This rally feels different

We've had a pretty good run in the market for the past month and a half.  We had similar good rebounds twice before this year - one in the spring and one in the summer both of which obviously failed. This time around the rally feels different in some respects. First of all, everyone is calling it a bear market bounce and I don't see any "is this the bottom?" queries. Some sectors like financial and biotech are exhibiting the hallmarks of a bull market advance, namely a strong, relentless low vol  move and they have just broken above the August peak although barely. The other thing to note is how the Fed's latest attempts at jawboning the market down is not having the same amount of bite. Monday's decline was driven by comments from Bullard who's saying the Fed funds rate needs to go to 5-7% to fight inflation. With the 10 year yield trending down and comfortably below 4%, the bond market is giving the middle finger to this tough guy stance these Fed guys have.  The Fed's "we don't see any meaningful signs of inflation easing"  rhetoric is a farce. Maybe part of this talking down the market tactic has to do with the idiotic perception that the wealth effect of a stock market rally would add to inflation pressures. I nailed it when I compared the Feds to inspector Gadget. On Monday oil prices hit an  11 month low and went briefly NEGATIVE YTD  yet  "we don't see any meaningful signs of inflation easing". 5 Year break even rates have been down trending big time since April and currently stands  at 2.29% This is the market's average CPI expectation for the next 5 years. Historically, this has been an accurate measure of what the CPI actually ends up averaging over the next 5 years.. Yet "we don't see any meaningful signs of inflation easing". Idiots. 

Getting back to market action. Did you know that despite all the horrific macro developments in Europe all year,  European stocks are down only about 9-10% YTD? I don't hear ANYONE mentioning this. Whenever the market is quietly going against the narrative you ought to pay special attention. On October 20th I read a market pundit make this comment "don't expect anything but a bear market rally until the Fed pivots, inflation eases and war in Ukraine is over". The problem with acting on this belief is that by the time those things happen the market will probably be at or close to new all time highs.  The markets will anticipate, they will price in information. That doesn't mean it gets it right all the time, but that's what it does. The more you wait for certainty, the higher the price you will have to pay for it i.e. lower the returns you will get.  I mentioned something similar in the summer of 2020 as the pandemic was raging. And think about how the markets behaved earlier this year. Stocks and bonds sold off hard from Jan-March well before the Fed did its first rate hike. Markets will anticipate/price in things.  It will probably do the same going the other way. 

The market is going to face an important test. The last 2 times we had a run like this where it became ST/IT overbought it ultimately fell apart. Can the market consolidate this time and not totally fall apart? From a market action and sentiment/indicator perspective the chances of this look better than before. But what about the inverted yield curve and other ominous macro signs like rising layoffs which suggest immanent recession? They are surely a concern, but if the market can consolidate here before moving higher again, it would suggest that the market is expecting that any recession would be mild and better times lie ahead. How long could such a consolidation phase last for? Typically they take 1-3 months but it's very difficult to predict these types of wiggles in the market. The best we can do is use tactical indicators to help navigate. By the way, I have never seen such a unanimous call for a recession as I do now. This is not to say that since everyone is calling for one it won't happen, but rather that a recession is very likely priced into the market to some degree. If the market can consolidate and break out above August highs it would suggest that  he market is looking past any recession or that there won't be one at all. If it's the former, it would suggest the recession will be mild without any financial crisis. There's some good reasons to expect this to be the case. More on that in a future post. 

Bottom line is that the latest market action is encouraging  but by no means an all clear signal. Let's see how it handles the looming overbought condition. 

