easily go from "rate hikes are good" to "rate hikes are bad" to explain why the market is going up or down because everyone is so Fed obsessed. Add to the mix the election clown show that awaits us and the dreaded months of September and October. But at the end of the day, it's all about earnings.  Are earnings going to be in tact? That's what matters and that's the main question one should focus on. So long as they are slated to remain in tact or improve, everything else will be just noise, as scary as the action may get. I know that can be difficult to have faith in when you're actually in the midst of bad market action because I know I myself always can't help but have doubts. This is one reason why I do these posts as I can look back to see what my logical/intuitive brains was thinking when my emotional/privative brain starts flaring up. If the market starts declining from here, I bet you're gonna get lots of fretting about a dreaded double top.  Let's see how things play out....

Japanese contagion

No shortage of drama in the markets as of late. Adding to the growth scare I had discussed, we have seen a meltdown in the Japanese stock market, down 12% last night. Apparently this has been fueled by the unwind of the yen carry trade which will had spill over effects to global markets. The narrative basically goes like this: investors had been borrowing in Japanese Yen at 0% for years and had re-invested this money globally to take advantage of higher rates. This trade will work so long as the value of the Yen stays the same or declines. For the past 3 years the Yen has been in a steady decline and so this trade was a a huge money maker, but in the past 4 weeks the Yen has had a surge due to the BOJ raising rates from, get this,  0.1% to 0.25%. LOL!  But I believe that expectations for the US Fed to cut rates imminently after that weak July jobs number fueled the fire even further and may be the bigger factor. As crowded as this carry trade may have been, I have serious doubts that it was one of the main things underpinning the run in US stocks which is is a narrative that I'm seeing. Sure seems like the unwinding of this carry trade is a lot of hyperbole to me. And if this carry trade was being used to buy global assets, i.e. US assets, why is it that the Japanese stock market got hit the hardest? Beware taking market narratives at face value. 

The VIX tagged 65 this morning. Wow.  You got to back to the depths of the COVID panic to find a similar spike and before that, the depths of  the GFC. So far the markets have clawed back a lot of the initial morning losses but I won’t hold my breath . I mentioned the unwinding of the excesses in my previous post. Well, today should pretty much rinse out all the excesses. Fear greed hit 18, put/call ratio has surged and the VIX has moonshoted. The weak handed momo types are now flushed out for sure after today.  Lots of people crying for an emergency Fed rate cut. Not sure to make of that, as this. On one hand it could provide a psychological boost as most investors are monetarist zombies and Fed is indeed behind the curve right now. On the other hand, if this sell-off is being fueled by the carry trade unwind, cutting rates would make it theoretically put more pressure on the yen carry trade unwind as it would lower the value of the US dollar (at least initially). The solution IMO, would be for the BOJ announcing some sort to intervention or signal to calm the market.   

In my July post I mentioned that I believed we were late cycle in this bull run but not done yet. If I'm wrong about this and July was in fact the top, then there will likely be another rebound still left whereby the market retests the recent high or comes close to it. Coming into 2018 was a time which I had warned about the complacent condition of the market. The market had a sharp drop in February but then  eventually recovered all the losses by the summer, then the market eventually rolled over in the fall and made new lows by the end of the year. In August 2007 the market had shown the first major crack which ultimately led to the GFC. This is when Cramer famously has his "they know nothing" rant. But by October the market recovered all the losses and actually made an all time high before peaking for good. So, my point is that it's likely that if a major correction or bear market is in the cards, the market would likely still give you a better opportunity to exit as tops usually take a lot of time to form. In my opinion, we did not see enough conditions met for a major top and this current decline appears to be a correction, but as I said, I think we are late in the cycle and so I'm open minded to the possibility that I could be wrong and that we are in the process of forming a major top. 

