Beyond the Infrastructure Stimulus

You are seeing the optimists rave about the reopening, all that pent up demand, all that stimulus money.  And then the pessimists with their calls for raging inflation and a Fed that will be forced to tighten more quickly than the dot plots show.  

One thing you can always rely on Wall Street is herd behavior.  It is instinctive, pervasive, and hard to ignore.  If you read what they write, you would believe that the infrastructure stimulus will be followed by more big pork projects and stimulus packages in the Biden era.  They all believe the government will just keep pushing out more stimulus, no matter what.  Even when the GDP growth numbers will be high well into 2022, and even when the Republicans take over the House or Senate in the midterms and create political gridlock.  Oh, you say, no way, if the economy is doing great, the Dems will gain seats in 2022.  That's not what history shows.  Midterm elections have almost always been a disaster for the party in the White House for the last 40 years.  

It is a bit too soon to look beyond the infrastructure stimulus, but let's do that anyway.  It seems like everyone has the next 9 months of economic activity figured out.  Unlike the crack high of stimmy checks and pork direct to state governments, the infrastructure spending will be drawn out over many years.  Knowing how slow the US government works, it will take several months to even figure out what to build and where, much less start hiring, buying the necessary equipment and materials, etc.  Really the only big variable left until the 2022 midterm election is how hot the economy gets in the reopening.   Based on all the economic forecasts, most are expecting a booming economy for the next 12 months.  But what the 15 minute macro experts aren't considering is how the economy looks after the stimulus wears off, sometime in 2022.  

The developed world population continues to get older, and the demographics are unfavorable for maintaining high aggregate demand.  Add to that the lack of productivity growth and increasing welfare mentality from all the stimulus.  People in the US are now used to getting government handouts and fat unemployment compensation.  There is less incentive for these low wage workers to look for work or even care if they get fired.  With states now well funded after the 2 giant boosts of federal stimulus to fill their cash hoard, they can now splurge on all kinds of welfare.

When the government takes up a bigger part of GDP, capital is deployed less efficiently, because the government has no accountability.  Most voters vote for their party, no matter what.  Government waste, grift, and incompetence means that the return on investment on all the government spending is very low.  In many ways, the US is becoming more like Europe, except for one big difference:  taxes.  Europe actually tries to keep government deficits under control with high taxes and strict rules from the technocrats in Brussels.  

The US has given up on that "old game" of balanced budgets and taxes to pay for spending.   The new game, government spending fueled by debt that is bought by the Fed, is the magic bullet that suddenly US politicians have discovered as being extremely popular among the public.  It is a game that leads to eventual ruin, but in the beginning, it works great so they will keep doing it, but only under 2 scenarios:  

1.  A unified Democratic government OR 2. a Republican President.  Democrats need to have both the White House and both houses of Congress to pass additional pork stimulus because as we've seen already, Republicans will not vote for anything a Democrat President tries to pass.  But it doesn't work the other way around.  A Republican President can pass whatever he wants even if his party doesn't control Congress.  Because Democrats are always in favor of additional government spending, even if it requested by Republicans.   And that easily assures enough votes to cover even a few dissents from Republicans who don't support pork stimulus.

With the Republicans likely to win at least one House of Congress in 2022, that gives Biden about 18 more months to pass legislation.  And if the economy is as strong as everyone predicts over the next 12 months, it makes it unlikely you will get more stimulus after the infrastructure bill passes.  Will Biden start watching the stock market and try to support it by passing more stimulus if you get a bear market?  I wouldn't rule it out, but unlike Trump, Biden doesn't seem like a guy who really keeps a close eye on the stock market.  

 

About the current market:  I see that there is a growing divergence between the S&P 500 and a majority of stocks which are lagging the index.  You can see this most clearly in the retail and momentum favorites.  Just look at the YTD performance for the ARKK ETF, and the SPX.  Huge divergence there, from outperformance to underperformance.  And also bonds continue to stay weak.  Another negative.  I'm not shorting, but it wouldn't surprise me if you saw a sharp pullback down to SPX 3700-3750 within the next 2 months. 

On Yields, Inflation, Stimulus

Here are a few thoughts on the zeitgeist of the market. 

1.  Nasdaq is underperforming because of higher yields. 

A few years ago, not many people thought that low yields were great for tech stocks.  Everyone equated low yields with low growth, and thus bad for tech stocks.  The biggest ever tech bubble (not including this one!) happened as the 10 year yield went from 4.20% in October 1998 to 6.80% in February 2000.  