Crypto rant

Anyone reading this blog knows I've been a crypto skeptic for some time. This post I made in Feb 2021 says it all. This year we have seen the unravelling of crypto with the latest being the FTX fiasco.  Due to the lack of regulation, there's a ton of scams and leverage underpinning the entire crypto space which is coming to light. I doubt this unwinding is over.  BTC in its current form will end up going to 0 in the long run because it's fundamentally worthless - you can actually make the case that it has negative worth given the environmental damage it creates. Eventually people are going to wake up and question the lunacy of BTC.  How the fuck can people not see how utterly asinine and wasteful the process of  "mining"  bitcoin is? Even if you believe in the possibility of crypto having a value, clearly there must be a much better way to manage/maintain it than to waste an astronomical amount of energy like BTC does.  BTC is the top crypto by "market cap" simply because it the was first crypto invented, nothing more.  Regardless of the system that is used to maintain any crypto, they are worthless unless they are backed by something of actual value. You can't just simply create a "coin" out of thin air and it expect it hold any value aside from greater fool buying which eventually peters out. Mind you, this greater fool effect can go on for quite some time as it did for crypto, but now the jig is up because the last and biggest batch of fools - institutional money - joined in just before the last peak and subsequent crash. In order to revive crypto aside from short term bounces, you are going to need a fresh batch of  greater fools bigger than the last cohort of bag holders and that  probably doesn't exist. 

After the GFC many people had  resentment towards the Fed and governments given how it was handled which very much persists to this day. So, some person or group invented  BTC and basically said "we  have come up with an alternative currency free from any meddling by governments."  Such an idea could garner a cult-like appeal from anti-establishment sympathizers which it did. The other main appeal was the clever blockchain tech that underpinned BTC. Regardless of the appeal, BTC was able to capture the imaginations of people on an incredibly wide scale. It had more than a few crashes and recoveries along the way all of which led to new highs, but the only reason why BTC was able to recover to new highs was because it was able to recruit a fresh batch of greater fools larger than the previous batch. The last run to $60K was the result of the last and biggest batch of greater fools - institutional money. The collapse of FTX exposed some of these institutional investors such as the Ontario Teachers Pension Plan. How embarrassed and ashamed must they be? This latest fallout all but assures that institutional money will be sellers, not buyers from this point on. 

The bitcoin rise and fall is very similar to that of dot com stocks in mid-late 1990s.  When dot com stocks first started turning heads it was driven primarily by retail. The internet was hyped to be the next big thing set to revolutionize the world and the way to profit from this was to invest in dot com stocks. It didn't matter that most of these companies had no earnings or real business plan, the fact that they had dot com after their name was good enough as it  symbolized that they were part of the internet revolution.  Dot com was initially scoffed at and dismissed by the so called institutional investors,  but many under-estimated how long and how intense the frenzy was going to be. Some of these skeptical institutional folks shorted the dot com stocks only to get badly burned. By the time the bubble hit its peak the institutional money had capitulated and jumped on board because they simply couldn't afford to miss out anymore. Then, just like what happened with BTC and other crypto, they had to come up with rationalizations to buy. At the end of the day, it was FOMO and greed that did them.  The crytpo Superbowl commercials this year marked the pinnacle of the euphoria just like the dot com Superbowl commercials in 2000. Crypto will survive, but the days of  creating coins backed by nothing and expecting success are over. 

I can sympathize with the Fed haters and the notion of seeking an alternative to fiat currency. However, you can't just come up with a coin and say "hey everyone, let's start using this instead of the US dollar as an expression of our hatred of the system" and expect it to work long term. This type of  "expressionist"  investing also underpinned meme stocks.  Such a thing can't work long term without anything of true value underpinning it.  The only thing underpinning it is inflows from the herd.  The herd is fickle, it's unreliable, it has no obligation to be loyal and when the inflows stop and the price starts sagging, it's just a question of when not if, the heard is going to stop supporting it and move on.  But wait, aren't fiat currencies backed by nothing? No. There's a central authority that enforces it; that deems it to be legal tender and the only way to transact, pay taxes and settle debts in the country it represents (many countries also do business in US dollars). Therefore you are essentially FORCED to use fiat currency of the country you reside in or do business with, the same way you are forced to abide by the laws and regulations of that country.  Nobody is forced to use a crypto coin in any way.  The herd can easily move on from whatever coin is popular at the time to another coin or get turned off completely by crypto. A central authority on the other hand, is always going to be there enforcing that same fiat currency. Do authorities  abuse or misuse their powers? Of course; some more than others, but they provide stability and assurance which is critical. Central authorities also enforce laws and regulations which is obviously critical. Again, the system is not perfect but it's necessary to have a government enforcing certain things otherwise we would be  living in a jungle of chaos. And yes, I know there are plenty of countries in this world that have oppressive governments. It should be obvious that I'm referring to democratic governments and not regimes like North Korea.  

