Post Bubble and Still Overvalued

We are in a post bubble world.  That is a heavy lead weight on the market for the next 6 months, or until we get down to pre-Covid bubble valuations, which is SPX between 3300-3400.  When you have the masses crowd into stocks at perhaps the worst time since 2000, you have a problem.  Households are overweight equities, getting nervous but aren't yet pushing the eject button.  Stocks widely held by increasingly weak hands that still haven't purged their holdings down to normal levels is the invisible hand that pushes down on stocks.  

For every buyer, there's a seller.  But one side is usually more eager than the other, and the eager side is the one pushing the market.  Despite the longest stretch below the 50 day moving average (almost 80 days, last above on April 21) since 2008, you haven't seen buyers eagerly push prices higher.  The market has been living under the 50 day moving average, as rallies don't have staying power and the market lingers near the lows.  That is classic post bubble price action, one way selling with only intermittent buying which fades after a few weeks, at most. 

Now on to the economy.  There is now recognition among investors that we're probably either in a recession, or about to enter one very soon.  Commodities getting crushed, including oil, and global bond yields screaming lower since the post CPI panic selling.  The bond market is right, and the stock market has its head stuck in the stand, hoping that a Powell pivot will come soon and rescue it.  

Forget about the leading indicators, all of which are forecasting a very weak economy in in the coming months.  You have a baseline of low economic growth in the OECD countries due to very low population growth + aging demographics (insufficient supply of working age labor), and productivity growth that's stagnant due to lack of breakthrough technological efficiencies. 

Add on top of that baseline a Fed that is not going to come to the market's rescue anytime soon, until they see inflation firmly going lower for a few months.  They will be late to pivot due to their lost credibility on controlling inflation.  Powell is a caver, and he will eventually relent under the constant pressure the bond market will put on him, but he also won't relent as easily as many expect, due to the political pressure from high inflation and his fear that inflation expectations will rise again as soon as he pivots.  

Given the asset price destruction so far this year (double barrel of stocks and bonds), that are hurting the wealthy, and the food, energy, and housing inflation that are hurting the poor, this economic slowdown is affecting a huge swath of the population, both US and global.  And both monetary and fiscal policy are no longer tailwinds for this market.  Basically a perfect storm.  

Let's look at copper and semiconductors.  Dr. Copper and Dr. Semi are giving out their diagnosis of the economy.  Its getting ugly.  Copper has started to plunge over the past month, and the semiconductors continue to underperform the SPX, even on rallies. 

 

Copper

SMH ETF vs SPX

Sure, there is probably a mild recession that is priced into the commodities market, but I'm not so sure its being priced in most of the stock market, as we are still close to bubble valuations on a price to sales basis.  

Notice how much higher the S&P 500 price to sales ratio got in this bubble compared to the dotcom bubble in 2000.  The P/E ratio didn't go as high, due to the ever increasing profit margins among S&P 500 companies, but are those profit margins sustainable when US corporate tax rates are near all time lows, the long term secular downtrend in yields seems to have finally turned (higher structural inflation), and the cost of labor rising amidst a shortage of workers due to an aging demographic (both domestic and off-shore) and low population growth?  

Earnings have gone higher through outsourcing labor to China, keeping labor costs low and increasing margins, while bond yields kept going lower due to the deflationary effects of shale oil and gas + cheap Chinese labor, reducing costs of capital.  But shale oil production looks to have peaked out, and Chinese working age population is no longer increasing.  They have a huge demographic cliff over the next 30 years. 

Can the oligopolies hold the center and keep making everyone poorer and making themselves richer as the politicians line their pockets via the corporate welfare lobbyists?  All the while their constituents get handed a few stimmy checks along the way to keep them from revolting, as the buying power of their dollars gets eroded away by oligopoly pricing exerted by huge corporations as well as the government excess and money spew which ensures an entrenched high inflation regime.  

Can the masses be continuously duped in a democracy that favors their oligopolistic overlords (corporations like AAPL, GOOG, MSFT, AMZN, etc.) over their quality of life?  

These are questions that will determine the fate of US corporate profit margins in the coming years.  My bias is towards a shrinking of profit margins as both the costs of capital (as corporate bond yields rise) and labor (fewer workers, more competition for skilled workers) rise more than revenue growth.  The only way for the margins to sustain at this high level is if politicians go batshit crazy and start handing out trillions to corporations, disguised as government pork projects or tax credits for this and that.  Its possible, you can never understimate the US politician for selling themselves out to corporations, but you probably need a crisis for them to have the pretext to do it, like Trump and Mnuchin did in 2020, and Biden did in 2021. 

They got to the last hiding place in this market, which was energy, while the SPX was in a bear market rally.  That is something I didn't expect, but I welcome this rally as it is starting to setup some great shorting opportunities for the next 3 months.  I am keeping my powder dry until after the CPI, as I expect a different reaction from the stock and bond markets this time around, regardless of how it comes out.  At this point, most investors can see that inflation has peaked, even if it won't be dropping as quickly as the Fed thinks.  After the CPI hurdle, hopefully the bulls will get excited and push the SPX and Nasdaq up to levels where the risk/reward for shorts are too good to pass up.  We'll see.  Last month, I was hoping for the same situation, and the market dumped post CPI.  This time, the setup definitely looks different as commodities have been getting crushed the last few weeks, which is probably enough of a sign for most that inflation isn't getting out of control.