Don't buy the argument that the reason Nasdaq is lagging the small caps and SPX is because yields are going up.  Yields were screaming higher in 2018 and the Nasdaq easily outperformed the SPX that year.  The main reason the Nasdaq is underperforming now is because it is over owned and way overvalued compared to the rest of the stock market.  That rubber band got stretched way too far in 2020 and you are getting a mean reversion to more reasonable relative valuations between growth and value stocks.  

2. High unemployment will keep inflation under control.  

Inflation is a monetary phenomena.  Let's say you suddenly give everyone in the US a million dollars when unemployment is high.  The money is printed by the Fed and sent as stimmy checks.  300 million x $1 million = $300 trillion.  The current USD M2 money supply is ~$20 trillion.  So if you multiply the money supply 15x, then everything should be 15 times more expensive, and retailers selling at the same prices after those $1M stimmy checks are idiots and will immediately sell out whatever they are selling.  In reality, instead of giving everyone $1 million, they effectively gave everyone $10,000 (per capita stimulus over the past 3 months ($3 trillion in stimulus). There will be inflation, its just the government and the Fed that will lie about it through their manipulated CPI and PCE numbers.  

3.  Fiscal stimulus will keep coming.  

There will just be one more stimulus left for Biden (infrastructure), one that will be spread out over 5 to 10 years, and then expect the government to take its foot off the pedal in 2022 (economy will be hot).  And after the 2022 midterm elections (odds are very high that Republicans take over the Senate, as midterm elections always heavily favor the party not in the White House + built in Senate advantage for Republicans), there will be gridlock.  And there is NO way a Senate led by Mitch McConnell will give additional stimulus for Biden ahead of 2024.  That means barring some unforeseen economic catastrophe, 2022, 2023, and 2024 will be without additional fiscal stimulus.  That's at least 3 years where the stock market is on its own, and with Fed Funds at zero with a possibility of it rising, but very low possibility of it falling.  That is a disaster waiting to happen.  The market is a forward looking mechanism, it may be too dumb to realize that Republicans will take back the Senate in 2022 but it will definitely consider that possibility, especially if the stock market falters and the economy begins slowing in the 2nd half of 2022 as I suspect.   

 

On the current market, I am waiting for a bigger dip to buy SPX and RUT. SPX 3820 is my target entry point. Not interested in NDX at the moment.  Expecting the next rally to be led by small caps, energy, and financials. 

Powell Following Bernanke

Pansy Powell.  Since the scolding he took from both Wall St. and the stock market obsessed media for raising 25 bps in December 2018, he has been nothing but a Wall St. sell out.  Always giving what the market wants, even if he has to come up with ridiculous excuses and new standards for tightening.  Much like Bernanke from 2009 to 2013, until he finally tapered just as he was getting ready to exit, pulling the pin off the grenade just as he was passing it to Yellen.  

Powell is pulling off the same maneuver that Bazooka Ben did by waiting till the latest possible moment before tightening and disappointing the markets.  What is Powell's excuse this time?  Waiting for the data, BACKWARD LOOKING data.  

Here is how the Fed works:  forward looking data (basically financial conditions) that is showing weakness is a reason to ease (2011, 2019), but forward looking data that is showing strength is NOT a reason to tighten (2013, 2021).  Only backward looking data, in other words stale economic data, that shows big growth will cause the Fed to tighten.  

That means Powell will be doing this same dovish song and dance until the hot data starts coming in during the summer and fall, and then he'll probably float some trial balloons on tapering just to gauge the market reaction.  If the market doesn't blow up, he probably eventually announces a taper after the market expects it at the end of the year.  If the market blows up before year end, you can forget about the taper, and Powell will come up with another excuse about not tightening, such as not meeting their inflation target, or repeating the same garbage about inflation being transitory or unemployment rate is still too high, etc.  

At this point, the market probably wants a tighter Fed, contrary to what Powell thinks.  A tighter Fed would probably keep long end rates from going even higher because at least the Fed will have regained a tiny bit of their inflation fighting credibility.  And if long end rates are under control, that benefits the tech stocks, thereby helping the S&P 500.  But with Powell's short term thinking, he probably thought he did a masterful job pumping the markets on Wednesday and it lasted, for one afternoon, and then an immediate double barrel selloff in both the bond and stock market the next day.

The Fed are a bunch of hard headed doves, they even are slower to tighten than the BOJ, with their moribund economy.  It probably takes more market worries about inflation before the Fed finally gets the message and starts talking more hawkish.  

As I was watching Powell lob dovish word salad at the press conference, stumbling to find one lame excuse after another to keep the bazooka QE going without a hint of tightening, I remember mealy mouth Bernanke doing the same thing at every meeting  from late 2009 to the middle of 2013, when he was ready to unleash the taper grenade to Yellen while he took the credit for the economic recovery.  

