Going Cold Turkey

The patient has been going downhill for the last 20 years.  The organic growth rate was naturally going lower from the early 2000s in the US, Europe, and Japan.  In the first shot of methamphetamine for the patient, banks supplied the drug.  From 2004 to 2007, bank lending expanded household debt via mortgages to anyone with a pulse, in both US and Europe.  This lead to the housing boom during those years, masking a declining natural rate of growth (population + productivity).  Then when the mortgages started going bad and the underlying weakness was exposed, the Fed took the baton from the banks and provided the cure-all: QE.  It kept the patient alive with constant injections of pain killers and uppers.  The side effect of money printing was kept to a minimum with help from shale oil, offshoring production to China, and lack of fiscal stimulus from 2010 to 2016.  

From 2017 to 2018, Trump tax cuts resulted in trillion dollar deficits (5% of GDP) during the peak of an economic expansion, unheard of in US history, and then the Rona fiscal bazooka + Fed unlimited QE rained money down on everything in 2020 and 2021.  

After so many injections of both pain killers and amphetamines, the patient is completely addicted to stimulus.  Now comes 2022, where Biden is having a hard time shoving more pork down people's throats with his low approval rating, putting some doubt on whether the Build Pork Bigger package will pass.  And with Powell now on his way to being renominated, he no longer has to pretend that inflation is transitory or play dovish softball.  He got what he wanted (4 more years of power), and he'll do what he has to maintain that power: pretend to fight inflation with tough talk and a few rate hikes, at least until the crap hits the fan.  

SPX valuations are at all time highs on a price to book and price to revenue basis, and near all time highs on a price to earnings basis.  The Fed is aggressively signaling tightening and midterm elections are only 10 months away.  Republicans are set to take over Congress from 2023 and will block any attempts by Biden to push through more pork, fiscal stimulus will be limited until at least 2025.  The Fed, with inflation raging and a Powell that has job security for at least 4 more years, don't have the luxury or the need to support the stock market for the time being.  Fed is off the table in regards to restarting QE or doing rate cuts at least for a year, and most likely longer.  

So the patient is on his own, for the first time since 2015-2016, when there was no QE and no fiscal stimulus.  Only this time, with much higher valuations and household equity allocations.  And even worse demographics and productivity trends.  In 2015, you had a 15% correction, under more favorable conditions.  That was a 300 point SPX drawdown from top to bottom.  A 15% drawdown in SPX in 2022 is 700+ points.  Very doable, but it could go up to 5000 first before going below 4300, so I wouldn't rush out there to get short. 

When the patient finally gets off all the drugs, what you are left with is a body wrecked from drug addiction and crashing hard from the withdrawal effects.  Thinking about whether the Fed hikes 2 times or 4 times is missing the point.  Its about the absence of stimulus, not the presence of tightening.  A Fed funds rate at 50 bps or 100 bps doesn't make much of a difference.  A Fed that is willing to pour in $120B+ a month or not is a big difference (Fed is even talking about reducing the balance sheet in the 2nd half!).  A government doing more money spew/passing more pork stimulus or not is a big difference.  

We got the CPI "bad news" event out of the way, and as usual, the market rallied after it came out.  But after a 150 point SPX rally over 48 hours, I am expecting the rally to stall out from here and head back south over the next few days.  After this choppy period passes (maybe 1 to 2 more weeks of chop from 4550 to 4750), expecting another confounding rally that will leave many scratching their head.  They're not going to make it easy for bears to make money shorting just yet.  Its almost too obvious to just blast off on the short side after the Fed has gotten hawkish and expect it to go straight down.  In 2015, there was quite a long period of sideways chop before the waterfall decline in August.   Expecting a similar situation here, where you get a sideways market for a few months, get investors complacent before bottom falls out.