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.