The argument that crypto's value is a reflection of the blockchain technology or anything along those lines is pure nonsense. Once again, this is expressionist investing.  Think about the Microsoft Excel program which creates spreadsheets (loosely analogous to blockchain which creates crypto). Cleary, the excel program has a worth as it creates spreadsheets which can be used to keep records, make calculations, ect., but what is the value of the spreadsheets it creates? Zero...with the exception of when it contains information that a person or entity may value, but even in such cases, it's the info not the  spreadsheet itself , that has the value. If Microsoft were to announce that all their excel programs would only be able to generate a combined lifetime total of 21 Million spreadsheets, would that then give these spreadsheets value? No. Because there are other companies that can generate unlimited spreadsheets. So you see, there's nothing special about a spreadsheet. 

Face ripper

We had an absolute face ripper of a rally last Thursday thanks to a better than expected CPI report. SPX up 5%, Naz up 7%. with no mercy to the bears as the market gapped up huge. Coming into the report the market was sagging and looking bleak. Given the last 2 disappointing monthly CPI reports expectations must have been quite low and bears were pressing. Lot's of folks talking about how good this report was and how it bodes well for the future but lots of folks were also talking about how bad last month's report was and how it boded ill. Suffice to say that one shouldn't get too excited or depressed about a single month's worth of data. I've been saying for a while that pipeline inflation pressures are collapsing in general, sure, some components will be stickier than others but overall it's clear that the trend for inflation is down. A great way to distill this is to track 5 year break even rates which has been hovering at around 2.5% for the past 4 months. I really like this indicator because it distills all the nuances of the CPI providing an outlook GOING FOWARD of what the average CPI will be for the next 5 years.  Meanwhile the bumbling, fumbling Fed keeps looking in the rear view mirror saying how they don't see inflation subsiding much. I suspect at some point in the next year or 2 there is going to be an overhaul in the Fed with respect to how they make forecasts as they will once again be made to look foolish. Mark my words. 

The market is just punishing everyone, whipsawing the shit out of both bulls and bears. Once again, read the motto of this blog and don't you ever forget it. So, is this latest rally yet another head fake? Most likely, but it could very well be part of a base building process if the bull case is playing out. I had given a target of SPX 4000-4100 for which we have hit the lower end of this range. The market could be forming a W type bottom, similar to what we saw in 2002 and 2011...obviously too early to know if that's the case as can only know in hindsight if that actually transpires. Take a look at the biotech index ETF BBH. The W bottom is much more pronounced here. This sector is one to keep on eye on as it's showing relative strength and not being talked about much.  Bears can easily make a good case that this is just another dead cat bounce but the fact that the market is now flat for the last 6 months is a big achievement given what has been an absolutely brutal macro backdrop. Keep an open mind. Nasdaq is showing early signs of decoupling from BTC. To me this is an important thing that needs to happen to suggest a true bottom is in. The market needs to shake itself off from the speculative crap of yesteryear. Meme stocks are another thing that needs to die but they are still showing correlation to the Nasdaq although they have been pounded quite hard and are not nearly getting the spot light as they once did. I'm going to make a post discussing crypto shortly. 

