Stocks Getting All the Love

They love stocks.  You get the fastest gains in the latter stages of a bull market.  Despite all the quant funds, robo advisors, and systematic strategies, humans are the ones behind the controls.  Human nature has not changed.  Greed rears its ugly head after several years of a bull market.  Envy is a powerful force, you can be rich and holding plenty of cash and be dissatisfied with your situation when you see your neighbor bragging about all the money he's making in stocks, while you make 0% in cash.  

Fear takes a backseat when the market has gone up for 12 years, with only intermittent corrections and "bear markets", which have been more like deep corrections that completely recover within a few months, not years.  You can't really consider 2011, 2018, or 2020 as bear markets, when the market went down 20%, but didn't stay down at those levels for more than a few days.  They were more like flash bear markets than a real bear market. 

So we've built up a psychological base of rock solid bulls, who will not be easily scared or deterred from buying the dip.  That's what happened last week, as the fear lasted all of 1 day, and then greed took over and when people get greedy, they are willing to pay higher prices and quickly.  

There is a popular weekly poll asking about the next 100 SPX points.  Here are the results from Saturday:

I was a bit shocked at the quick turn in investor sentiment based on the past week of trading.  Yes, we made a bottom on Monday and kept going up all week, but SPX is still well below the highs made in early September.  It shows you how quickly investors turn bullish at the first sign of a bottom.  FOMO is in full force.  

It seems like even 5% corrections can't get investors bearish for long, maybe for a day or two, before they get FOMO and start calling bottom when they sense a trend reversal.  Unlike the previous V bottoms, you actually had a longer downtrend and a deeper pullback, despite investors staying tenaciously bullish for most of the way down.  Maybe they are right and they've figured out the V bottom pattern and know that there are no retests and it always goes straight up to a new all time high.

Don't feel comfortable chasing the rally when I see this kind of complacency so quickly.  Yes, it eventually will go to another all time high, but a much better setup would be to get more put protection being bought, some more consolidation at the 4300-4450 zone, to build a better base before making another rally.  The up trend has been so steep in 2021 with almost no base building that its getting dangerous and more vulnerable to a February 2018 style sudden plunge.   

The bond market has been weak since the FOMC meeting, and all things equal, a weaker bond market is a negative for stocks.  The February 2018 plunge happened as 10 year yields were rising strongly.  The stock market tops in 2000 and 2007 coincided with rising bond yields that topped out at the same time.  The big drop in August 2015 was preceded by a weakening bond market from February to June that year.  

That being said, you have to deal with the market that is here, not the market that you want.  No one forces you to make a trade.  Cash returns 0% but it does give you optionality and flexibility to take advantage of sudden opportunities.  There is a value to that which is underestimated.

On Evergrande.  It seems most 5 minute macro experts are missing the point.  Its not about contagion or systemic risk.  Really, there is no systemic risk anymore because we all know that if things get bad, the central bank will ride to the rescue every time.  Its about the economic damage that happens during that process which leads to eventual central bank rescue.  The financial crisis in 2008 didn't happen because they didn't save Lehman Brothers from going down.  Don't confuse cause and effect.  

The cause of the financial crisis was not Lehman Brothers, it was the excessive household debt that was built up in the previous years as real estate speculation went overboard.   Lehman Brothers bankruptcy was just the result of years of speculative excess and household debt accumulation that was unsustainable and eventually blew up the market.  

Evergrande is the same thing, but its more like Countrywide in 2007 than Lehman Brothers in 2008, because we're still early in the Chinese real estate down cycle.  First the most important point:  China has built up the biggest property bubble in world history, with way too much inventory and speculation.  It makes the US real estate bubble in early to mid 2000s look like child's play.  China is now trying to tackle the problem instead of just ramming more debt down the throat of the system, seeing if it can swallow it.  That is causing convulsions in the fragile market.  But they want their cake and eat it too.  They want to de-leverage the property sector but also keep house prices stable.  You can't have it both ways, unless you put in price floors, which is possible given their heavy handed style.  All that would do is kill almost all real estate transactions, making them into totally illiquid assets, which would bring on another slew of unintended consequences.  

Probably the most likely scenario is that Chinese property prices start going down in 2022, the economy gets weaker, and China can't take anymore pain and decide to do RRR and interest rate cuts to keep the market from going into a full blown crash.  Real estate to China is like stocks to the U.S.  It is the most important asset class.  If real estate prices go down, the negative wealth effect will lead to a much weaker Chinese economy, in addition to the slow down in construction and property related sectors, which are a big part of Chinese GDP.