Growth Scare

The market has taken quite a pounding late last week thanks to a "growth scare" that has now gripped the latest narrative with the latest news piece being the weaker than expected July jobs report.  Coming into the year we had expectations for 6 rate cuts which by end of April got revised to 1 or 0. At the time I had suggested the pendulum had swung too far given such low expectations. Now, not only is a rate cut a lock in September but the market is pricing in a 75% chance of a 50bps cut! What a manic depressive market.  The uptick in the unemployment rate has triggered a recession call as per the  SAHM rule and so now the "R word" is now back on the table further fueled by fears that the Fed is behind the curve. First of all, the uptick in the unemployment rate as of late is coming off all time historical lows, and at 4.3%, is still quite low. Higher labor force participation rates and to a smaller extent the impact of Hurricane Beryl are at least partially responsible for the uptick. If you look at announced monthly layoffs you will see that they have actually been declining and remain near historical lows and so it would be more alarming if the rise in unemployment was due to job cuts. So, yes, there has been less hiring for new jobs but there hasn't been a massive wave of layoffs either.  Anytime the SAHM rule had a successful recession call it was accompanied by a significant rise in layoffs. The leading indicator of layoffs is corporate profitability which is currently quite healthy. Absent a shock of some sort, economic growth should just ebb and flow.  One might argue that we may soon feel the effects of the Fed rate hike campaign and therefore the shock is immanent. The bears will say that it took longer than most expected but now we are about to get the reckoning. I just don't see the evidence of that. In Canada, yes, this is a valid concern as a massive wave of mortgage renewals are coming in the next 2 years, but in the US, debt was termed out by the majority of home owners and large corporations in 2020/21. There is stress in commercial estate market no doubt. Could that end up being a shock? Perhaps, but I have my doubts that this is a big enough problem to derail the economy....I will definitely need to look into this further. But so far as what the evidence says right now, recession fears are premature in my opinion. 

Let's discuss tactical. In my previous post I warned about the precarious positioning that was in place. The usual cadre of momentum chasing, sheep traders/investors were all in on the market by mid July. These weak handed folks were only long because they chase momentum and so once the tide turns these "savvy traders" will puke their positions en masse and this is what happened. On Friday, the VIX just about tagged 30 , fear greed index hit a low of 24, the put/call ratio  hit an intra-day high of 1.46 before settling down to 1.16. These are the types of things you see near a ST low. Given the extent of the excesses we had prior to the recent peak, it could take more time before the market can regain its footing, but there's enough evidence to suggest that most of or perhaps even all of the damage is done. The last time we had a VIX this high was during the depths of the 2023 "banking crisis". Last year at this time we had a similar situation with the market. Recession fears were palpable and the market didn't ultimately bottom until October. Maybe we see that again, maybe not. Beware of using analogs because they rarely work.

I got this chart from Twitter posted by Tier1 Alpha which stated "Our Systematic Positioning index, which tracks Vol Control, CTA, and Risk Parity strategies, just crashed to the lowest level since late 2023. So, with just a mild pullback of about 6% with the SPX still up 13% YTD, these folks are now at a YTD low in exposure. That's a significant reset. Yes, exposure has room to decline further but it has already declined by such a large amount, disproportionate to the 6% pullback in the market. I've read somewhere that CTAs are slated to continue selling a lot more for the next 2-3 weeks. If that's the case, it would suggest that a lower low could be in the cards or that the market would need time to consolidate even if the low has been made. It's just one indicator mind you, so don't hang your hat on this alone.

Let's forget about all the narratives for a moment. In any given year, the market has 5-6% corrections about 3.5 times on average, and a 10% correction 1 time on average. This is now the 2nd 5-6% correction for the year and the market is still up 13% YTD and so there's nothing out of the ordinary happening so far this year. Meanwhile the VIX spiked to 30, fear/greed hit 24 and CTA's are already running for the hills. Let's see when NAAIM and AAII sentiment stats get released on Thursday but so far the evidence from pure sentiment/positioning perspective suggests this is a bull market pullback which has had enough of a sentiment reset already to establish a bottom or be in the vicinity of one.

