Its Right to be Bearish

There is an old saying that bottoms are an event, while tops are a process.  Fear is a much stronger emotion than greed (the new kids call it FOMO).  The action so far in 2022 is showcasing that, as the downtrend has been choppy, and this rally off the bottom for the last 2 weeks is catching a lot of investors off guard, holding too much cash.  They are right to be nervous, but its never a straight line when transitioning from a bull market to a bear market.  Tops are much choppier and take longer to play out than bottoms.  Tops are flatter, with prices hitting the upper end of the range multiple times before finally going down for good into a bear market.  During this topping process, investors actually get less bullish even though prices are trading in a range for several months.  For example, investors are much more bearish now than last November, when the S&P 500 was trading at 4600. 

There is a misconception about investor sentiment and psychology.  Most contrarians view a lack of bullishness as a positive and a sign that there is room for investors to get more bullish.  That assumes that the crowd as a whole are dumb and don't have a clue about fundamentals, and blindly get more bullish as prices go higher.  But investors as a whole aren't idiots, and are definitely smarter than they were even 10 or 20 years ago.  In the past, macroeconomic fundamentals were considered the most important variable for the stock market, when it was actually monetary policy.  The market now knows that the most important variable for the stock market is Fed policy.  Then comes fiscal policy, which is a distant second.  

Investors actually are sensing that this is not a good time to be in stocks.  This is based on the simple assumption that a hawkish Fed looking to do a bunch of rate hikes in a hurry after a huge move higher in stocks in 2021 is not a good thing.  And that's the correct view, even though it doesn't look so correct when stocks are screaming higher like they have for the last 2 weeks. 

 It was great time for stocks for all of 2021, as the Fed was way behind the curve, doing massive QE while CPI was printing 7% month after month in the biggest fiscal pork stimulus bonanza in US history.  Powell screwed up big time, although he'll never admit it,  mainly because he put his own political situation ahead of the facts, which he brushed off as transitory.  Now the Fed is so far behind the curve and the economic cycle that they don't have enough time to tighten sufficiently before the economy completely rolls over.  You will likely get lower inflation prints in the 2nd half of the year (ex food & energy) due to the weaker economy and less fiscal stimulus, not because of the Fed's tightening.  The Fed should already be at their so-called neutral rate of 2.5%.  

The Fed is so late that they are early.  That's right, they are so late to tighten that they won't be able to hike as much as they want before the crap hits the fan.  And no, the Fed will not be hiking when the stock market is going down a lot and the economy is quickly slowing.  Right now, the economy is past the peak but still in the gentle downslope part of the economic cycle.  When the leftover stimulus is mostly exhausted and higher rates and QT begin to curb speculative activity, the downside of economic cycle will gain momentum and at that point, the Fed will freeze, and then make a dovish pivot.  Similar to what they did in early 2016 and in early 2019.  This time, they will stop hiking rates not because inflation is under control, but because they don't want to take the blame for tightening the economy into a recession.  

You see, the Fed's main goals are not to maximize employment and have price stability.  They want to:  1. Protect themselves, to not receive any blame, so always doing what is politically popular (right now fighting inflation is politically popular)  2.  Keep goosing asset prices higher as long as there is no political pushback from high inflation caused by loose monetary policy.  

The Fed could care less about high inflation if it wasn't so unpopular amongst the public.  But since people actually don't like it when their purchasing power goes down due to excessive monetary stimulus, the Fed has to react to that.  If people didn't care much about inflation, the Fed wouldn't care either.  They are academics, but political academics.  There is no such thing as Fed independence.  That's a joke.  The Fed is like the 4th branch of the government.  

Sold the rest of my SPX longs, too early again, looking to have dry powder to buy into a pullback.  It looks like another one of those classic run for the hills rally towards previous highs.  Its been just over 2 weeks since the bottom before the FOMC meeting, but it feels like its been so much longer considering how much ground the SPX has made up.  Its only down 4% from all time highs.  There will be great opportunities on the short side, but you have to be patient and can't rush to get short.  It takes time for the herd to get their fill of stocks, and considering how low the net equity exposure is, it will take at least another month or two before it will be safe to short.  

Same goes for going long on Treasuries.  It feels like its still a bit too early to get long bonds because I still hear many people skeptical that the Fed can do so many rate hikes that are priced in.  Only when that skepticism turns into true fear that the Fed is serious about hiking 50 bps clips at each meeting, will you be able to finally get the weak hands out of the bond market.  Then it will be a safer spot to get long.  Until then, its a waiting game.