The burden of proof

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

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

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

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

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

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

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

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