Warning signs

It's been a while I know. Trump assassination attempt and now Biden stepping down...wow. Both these events are once in a lifetime type shit and they happened in just over a week.  Since my last post the market has chugged higher with only minor pullbacks and we are in the midst of a pullback now. I'm seeing some things that are worrisome for the market. This whole AI driven run feels to me to be over hyped or at the very least, more than discounted in the short to medium term. First of all, just look at the charts of these stocks - they are parabolic. Using my "waking up from a 5 year coma" perspective, if  I saw a chart of NVDA it would scream bubble to me...or at the very least very overextended. The brother -in-law and client of my branch manager, a person who is known to do the wrong thing at the wrong time when it comes to getting in and out of the market, had inquired about AI funds recently. I mean Jesus Christ, where were you a year ago? Hiding in cash is where. I just read a really good report issued by Goldman Sachs in late June which discussed the AI boom via interviews with some of Goldman's highly ranked analysts and a professor from MIT.  It provided both positive and skeptical points of view. The main points of the skepticals are that there's been a lot of spend and not much to show for in terms of a return on investment and there doesn't appear that this is going to change anytime soon. AI is costly to implement and yet there's no "killer app" which is going to move the needle significantly enough to justify the investment generally speaking. Whatever automation benefits AI does currently provide is simply not enough to justify the high cost since AI is not capable of doing complex tasks. Replacing just the simple tasks using AI doesn't move the needle much given the costs.  The optimists will counter that AI costs will decline over time just like all new tech innovations tend to and that AI will be able to ultimately replace 25% of all work tasks, but even they concede that this is not expected to happen anytime soon and that currently it's a story of "if you built it, they will come".  I side with the skeptics on this AI debate. So far it's been primarily the picks and shovels companies who have benefited i.e. the NVDAs of the world. But it seems to me that it's just a matter of when not if, all of this AI spend peaks and then declines as companies who have been investing in this realize that the return on investment is just not there. There has been a big case of FOMO with AI spending and it appear that many firms don't even have a gameplan on how to incorporate it. There's also the risk of AI backfiring in some cases as companies try to incorporate automation too quickly or incorrectly as they feel pressured to do something with it. Lot of people, even one of the skeptics in this GS report, think that there's still a ways to go before we see the "bubble bust" for these picks and shovel companies. I don't share that notion. Based purely on the duration and intensity on the hype, my gut instincts tells me the end game is coming sooner rather than latter - within the next 9 months is my best guess.  

According to the Economist,  MSFT, AMZN, META and GOOG plan on spending $200B in AI this year which is 45% more than 2030 which itself was a huge spend. Venture capital firms have been tripping over themselves investing in AI start ups - they invested $27B in Q2 alone. The last time there was a frenzy like this was with blockchain companies back in 2021....and how did that go? What is the killer app for blockchain? Shitcoins? The hype was similar to AI now. What's missing to mark a peak is an AI IPO frenzy but I suspect that's coming soon. 

There's other things that were and are bothering me about the market from a short term point of view. There's been a lot of FOMO in general from market traders similar to that of last year at this time. Once again CTAs had piled in to the long side like lemmings just prior to this recent pull back.  Put/call ratios had finally given up the ghost as well. Remember how I have been saying for quite some time how they were elevated? Not any more. Fund flows have spiked including those that bet on bullish leveraged ETFs. 

This chart would suggest an ominous bull market killing euphoria but it's only one indicator. Also, it could end up being the case that the peak happens at a significant higher high as was the case in late 2021. 

The put/call ratio while showing low readings recently is not at the extreme lows we saw in 2020/2021. So, it could very well be the case that we saw a ST peak, not the bull market peak. 

And then there's the BofA bull bear indicator. If I was forced to only follow one market timing indicator, it would be this. It is currently at 6.5 which is the high side of neutral. Bull market peaks or severe corrections of 15%+ have not occurred until we saw a reading of at least 8 and we are one surge away from that.  We can still however get 5-10% corrections at current readings or lower as was the case last year and so for now, it's suggesting no greater downside than that.  

