Mind Bender

Investors have a way of bending reality to back up their current position and outlook.  You heard all kinds of pseudo scientific rationalizations from economists about economic scarring, a term that was just made up to try to support their view that the economic recovery would be slow and prolonged.  I don't hear that anymore.  Also a new letter was used to describe the recovery, no V, no U, a K.  I don't see anything doing worse after the vaccine rollout, so that explanation should also be thrown in the garbage bin.  Now almost everyone is on board with the roaring inflation call, due to fiscal and monetary stimulus, and all that money printing.  The go to answer to explain stocks and bitcoin going up. 

Most investors believe that the main reason that we are seeing this huge bull market is because of monetary and fiscal stimulus.  I also hear a lot about the M2 money supply growth over the past year.  So let's look at the M2 money supply chart for the US and Euro zone for the past 5 years.  And compare the SPX vs the Dax over the past 5 years.  

M2 Money Supply 5 year chart

SPX (red/green bars) vs DAX 5 year chart

While the US is blowing everyone away in the money printing department over the past year, most of that occurred in March and April 2020, since then, the M2 money supply growth rate is similar for the US and the EU. 

And the often ignored aspect of the inflation fears is that it eventually leads to the Fed reacting to the market.  Expect the USD M2 money supply growth to slow down sharply if the Fed follows through with taper and interest rate increases like the market expects (1 rate hike priced in by Dec 2022, 3 rate hikes priced in by Dec 2023).   Under the market priced scenario, the US will once again fall behind Europe in M2 growth in 2022 and 2023, just like it did from 2017 to 2019, as shown in the M2 chart above.  

You don't hear too much about money printer goes brrrr when talking about the Euro area.  But Europe has printed just as much as the US over the last 5 years. 

The beginning of the end of most bull markets is an increase in interest rates.  That's not just for the Fed funds rate, but for interest rates across the curve. That is a market signal that money supply growth in the future will likely slow down as the Fed tightens monetary policy.  Right now, the Fed is not pushing back on the market pricing in 4 rate hikes by Dec 2023, just repeating their mantra that they need to see real data rather than forecasts before they change their stance.  We'll be seeing the hot data come out in the GDP numbers in the 2nd half of the year, and then what?  Powell will be running out of excuses to keep the easy money flowing. 

In most cases, the Fed follows the market.  It usually takes a few months for the hard heads and rear view mirror Fed governors to catch up, but they eventually do.  Everyone on Wall St. is forecasting a big jump in GDP over the next 12 months, so when the forecasts turn into real data, the Fed will be changing their language.  

That will be enough to change the current Wall St. paradigm of the Fed money printer goes brrr, weakening investor psychology just as the stock market is at the most overvalued levels in history.  Not a good combination.  

Longer term, I don't believe the Fed will be able to raise interest rates, mainly because of their reaction function vs SPX.  With the SPX going up so high and getting more and more fragile as it goes higher, it would get crushed during the prelude to the interest rate hiking cycle, which would be QE taper.  Not many share my view, the Eurodollars market certaintly doesn't, as the first rate hike has been brought forward to 2022, contrary to the dot plots showing the first rate hike in 2023.  

I can picture the following scenario in 2022, which is contrary to what both the stock and bond market are showing:  

1.  A hot economy that leads the Fed to start tapering in the beginning of 2022, but a stock market crash happening in the middle of 2022 which stops the Fed in its tracks, preventing the Fed from completing their QE taper, effectively reversing the market's rate hike forecast and opening the door to yield curve control.  A real taper tantrum, not the weak one we got in 2013. 

2.  Republicans winning either the House or Senate, or both in the 2022 midterm elections, assuring that there is no more fiscal stimulus until November 2024.  Economy weakens without the drug of fiscal stimulus.  

3.  A bear market starting in 2022, and continuing into 2024 due to a lack of fiscal stimulus, and the Fed going to yield curve control and back to full blown QE unable to stop the bear market.   

Current market doesn't entice my interest, so thinking about what happens in 2022 and beyond.   A dull market, grinding higher every day to new highs on low volume, in a seasonally bullish month.  No thank you. 

I am not a masochist, I've mostly avoided fighting this bull market.  However, we're getting closer to a point where it is worth a shot to put on a short for a sell in May and go away scenario.  Was thinking SPX 4150 to start the short campaign, but probably won't be willing to put on big size on the short side until its closer to 4200.  And this is just for a short term pullback (3-5%), nothing major like 10% on the downside. 

As crazy as 4200 is, this sucker probably goes even higher later in the year (4500?)  just because of the bubble dynamics and the infrastructure stimulus carrot still in front of us.  You probably need to see the infrastructure bills passed AND the Fed trial ballooning a taper before you see a halt to the uptrend.  That's likely not happening until September, at the earliest.