In the bond market, we are looking at a taper tantrum light scenario, similar to 2013, except this time, the bond market is wiser, knowing that the Fed will always be late to tighten and always willing to talk down any inflation as transitory, making it less likely bonds go into full blown tantrum mode.  And if it did, I'm sure Powell would make a rash decision to placate the markets with either an Operation Twist (Bernanke playbook) or yield curve control (Kuroda playbook).  Bonds look oversold now, so probably see a bounce soon, but heading into the summer, 10 year yields probably get closer to 2%, which would probably act like the 3% ceiling did back in 2013.  

As for stocks, if rates calm down, and I expect it will, you probably don't get a big selloff until the summer, when taper talk will start to get more media attention.  And with stimulus mostly done (infrastructure stimulus probably doesn't happen until fall), the stock market probably trades sideways over the next few months.  Its gone up a long way and bond weakness is probably enough to halt its upward march.  

But you can't ignore the stimmy effect coming over the next few weeks.  Stocks are now the most popular way to spend excess cash among the masses.  Its almost like a time machine back to 1999, except this time, its not the internet revolution that's doing it, its the stimmy revolution.  Human progress has stopped, and the governments will do anything to put lipstick on this pig before the whole MMT house of cards falls apart.  This MMT honeymoon period won't last for long, in the long run, there is no free lunch from money printing.

Artifical Forces > Natural Forces

Forecasting the stock market used to be about predicting economic growth, but now its about predicting central bank actions.  The two are related, but the Fed works with a lag.  When everyone can see huge economic growth in the near future, the Fed sees it too, but try to downplay it in order to keep pumping the markets.  They want to squeeze out every last bit of their easy money policies for as long as possible until the economic data undeniably shows the growth and they can't lie anymore.  

If it wasn't obvious since the Greenspan days in the 1990s, the modern day Fed could care less about inflation or jobs, their supposed 2 mandates.  They are short term thinkers looking out for their post Fed careers.  Obviously pumping the markets and giving huge favors to bankers is in their best interest for their Wall St. backed golden parachutes.  Don't blame the player, blame the game.  When the government recklessly wields its power, the influence of politicians and central bankers becomes enormous.  

The balance of power has shifted from New York and California to Washington D.C.   That has changed the game from focusing on natural forces driving the economy such as population, productivity, wages, etc. to artificial forces of fiscal and monetary stimulus.  When heavy handed government policies overwhelm the natural business cycle, they become the driver of asset prices, not the economy.  

The market is doing its usual job of front running economic and central bank decisions by 6 to 9 months.  It is no coincidence that with the Rona vaccine rollout well underway, with expectations of the majority able to get the vaccine by summer/fall, with all the stimulus working its way through the system, the bond market saw the future 6 months from now and promptly panicked, regardless of what Powell and company said. 

When the artificial forces driving the economy begin to recede, then the natural forces become more important in driving financial markets, at least until you get the next stimulus. 

With this in mind, the only carrot remaining for the stock market is not the reopening after the vaccines, but the infrastructure bill that Biden will be pumping soon.  The re-opening is now a risk asset negative event, as it will now force the Fed to either choose between:

1. Lose their credibility and the dollar by continuing their dovish talk and easy money policies or

2. Tighten policy by talking about tapering Treasury and MBS purchases.  

Since market participants are now used to getting the baby treatment and having a tantrum at even the slightest hint of tighter policy, I am sure the Fed will go out of their way to only talk about taper, and not actually go about doing it until its way too late and the economic cycle is near its peak.  Or they could actually start to taper but do it as such at excruciatingly slow pace that the market will quickly realize that the Fed will never hike again.  

If the Fed chooses number 1, by dragging their feet and talking about inflation being transitory and about unemployment still being too high, even with blockbuster GDP growth, the stock market will love it.  That will just increase the everything bubble even more and make policy normalization that much more of a nightmare when it happens. 

If the Fed chooses number 2, they will likely officially announce a turtle taper in the December meeting, but only after trial ballooning and testing the market response like little pansies for a few months before pulling the trigger.  The number 2 option is more likely, just because the growth will be so big and inflation talk so intense that even the cooing doves like Powell will feel the pressure to ease back on the throttle.  

The Rona is the only excuse that the Fed has left.  Once Rona is in the back burner, likely as the numbers settle down to a much lower plateau after the vaccine rollout, then the pretext for more stimulus is gone and the market will have to stand on its own, which means down.  