AAII investors allocation to equities has just broke above 70% in June which is where the market tends to run into trouble. The last time it broke 70 was March 2021 and it hovered there until the market peak of Nov 2021 and so although the market didn't peak right way when it broke 70, it was a signal that the bull market run was much closer to the end than the beginning. 

So, all in all it would appear to me we are in inning 6-7 of this bull run. There is still room for one last euphoric push higher before the year is over. Perhaps that happens once the Fed starts cutting rates. Everyone is such a monetarist "zombie" to borrow a term from Mike Norman. Most seem to think that monetary policy is the end all and be all of the market. They were largely incorrect in being bearish as the Fed raised rates and they may very turn out to be incorrect again if rate cuts are celebrated as an "all clear" to buy stocks. Initially, yes, Fed rate hikes were bad for the market but the market essentially bottomed in June of 2022 (October was slight lower low) when the bulk of the rate hikes still lied ahead. 

I suspect there's still a significant amount of money on the sidelines still clinging to their 5% HISA/T-bills who are on the verge of capitulating and getting back into the market. Rate cuts would be the trigger to squeeze out a lot of these folks. I know I'm getting quite ahead of myself here. As always, I defer to the indicators but I will say that for the first time in quite some time, I'm getting worried about the market.

In my next post I'll discuss what may be a possible regime change that is immanent. 

Better to be lucky than good

It's  been quite a while since my last post. I've been busy with work and still am but I got some time now to do a post. 10 years ago to this very day, April 28th 2014,  Greenstar announced there would be a delay in filling their year end financials and so began the chain of events that led me to where I am now. Greenstar ended up being a fraud and I had made the foolish move of putting pretty much all my eggs in one basket. This loss ended my 6 year stint as a full time private investor. It forced me to find a "real job" in order to support my family.  Having not had a real job for so long, I had to start by taking a job that was well beneath my capabilities. I built my way back up but there were still ups and downs, My 2nd job was a nice upgrade but was still below my potential.Then I got offered a job with a firm that promised me the world but ended up pulling the wool over my eyes and I was basically forced to leave which placed me back to square 1 without a job, but the ironic thing about this was that I had made the connection with the firm I am with now as a result of working with that clown show of a company I left. I could not have landed in a better place. Literally. The people, the opportunities, the location were all I could have hoped for. It started off slowly but now, after 6 years with this firm, I'm in a really good spot - far better than I likely would have been had I never invested in Greenstar  (I ended up recouping my losses in Greenstar by the way, thanks mainly to my big score in Foran mining stock).  I’m now in a position where I can be effectively be a private investor again and have a good "real job" at the same time. It's amazing how in life, a single incident can dramatically shape the course of your entire life. Was I lucky? You bet your ass I was. Yes, I did make the most of  the opportunities but I'm not ashamed to admit that luck was just as big a factor if not bigger. 

Things were already looking good coming into this year but now I've had even more good luck come my way. ..so much so that it's making me fearful that I'm overdue for some bad luck!  I'm also feeling a bit guilty about this luck...let me explain. There was this advisor at our branch who recently had to retire because of long COVID symptoms and so he had to give up his book of clients and decided to transfer them to my partner and I. We  had  a zoom meeting with him to discuss his key clients and we were expecting him to mention something about compensation for him handing over his book of business, but it never came up! He ended the meeting by wishing us all the best and thanking us for handling his clients. It's been 4 weeks since and no follow ups from him mentioning compensation. I know he had a liking to my partner because my partner had helped him with any tech and admin issues. He is a young guy and so perhaps he gave the clients to him as a opportunity to get ahead in his career.  There is now another advisor who had to retire due to illness which apparently has taken a major turn for the worse as she will now be in hospice care. We were given the opportunity to acquire her clients and we were supposed to have a meeting with her to discuss compensation but she has now apparently fallen terminally ill and so this is no longer possible. We will likely either get her clients for free or pay a fire sale price for them. So as you can see, I can't help but feel giddy and guilty at the same time as I have been benefiting from the demise of others.