Let's talk indicators. Prior to this surge there were some indicators showing some extreme bearish sentiment, namely, put/call ratios and DSI. One surprising development was how AAII equity allocation declined to 61.5% and cash is at 2.5 year high at 22.5% in October which means AAII members sold into strength. At 61.5%, exposure is about as low as it was at the end of 2018, shortly after the market had decline 20% from the peak. This is a good contrarian development but I still think think this needs to come down a bit more. Other indicators were neutral such as NAAIM. Fund flows had reversed course flipping to negative for the week but only after having been positive for the 3 weeks prior. These latter 2 are now poised to jump to excessive optimism territory when next Thursday's readings come out assuming the market doesn't totally far apart by then. 

Let's talk more about positioning. Throughout 2022 the strongest case for the bears in regards to sentiment is positioning from investors. AAII allocation surveys have pointed out all year that  they are feeling very bearish but they haven't actually positioned their portfolios to reflect it,  having only grudgingly decreasing equity exposure. Market watchers are saying that we can't bottom until we see more capitulation. Well, here's another possibility that nobody is considering. What if the market hits a bottom and Investors sell into the strength early in the new bull market? As mentioned, AAII did sell into strength in October. If the market keeps rising and they keep selling they could  end up capitulating into strength rather than into weakness like everyone is expecting. It should be noted that AAII members also sold into July's rally but then bought back in August. And so here lies the problem of these kinds of sentiment indicators - they can flip flop and whipsaw you. What I've learned through out the years is that when a lot of market watchers are focusing on a particular indictor or strategy it will end up becoming less effective. 

Let's talk about the Ukraine war. When this war started about about 9 months ago, who could have predicted that Ukraine would been preforming so well and Russia so poorly? Nobody.  I have heard that Ukraine has obtained more stranded Russian weapons/equipment than what they are getting from NATO. Who could have predicted when the war broke out that that the price of oil and wheat would end up being being about the same as it was pre-war in November? Nobody, not even the most rose-coloured glasses wearing optimist. Oil was supposed to be at $200 by now. Granted, natural gas prices are notably higher but have come down substantially since September.  The bottom line is that so far the world has been able to cope and adjust to the loss of Russian and Ukrainian commodities. Sure, that could change, but then again it would appear that Russia is in terrible shape. In regards to the war they are  running out of ammo and troop moral must be rock bottom  and it was probably never good to start with. Meanwhile Ukraine is getting more supplies by the day and moral must be sky high after taking back Kherson. Russia is isolated from most of the world and have a poorly educated workforce to pick up the slack from all the skilled foreigners who have left and closed shop. It's seems like the walls are closing in on Putin quite fast, but perhaps that means he is going to do something desperate as a last ditch attempt to turn the tide. I don't know. But let's say the Russian regime as we know it collapses, Putin is ousted and Russia withdraws from Ukraine. That's gong to create another face ripper of a market rally and tank commodities. This is just me thinking out loud here. I won't be holding my breath for such a scenario to play out, but it sure looks like Russia's war effort is collapsing. We can't however get complacent because Putin is known for cranking up the brutality when things aren't going his way. The problem this time around though is that the Russian economy is isolated and crumbling and patience must be running thin. If he orders a nuclear strike, his generals may very well turn on him as they know the repercussions will be so severe including a fear for their own lives The Russian military authorities know they are absolutely no match for NATO, the US in particular. Once you play the nuclear card that gives license for NATO to do a full assault on Russia as they will do it the name of saving the world from a madman. 

Bottom line is that although this bounce is good and there's promising signs that inflation is showing deceleration in the rear view mirror CPI reports, it's way too early for bulls to declare any kind of victory. How can you tell when a new bull market has been born? It will most likely show up as via a relentless 2-3 month rally. 