But there are still a few months left before the majority can get their vaccine shots, so we'll likely see limited downside until the summer, SPX 3700 at the worst.  With the bond market weakness, stock strength will be more limited as well, just because the weight of the now interest rate sensitive Nasdaq is so large.  It used to be utilities and consumer staples stocks that were the most sensitive to interest rates, now its tech stocks.  That's what overvaluation and too much popularity does for a sector, it makes it more sensitive to tertiary factors it used to ignore.  

As for the Fed meeting this week, I expect Powell to be mealy mouth as usual, trying to run out the clock with a 5 point lead in the fourth quarter, trying not to do anything rash to threaten his reappointment for a 2nd term as Fed chairman.  Powell is a politician first, central banker second.  He could care less about fomenting bubbles as long as they don't crash on his watch before reappointment.  

The market probably breathes a sigh of relief and we probably hit a euphoric peak over the next few days.  I'm not interested in putting on any big short positions until the re-opening, so probably until summer time.  Until then, will mostly play small looking to capture short term moves more out of boredom rather than any big edge.  There will be a time later this year to try to catch the big down move, no need to rush in yet.

By the way, I've been writing fewer blog posts mainly because from a trading perspective, I don't see much to do here.  If I don't put up anything for a while, its probably because there is nothing to say.  The joy of trading just for the sake of trading and the ups and downs is not there for me anymore.  I've been there, done that.  Looking back, the short term trading and trying to make money every day doesn't create wealth.  I do it to keep abreast of the market, not to make any kind of meaningful money.  Its about putting on big positions at the right time, holding on and catching big moves that make the difference. 

Inflation Hype is Real

I am not usually one to get caught up in the latest market hype, as its usually more fluff than substance.  I usually take the other side when the knuckleheads on CNBC get all excited about something.  But the rising inflation isn't just hype.  WTI Crude oil over $65, highest since 2018, when everyone was talking inflation.  Corn and soybeans at the highest prices since the drought induced price spike in 2012-2013.  Copper at the highest levels since 2011.  Lumber prices more than double 2017 prices.  US Housing market is very strong as there just isn't that much supply.  Yet you have the lying government inflation statistics showing low inflation.  And the Fed and their academic cronies saying that inflation is transitory because of base effects.  These aren't base effects.  They are price surges to multi year highs.  

And the reason is simple.  When the Fed prints so much money and the government pumps out so much pork, you will have a lot of dollars looking for a home.  M2 money supply is up 25% year on year.  That is ridiculous for an economy with an organic growth rate which is probably less than 2% real.  So you have a lot of excess dollars that have no economic use, so they go to either speculation or savings.  It seems like people these days don't really differentiate much between those 2.  Those new printed dollars will chase anything, stocks, bonds, commodities, real estate, bitcoin, etc.  You are getting a big time surge in inflation that is the strongest inflation impulse since the 2006 to 2008 commodity boom cycle.  

At the foundation of money, is confidence.  If people really start to lose confidence in the US government to maintain fiscal discipline, that naturally takes away a lot of demand for dollars and bonds in particular.  The Fed and the government may think they are having a free lunch as they pump out pork stimulus after pork stimulus one after the other, but that confidence in the dollar is being eroded day by day.  

Now Biden will go on to his next pet pork project, infrastructure.  Numbers anywhere from $2 trillion to $5 trillion are being thrown around like its casino chips at the blackjack table.  M2 money supply is roughly $20 trillion.  So each of these stimulus packages (avg. $2 trillion) are diluting the existing amount of dollars by about 10%, if the Fed monetizes all of the debt issuance.  At the current pace, the Fed is buy $1.5 trillion in Treasuries and MBS per year.  The Fed has told you repeatedly that they aren't going to be the ones spoiling the party.  In fact, they are the ones who want to spike the drinks with even more cheap liquor.  

This level of pork spending during peace time has never happened before.  And if Biden is off his rocker like I suspect he is, he will keep pushing for more spending until the inflation gets so out of control that even the Fed will have to stop pretending like inflation is low and get on top of it or let the dollar get crushed.  

And what about those economist blowhards whose BS is so overflowing that no one calls them out when they use terms like economic scarring.  It seems like these BS artists come up with a new term every few years to sound like experts.  When people go bankrupt or their businesses fail, they have to go look for a job.  While they are looking for a job, they are getting very generous unemployment benefits, almost as much or sometimes even more than what they would earn when working.  That money is spent.  People with money, and there are lot of them, start new businesses when they see the opportunity after others go bankrupt and the competition is weeded out.  Those new businesses require investment, which jump starts the economy.  