When I look back at my life, I can see how I was blessed with so much good luck in general. There were moments when I was on the brink of the abyss both from a personal and financial perspective but somehow, someway I would get rescued, often just in the nick of time, like if you're on a highway and you are about to miss getting off at an important exit but you manage to squeeze in at the last second.  It makes me shiver thinking about my good fortune and it makes me paranoid to even share this for the fear of jinxing it, although I don't think anyone even reads this blog! Yes of course, I will give myself some credit for being resilient during tough times and making the best of the opportunities but man, better to be lucky than good as the saying goes. However it would be even better to be lucky AND good.... and I can hope to be so. I will NOT get complacent and take things for granted, but I think I have somewhat of an imposter syndrome which has made me more anxious and less resilient that I used to be. I think part of it also has to do with the fact that I'm at an age now where I can't afford to fuck up again...I don't have the time to make a comeback.  

Ok let's talk markets. In my last post back in early January I said I was expecting some sort of consolidation but if I was going to be wrong it would be that the market simply marches higher relentlessly because of the new all time high effect. Well, I was right about being wrong! When an asset class makes a fresh all time high, especially after not having done so for quite some time, it tends to be be powerful signal leading to further, multiple new highs. That's what happened, but in doing do we got quite overheated from a technical and sentiment perspective much like what happened last summer before that 10% correction. CTAs and other momo trader types were pretty much all in and were even getting away with it for a few weeks, but the market finally cracked after rate cut hopes were once again dashed. Coming into this year there were great hopes for multiple rate cuts to start as early as March. Then they got pushed out to start June and now there's serious concerns that there won't be any rate cuts at all this year. It would seem that the pendulum has swung too far in the opposite direction now.  This latest market decline has CTA puking written all over it. Quite frankly, it's a necessary purging of these jokers and other weak hands who were reluctantly long the market only because momentum underpinned by rate cut hopes. 

The question I ask myself is was the market overheated from a longer term point of view when examining sentiment/positioning? The answer is no. As I said, ST sentiment did indeed get overheated similar to last summer which warrants a correction, but like I also said last summer,  LT sentiment did not reach a bullish extreme which suggests the bull run is not over.  Let's examine some interesting charts I came across which captures sentiment in different ways. 

This charts suggests we have likely hit an intermediate term top at the least, given how prior ones coincided with an upward spike like what we saw. Could it have signaled something more ominous? Perhaps but I don't think so. You can see that over time market peaks have been occurring at progressively higher levels and also, the L/S ratio has risen sharply only after having been in the doldrums for the better part of 2 years and look at how quickly is has declined now after the 5% pullback. 

This recent surge in optimism could suggest a ST/IT top but is not at LT top levels. Like with the previous chart, this burst in optimism is coming after prolonged depressed levels which is what you tend to see in the first half of a bull market advance, not the latter stages. 

 

Margin debt has only recently bottomed out and has had a moderate increase. LT tops have occured after major y-o-y surges as was the case in 2000, 2007 and 2021.

This unique twitter poll  is unconventional measure of sentiment. Sentiment was firmly bearish for better part of 2 years and only recently has switched to the bull camp, but only moderately so. It's still not at bullish extremes found at prior LT tops.    

IPOs have been in the doldrums for 2 years+  which is not what you see near a major market top. Apparently, IPOs are slated to make a comeback in Q2 but even if they do it would take some time before this metric gets overheated.  

Other notable mentions are the BofA bull bear indicator which got as high as 6.8 at the recent market peak and has subsequently dropped back to 5. Prior major market peaks happened when this indicator hit 8 +.  While 6.8 is on the high side, it's not extreme and its coming off a long period where it was at rock bottom lows. AAII sentiment has had multiple weeks of bulls greater than bears but it's coming off a record streak of bears outnumber bulls. Do you see the common theme here with the all the above indicators?  Most of them had a surge in bullishness but it's not extreme and it's coming off of a prolonged period  of deep bearish sentiment. That doesn't scream LT top to me and it's only natural to see bullish sentiment surge like this given that the market has been in a bull market for the past 18 months and has made new all time highs. This bullish surge warrants a correction/consolidation but the evidence suggests we haven't seen bull market killing euphoria yet.   