Fed fatigue and seasonality

I meant to post sooner but I was busy and then I caught COVID. It was another crazy month. We went from a horrific September to a blissful October.  After my last post the market dipped back down as once again, any notion of a Fed pivot got shot down. As were were drifting near 52 week lows the notion of no fed pivot kept getting hammered into everyone's brains to the point where I was sensing that maybe we are getting to the point of Fed Fatigue i.e. an acceptance of no pivot. So if that's the case, I thought that maybe the market would get tired of going down over the same thing. The so called next shoe to drop according to the bears is for earnings to collapse and layoffs to spike. As earnings started rolling in that was simply not the case. Sure, there were some disappointments including some of the big tech names, but overall it has been a rather benign earnings season. Even though the tech giants AMZN, GOOG and MSFT had disappointing results and/or outlook banks and other companies have had good or OK results. This less than disastrous earnings season coupled with the so called bullish seasonality of the mid-term election cycle started the rally and when big tech earning disappointments last week couldn't take down the market, a lot of bears who positioned for the kill shit themselves and covered adding fuel to the fire. 

So now what? We have the widely expected 75 bps hike this coming week. Bears are counting on the Fed to piss all over this rally again, but this time around the set up is different as the market has not been rising on hopes of a Fed pivot and so even if the Fed reiterates this, it may not amount to much aside from a knee-jerk reaction. If the market fails to show any sustainable downside, it's going to embolden the bulls more and make the bearish shit themselves yet again. I could see the market ultimately going as high as SPX 4000-4100 on this latest rally. We'll see. The Bank of Canada hiked by only 50 bps last week which was taken by some as a pivot which is a bit of a stretch in my opinion. A true pivot is a clear indication that rates are going to at least stop rising in my opinion. People have been so desperate for a pivot that they are willing to count this less than expected hike as some sort of a quasi pivot; that perhaps the end of the rate hike cycle for Canada is getting close. I believe this too may have contributed to the positive market tone last week but not much.  

Despite all I've said, there's still problems with market action, namely, the fund flows continue to show FOMO. At the same time though, positioning from hedge funds and other measures like option activity shows bearish extremes that you see at major lows. I'm really struggling with these offsetting indicators. Therefore, I continue to believe that one be tactical. The tactical bullish call I made earlier this month is still in play although now the easy money has been made. If this rally ends up going to SPX 4000-4100 it will look a lot like a base-building bottoming scenario is in play. I would then expect more base building until March 2023. I'm clearly getting way ahead of myself but that's kind of how I see things unfolding IF the bull case is to play out.  By the way...Trader X once again mentioned earlier this month that it was not the time to start building long term positions.  Remember, he said the same thing in early July and in April 2000. Food for thought....

Critical Juncture

FYI most of this was written yesterday and an update to reflect today's action provided at the end. 

September was a brutal month with the SPX dropping 9%. Coming into Monday the market was in an acutely oversold condition with some notable extremes in pessimism. NAAIM for instance is at 13.6%. This is the lowest exposure since March 2020. DSI sentiment which is something I don't normally pay attention to unless it's an extreme  is currently single digits for both SPX and bonds. Over the weekend there was lots of chatter about an immanent major bank failure, Credit Suisse. in particular given the trading of their CDS swaps. The fear is that this will be the next Lehman moment. The US dollar strength has been a wrecking ball for global markets and you can just feel the global angst is reaching a crescendo. Surly the US Fed must now have some serious worries about this and are getting some pressure from foreign authorities to back down on their hawkish outlook

It looks like today's bounce is mainly a relief that the doomsday scenario did not pan out just yet, but obviously the market is still very much in a precarious position bouncing from a 52 week low. I've been saying  since July that if the bull case were to play out it would require base building. The other scenario obviously is the bear market still has a ways to go and it's quite conceivable this could be the case. Let's examine again the case for either side.  

Bull Case

We have seen multiple extremes in selling pressure and negative sentiment. Although there are some missing links, positioning shows extreme risk aversion that you typically see at major lows. The excesses of 2021 have been largely wiped out when you look at the unwinding of margin debt and the dearth of IPOs. Valuations although not historically cheap, are back to reasonable levels when you look at forward or trailing p/e.  The latest slide in the market has been largely self-inflicted by the Fed's unnecessary hawkish outlook which was been wrecking havoc on global financial markets given the parabolic rise in the US dollar. With pipeline inflation pressures collapsing and global stresses mounting, it gives the ability for the Fed to back down on their hawkishness at the very least. Doing so would bring much needed relief to the markets. Although earnings have been under pressure this year, they have not collapsed and since the main culprit of earnings pressure was inflation related, there will be relief when inflation pressures start subsiding which should happen soon although some sectors like retail might get hit because of inventory surpluses. The odds of Putin getting ousted are growing by day given the terrible results in the war and latest call for mobilization. The base case now is that we are in a recession and things are about to get worse. With expectations so low, it leaves the market ripe for an upward repricing. 