There is a huge source of pent up demand looking to be released once lockdowns are eased and vaccine rollout goes through most of the population.  With all this pork, this will end up becoming the hottest economy since post World War 2.  

If the Fed does nothing for the next 6 months, which is the base case and what probably happens, by the end of the year, they will be back to where they always end up, keeping easy monetary policy for too long, ignoring inflation, and fomenting bubbles.  They will be way behind and end up with some token tapering before the cycle self combusts from the bubble getting so big that it pops spontaneously and the Fed will be back to pleasing the market with gobs of more free money.  Wash, rinse, and repeat.  Since 1998.  

The speculative juices are flowing again, as bond yields stabilize and the stimulus checks are coming over the next few weeks.   Those stimmy checks are going to be used to buy a lot of junk stocks over the coming weeks, so investors are front running the stimmy fueled dumb money.  Everyone is sucking on the government teet now.  Biden will give 'em more when it runs out. 

Powell Pause

 The stock market has high expectations for the Fed, even as the bond market is lowering its expectations. You are getting these knee jerk intraday selloffs but they don’t last for more than a day.  We’ve seen these intraday V bottoms from lower lows, one last Friday, as the end of the month stock selling and bond buying poured in, and this Friday, as the short term panic from a strong jobs number and a weakening bond market and residual disappointment from Powell not giving Wall St what it wants took it down briefly to near levels where I was waiting to buy, only to see that buying chance disappear.  

I don’t think this bounce in stocks is going to last as the bond market weakness should keep it the buyers wary.  Perhaps its investors not wanting to be left in cash as the Biden pork package gets passed this month.  If thats the case, then I expect a sell the news reaction after Biden signs the pork bill.  

There are still a few potential negative catalysts as the 3/10/30 year Treasury auctions come up next week as bond demand has cratered with crude oil and commodity prices continuing to rise as the strongest major market in the world.  That commodity market strength and strong jobs number will keep some pressure on Powell to not cave in to Wall St demands.  Although we all know he eventually caves in, its just a matter of at what point.  And it seems like Powell isn’t scared of the 10 year above 1.5% and SPX at 3800.  Probably need to get to closer to 2% 10 year and a SPX that is below 3600 for it to catch Powell’s attention.  

As for now, I am waiting for lower prices to buy either stocks or bonds.  

Bonds are Controlling this Market

You get these type of markets about once every 4-5 years.  They are not common.  A sharp bond selloff after a parabolic bull run the previous year.  November-December 2016.  June-July 2013.  May-June 2009.  The bond selling is front running either an economic recovery or a fear of a change to a tighter Fed policy.  By the time the economy actually starts getting better and Fed is getting tighter, the selling is usually over and bonds are actually a good investment again.  

In all 3 of those instances, 2009, 2013, and 2016, there was a lot more rally left in the stock market.  But I have a feeling this time is different.  The financial markets have gotten smarter.  They now mostly ignore ecoomic data releases like the nonfarm payrolls report and ISM and CPI reports.  They know now that its better to have a weak economy with a very loose Fed than a strong economy with a tightening Fed.  And its the best to have a strengthening economy with a loose Fed (like now) at least until the bond market stops playing along.  

Last week, the bond market stopped ignoring the insanity of the government spending $2 trillion more every few months without any tax increases.  It started realizing the consequences of the lopsided supply/demand dynamic with a Fed keeping purchases the same as Biden goes on a spending spree.  Bond prices have to go down when there is more supply, inflation rising, and commodity prices making 2 year highs.  

What is interesting about the stock market is that its at such a high level compared to past bond market panics, that it is having a hard time shrugging off the selling in bonds.  The S&P 500 feels very weak, even when it made that big move higher on March 1.  It felt more like automatic first day of the month inflows pushing prices higher than where the natural buyers and sellers are at.  

A lot of picking the right direction for the market is based on that gut feel, the intuition gained from watching AND studying markets for several years.  And its still tough, because the market always provides the most liquidity for the wrong side of the trade.  Its always easier to get long weak markets and to get short strong markets.  Strong markets don't give longs much time to get in.  That's how November to February felt like.  Now its a different ball game.  It still doesn't feel like a weak market, but it does feel more balanced than the previous 4 months, when bulls were clearly the stronger side.  

One of the most important lessons that one can gain from these type of markets is that avoiding the big drawdowns and flush moves lower is the most important part of trading.  Its not about hitting home runs and offense.  A good defense goes a much longer way than a good offense.  Good defense with a mediocre offense will give you a chance to making a living at this game.  Good offense with a mediocre defense is asking for trouble and a blowup is just a matter of time.