Chuck your biases and just do the opposite of dumb money

Back in April of last year I wrote this: 

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. 

I didn't see one single person on twitter or in the entire financial media make an observation along these lines. Instead, all you heard throughout 2023 were complaints about how the market was only being driven by 7 stocks (not entirely true) or warnings about the inverted yield curve, SAHM rule, or what have you. Instead of listening to the market, they resisted it.  I know a lot of people came into 2023 happy to just sit in cash and collect 5%. Ok, great. You made your 5% but you  missed out on 25%. And it wasn;t just the mag 7. There were plenty names in consumer discretionary and elsewhere that did well. European and Japanese stocks also had a great year. Now what will all these folks do if interest rates start getting cut while the market is making new all time highs? At first they will resist because the market is "too high"  but eventually they will do what they always do and find some rationalization to get back into the market.  Rates can't get cut with the market at all time highs you say? Think again. Look at 2019. Look at 1995. Look at the 1980s. Rates cuts aren't necessarily the result of a recession. If  it becomes painfully obvious that inflation has settled down - even in the 3% range rather than the 2% target  - the Fed can't justify keeping rates at 5.5%. Furthermore, if it turns out that 3% becomes the new floor, the Fed may eventually capitulate on their 2% target.  

Getting back to the coma observations; this is not the first time I wrote something like this. I did the same thing in 2011 when the market had a big scare and concluded that using the "waking up from a coma" perspective, it looked like  market may just be having a major pullback after having been so strong during the previous few years.  So, what would my outlook be now if I woke up from a 5 year coma and the first thing I did was look at the chart of the market? I would say that the market trend looks quite strong as it's on the verge of making new all time highs. I would say that based on experience, any asset price that makes a fresh new all time gives a powerful bullish signal which tends to lead to further new all time highs. I would also say though that the market is quite extended above its 200 DMA which leaves it vulnerable to a significant  pullback and/or sideways consolidation phase.. These appear to be 2 conflicting scenarios but not necessarily. It is possible, and likely in my opinion, that we see the latter happen before the former. If we don't get a pullback/consolidation and the market does go on to make all time highs, I suspect it will be a bull trap and not have legs....at least initially. That folks is my unbiased  "waking up from a coma" assessment. If I'm going to be wrong, I will likely be wrong in that the market simply marches higher relentlessly. because the all time high signal is quite powerful.

The market is currently doing what it does best which is frustrating both bull and bears a like by not budging much to the downside despite what appeared to be decent excuses to do so such as hotter than expected CPI. One thing I continue to notice is stubborn put buying. I pointed out in November how this was providing support to the market.  At some point these hedgers/speculators will throw in the towel and perhaps that's when the market will see some meaningful downside.  

I do want to reiterate something I stated in my previous post: Despite the notion of "soft landing", the vast majority of outlooks I have read by strategists and fund managers/are NOT embracing it. You can see it by the price targets, you can hear/read it it in their discussions. This once again sets the stage for the markets to surprise on the upside this year. But unlike last year, we entered this year quite overbought with overextended CTA positioning. The market had been up for rare 9 straight weeks and now that it's stalling you are starting to see people quote ominous stats about how the first 5 days of the year of Jan are negative it bodes ill for the market and if January is negative it's going to likely be a negative year. I for one will not give much consideration to this stat because the market had been so overbought to start it and I say this without having a bias. Quite the opposite actually. I'm taking context into consideration. In January of 2018 the market started off strongly and ended the month up solidly. That would have suggested a great year was in store....we all know how that played out. Again, you had to take context into consideration. Heading into 2018 we had a complacent "global synchronized growth" narrative and signs of froth with weed stocks and BTC going parabolic. 

I am not going to let me guard down, but the odds still favor another positive year based on what I'm seeing from a longer term sentiment perspective. I will show a few more charts next time which shows that the level of speculation/froth still has a ways to go before reaching bull market killing levels. 

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.