PMIs are Still High

The stock market cycle has run ahead of the economic cycle when it comes to pricing in an economic slowdown.  The stock market is actively front running economic weakness before it even arrives, which is confusing those that see the data and wonder why so many are afraid of a recession.  Let's look at the ISM Manufacturing Index for the last 2 proper bear markets, the 2000-2002 bear market, and 2007-2009 bear market.  

You can see that the ISM index bottomed in late 2001, but only after several months below 50 which is contraction.  The SPX didn't bottom till much later in summer of 2002 when the ISM rebounded back to above 50.  

In this recession, the ISM bottomed in late 2008, and spent several months below 50 before the SPX bottomed in March 2009.  

Here is where we are now.  Not even below 50 on ISM.  Its almost a given that it will go below 50 in the coming months, but even before it has, the SPX has already sold off over 25% from top to bottom.  That wasn't the case in either 2001 or 2008.  The stock market has become more forward looking than ever, and are more aligned with liquidity factors than in previous cycles.  Does that mean the bear market is over when the Fed pivots?  It depends on how much damage has been done when they do.  If they are pivoting with SPX between 3800-4000, then no, that's not likely to be the end of the bear market.  But if they pivot with SPX between 3000-3200, then I give it much higher odds that's the end of this bear market. 

Its a tricky market out there.  The bulls are not behaving like they normally would when you hit a one month high.  The put/call ratios have not been going down, but have stayed near the same levels as you saw for the earlier part of July.  Actually a bit more elevated than normal the past 2 days, even though pullbacks have been small.   I also keep an eye on the net deltas for the SPX, SPY, and QQQ.  When the net deltas are strongly negative, it tells you that investors are either selling calls or buying puts, or both.  For the last 3 days, the net deltas for the SPX, SPY, and QQQ options are very negative, as investors are not chasing this rally and are hedging for downside.  

CNBC Fast Money also seems to be less bullish now than they were on Friday, June 24, when the SPX rallied up to 3910 and then promptly sold off the following week.  Perhaps its the earnings jitters ahead of the big tech earnings announcements, with WMT's warning only increasing the caution among the crowd.  This doesn't feel like a great setup to be heavily short going into the FOMC meeting tomorrow.  I would like to see the bulls embrace this rally a bit more before putting on a big short position.  Maybe after the earnings are announced this week, and there are fewer walls of worry, there is a better setup to short.  But right now, I don't see much of an edge here to be short in the short term.   

The main factor that is giving me pause on holding short positions is the strength of the bond market.  Bonds are starting to get rebellious, not believing the Fed's word and starting to aggressively price rate cuts for 2023.  The Fed is usually bullied by the market, so there is a nontrivial risk that Powell caves to the bond market AGAIN and starts a dovish pivot early.  That would be the worst nightmare for the bears, as that's the linchpin for the bearish case, a Fed that is tightening financial conditions as the economy heads into recession.  If the Fed backs off their hawkish tone, you could see a continuation of this rally.  That's not my base case, I expect Powell to come out hawkish on Wednesday and focus on inflation being too high, but there is a small chance he goes mealy mouth and the market interprets that as him being dovish.  

After a nearly 6 week uptrend off the bottom, you would think that more investors would embrace this rally and start talking about higher SPX targets like 4050, 4100, 4200, but I'm not seeing too much of that on Twitter or CNBC, which is worrisome for a short seller.  I do believe that a definitive move above 4000 would change the minds of those on the sidelines and set the bull trap for later this year.  But I have to see the numbers to confirm that indeed the complacency has returned.  Currently, that's not the case.  

I covered my shorts on Friday and Monday, and waiting till later this week to see where the dust settles after all the big tech earnings, FOMC, and GDP number are behind us.