Bear Case

Although there are indicators showing extreme bearish sentiment and an unwinding of excesses, a very important holdout has been fund flows. We still have a long way to go to unwind all the inflows in 2021 which were still positive in the first couple of months of 2022. Fund flows were negative in September but only grudgingly so.  We have yet to have seen a 20+ billion weekly outflow.  AAII positioning also shows stubborn lack to capitulation with equity exposure at 63%. This should be at least in the mid 50's given all the damage. The crypto bubble has not been totally deflated as it still pretty much moves in lockstep with the Nasdaq. Bubble bursting typically result in 90%+ crashes. That implies BTC to $6000 as a long term target. Unlike in recent years, there is an alternative - TIAA.  Both short and long term GICs are providing rates not seen since 2000. We haven't felt the full impact of this interest rate shock as big hikes have only recently taken place and more is still to come and so even if we get a Fed pivot soon it will be too late. The yield curve inversion is quite entrenched and is set to go negative across all maturities if the Fed hikes another 75 bps in November. An inverted yield curve is a sign of immanent economic weakness, usually within the next 12 months. So even if we get a Fed pivot, at best it will result in only short to medium term relief. 

The Verdict

There's certainly enough evidence to suggest one be tactically bullish here, but nothing more. I'll repeat something that I've said a few times earlier in the year. For a bullish resolution to all this, we need to get to the point where the market sniffs out an end game to the rate hike cycle,  (i.e. the pivot) without there being too much damage to the economy. After the Fed's last meeting they poured cold water over any notion of a pivot coming any time soon however the subsequent market turmoil may have made them start to reconsider their hawkish plans. 

Update: 

The UN apparently has pleaded with the Fed to stop rate hikes given the havoc the strong US dollar is having on non-US economies. They confirmed the suspicions I had about the Fed coming under pressure from the global authorities to back down. Renewed Fed pivot hopes coupled with a still oversold market resulted in another strong bounce today. But even if we get a Fed pivot, will it be too late? And what kind of pivot, if any will it be? Any meaningful pivot would have to require the Fed to cancel any further hikes...at the very least one more hike and stopping. Bottom line is that the foundation for this bounce is shaky even though it has the potential to carry on longer. So long as we keep seeing crap like BTC, AMC, GME and BBBY surging every time the market is strong, it tells you that we haven't fully wrung out the excesses/stupidity of the prior cycle and so keep your guard up. More thoughts coming soon. 

Inspector Gadget Fed

No shortage of drama in this market. I called for a bounce in my last post which we got but it was very short lived and it's been nothing but pain since. The "poor" August inflation data was the trigger that started this latest shit show. The Fed's subsequent hike of 75 bps was expected, but it was the Fed's hawkish upward revision of rate hikes to 4.5-5% by March 2023 which cratered the markets. This outlook was no doubt fueled by the result of this single backward looking CPI report which is quite asinine. Meanwhile, the oil price, one of the main culprits of the inflation problem, has just about given up all its gains YTD.  Several other commodity prices and many other inflation pressure points have been abating since June as well.. One of the things the Fed cited as a concern was shelter costs but that too has rolled over, it just hasn't showed up in the data yet. The pipeline inflation pressures are clearly collapsing. 5 Year break even rates which is probably one of the best forward looking indicators peaked in April at 3.41%  and is making new lows almost  daily currently at 2.19%. back to normalized levels which is so significant but of course, the Fed doesn't seem to care. Instead they panicked over a single month's worth of rear view mirror inflation data. 

Here's the funny thing....interest policy won't do shit to move the needle in inflation the way most people seem to think it can. The obsession of the  Fed and interest rates reminds me of a cartoon I used to watch called Inspector Gadget who's job it was to thwart the evil schemes of the sinister Dr. Claw. When Gadget was assigned a case he was always accompanied by his niece Penny and her dog Brain. It was Penny and Brain secretly doing all the work to solve the case while Gadget was fumbling and bumbling chasing false clues often times interfering with the good work of  Penny and Brain. Near the end of each episode Gadget  just happens to be in the right place at the right time to get all the credit in foiling Dr. Claw when it was Penny and Brain all along who truly deserved the credit.  

Everyone seems to think that the Fed has the ability to reign in inflation via monetary policy because of the myth of how Paul Volker supposedly broke the back of inflation in 1982 by jacking up rates. I'd like to see how inflation would have  broke without the peak and subsequent long term decline in the oil price from 1982-1999 which was the result of the significant increase in the SUPPLY OF OIL spurred by significant new production from non-OPEC countries. Interest rates had fuck all to do with this. The mid-late 1940s had an episode of high inflation as a result of hampered supply which couldn't keep up with a surge in consumer spending post WW2. Sound familiar?  Inflation got as high as 18% in 1947. It eventually came down hard and by 1949 there was actually deflation of 2%. Surely the Fed had to jack up rates to break the back of this inflation right? Nope. Rates were rock bottom the whole time. T-bills were yielding less than 0.5% all through out the 1940s.   The economy eventually rebalanced on its own and perhaps was aided by government programs to restrict consumer borrowing which  directly targeted  demand for goods and supply of credit. Everyone points out the demand destruction that rate hikes can cause but nobody ever mentions or even realizes the impact to the supply side of the equation. Rate hikes increase the cost of capital which encourages prices hikes and makes capital investment to increase supply less attractive - both of which ADD to inflation pressures. 

Let's revisit the credit restrictions enacted in the late 1940s. In the US it was required that consumers  put down at least 33% for the purchase of household appliances and autos and must repay the balance within 12 months. At the time interest rates were very low as mentioned. Now, let's say that there had been no such borrowing restrictions but instead, interest rates were jacked up by 10%. Which of these 2 measures would have been more restrictive for spending? It would still clearly be the original scenario.  With the higher interest rate scenario, it would be lucrative for lenders to offer consumers loans to purchase goods with  little or no money down with the option to pay back the balance over several years. There would no doubt be a greater pool of qualified and willing borrowers than the first scenario. That's the other things about higher rates - it makes bank lending more attractive and therefore can inflame inflation as there would be more willingness for banks  to lend. More loans = more money supply and therefore higher inflation pressures. Also, higher rates means higher interest payments on interest bearing securities, which increases money supply.  The credit restrictions used in the 1940s were draconian and anti-free market no doubt, but they were probably more effective than hiking rates would have been since it directly and specifically targeted demand by suppressing the supply of credit for the purchase of certain goods. So, the bottom line is that changes in interest rates have several offsetting impacts when it comes to inflation -it's not simply a case of demand destruction or creation. Hiking interest rates won't directly target the root causes of inflation unless it happens to be mainly related to housing.

During the pandemic there was a clear mismatch between demand and supply and prices surged....we all know why.  These problems got exacerbated once people realized the situation and start hoarding, triple ordering supplies and so forth.  Eventually, this will self correct once everyone has had their fill. This is the so called "transitory" inflation the Fed was expecting. It is indeed transitory but it took longer than the Fed had expected. The war and Chinese lockdowns obviously made things even worse. The Fed eventually caved into the narrative that they had to "do something" about all the inflation....as if the Fed is the master of the universe.  I mentioned in a prior post that I believe rate hikes were a good thing to cool off housing as prices were getting way out of whack which if left unchecked would likely result in even more pain down the road. Given the weakness we have seen in housing, the job has been done with regards to what  part of the inflation equation rate hikes actual have a direct impact on.  By insisting on higher rates the Fed is wrecking unnecessary havoc in the global economy and markets. In addition some aspects of rate hikes are actually inflationary as I have explained. The inflation problem will naturally correct itself but if authorities want to help speed up the process they need to target the root causes of the inflation, directly addressing them much as they can and stop with this myopic and misguided obsession that monetary policy is the answer. If we do get a recession and inflation drops as a result,  unless the root causes of high inflation have been addressed, it will come back quickly and could actually be worse due to the decline in capital spending you get in recessions, but it would appear that a lot of inflation pressures are naturally abating making a Fed induced recession unnecessary. 

Wow that was a long winded post.  I really wanted to get my thoughts off out my head and into the open. Next post will be about the current conditions of the markets. Obviously things are not looking good right now.  

Labor Day thoughts

Past couple of weeks have been pretty nasty in the markets. We are seeing the opposite of the action we saw in late June and July i.e. falling yields and tech leadership. July Job numbers released at month end were fairly robust. At first the market response was positive but by end of the day it was negative.  You always got to be careful to give too much credence in the market's reaction to a single data point. These types of headlines often create knee jerk, emotional type moves and a game of chicken element amongst traders who have made bets on either side of the market. One thing I noticed is that when the market had been up on the day the put/call ratio was high which says there was plenty of hedging/bearish betting going on which is contrarian bullish even though the market reversed course and closed in the red. Put/call ratios have rapidly risen during this market slide, fund flows have reverted back to negative and NAAIM exposure has retreated to 33% and is probably in the 20s right now as the latest figure was as of Wednesday's close. AAII sentiment last week had 50% bears vs 22% bulls. That's back to a lopsided 2:1 ratio you typically see at a market low. The market is also now ST oversold. All of this is suggesting that that the market is ripe for at least a strong bounce and supports the notion of a base building scenario unfolding rather than a market that is primed to make major lows....at least at this point right now.  AAII positioning showed a marginal uptick of equity exposure to 65.5% for end of August. That's disappointing if you're hoping for an eventual bullish resolution to this market. Once again, AAII is showing a clear disconnect of how they are feeling vs how they are positioned and suggests that if the bulls make some kind of stand here, we're not going to be out of the woods. Granted, this is just one indicator and you should never hang your hat on just one indicator. I've showed plenty of other positional indicators which suggest extremes in bearish positioning. Bottom line is that market action looks ugly but there's enough pessimism to suggest a bounce is immanent. At the very least, not an ideal time to be going short here.

There's this narrative that strong job data automatically equates for the need for higher rates. This is such naïve and dangerous thinking.  From 2010-2020 we had generally strong job creation with a fed Funds rate averaging sub 1%. Where was the hyper inflation that this should have created? Even when the labor market was considered tight in 2018 and 2019 inflation was tame. Low rates did however contribute to asset price inflation i.e. housing and equities but not in the CPI/PPI as many doomers were predicting. 

Inflation pressures have recently been generally abating despite the strong payroll numbers we've been seeing in recent months.. In Europe, not as much due to obvious reasons.  To try and kill the economy in order to reign in inflation  due to the external factors causing it is ludicrous. That's like cutting off a healthy foot  in order to deal with a mangled toe. If the Fed hikes rates high enough for long enough, that will probably induce a recession and the bankruptcies and liquidations which result will temporarily help suppress inflation but unless the fundamental factors which created the inflation in the first place aren't dealt with, it will come back with a vengeance. If while in recession the factors that actually created the high inflation are sorted out, it, then the Fed may end getting undeserved credit. That's what happened in the 80s when Paul Volker was given credit for "breaking the back of inflation" which is bullshit....that will be the topic for another day. All I have to say for now is look at the high inflation rates in countries like Turkey and Argentina and you will see how toothless high interest rates were in taming it. Alternatively, look at Japan which has struggled with deflation for decades with 0% interest rates.