Spring Season for Bears

Shorting is not natural for most investors.  It presents a unique edge for those willing to go short just as easily as they are to go long.  During a bull market, that edge actually turns into a handicap, as those with a willingness to short don't put a short leash on that dog.  They short when the odds aren't completely favorable, or even during a raging bull market, when the market doesn't give short sellers any air.  But that handicap turns into an advantage in a bear market.  

My bearish tendencies has been a big handicap since 2008.  Its made me short in suboptimal spots, and more importantly, I missed a lot of good chances to get long and ride the bull trend.  And valuations weren't outrageous for the first few years of the bull market, yet I was still too cautious.  Huge opportunity costs along the way.  I did eventually adjust to playing the game in a QE world of excess reserves and TINA, but it was a rough road to get there.   

Shorting has been difficult for so long since the US stock market has spent most of its history in a long, strong bull market.  This has taught investors that shorting is hard, and a loser's game, as you can see from the miniscule amount of money in short only hedge funds vs long/short, macro, event driven, etc.  Its taken for granted that the stock market will always go up, cranking out average returns between 8-10% per year.  But that's a false assumption.  Just look at Europe, Japan, China, etc.  Stock markets that have been in sideways to down markets for several years to decades.  Investors in those regions have a much different view on stocks than those in the US.  It is no wonder that the equity valuation gap is the biggest its ever been between the US and Europe. 

At least the bulls and bears have one thing they can mostly agree on:  we are in a bear market.  The best way to profit in a bear market, especially an inflationary bear market, is to short stocks.  In non-inflationary bear markets, its actually much easier and safer to just buy bonds.  That's what's made this environment so nerve-wracking for investors.  They are used to having bonds provide a hedge against stock market weakness.  Its been a positive carry equity hedge for 40 years.  Shattering that hedge has big consequences forthe  risk appetite for investors.  Those consequences don't go away after a run of the mill bear market that ends in 9 months. 

But in a strong bear market, especially after it comes from a long, extended bull market that ends in a huge bubble, playing the short side becomes easier than playing the long side.  Its an uncommon time, in stock market history, but one that gives an edge to those who are willing to take on short positions and hold them for weeks.  There aren't too many speculators who are willing to do this.  Those that are have been burned numerous times over the years shorting in a downtrend, only to see it end prematurely due to easy Fed policy.  So you have a fairly small group now that are actively shorting the indices for longer term moves. 

If you a natural bear, you have to take advantage of this bear market because so many things are lined up in your favor.  Its rare to have the central banks actually on your side!  In a post-bubble, downtrending market.  Its so uncommon that its actually confused a lot of stock investors, making them feel bearish, but years of bull market conditioning make them reluctant to sell their stocks so far down from the highs.  Retail investors were brainwashed into buying stocks at the top in 2021, in the largest volumes since 2000, the total opposite of what they were thinking from 2008 to 2016, when they were reluctant to buy stocks after the 2008 carnage.  And they've only recently started to sell, and its been just a trickle.  They are heavily invested.  

The Fed pivot, the great hope of the bulls, will not be the savior that many think.  A Fed pivot would be good for bonds, but if the Fed pivoted with SPX where it is now, stocks will still be too overvalued given the fundamentals.  High interest rates are not the only problem for stocks.  Its a economy that can now only grow strongly on a nominal basis with a expansionary, populist fiscal policy.  A midterm election with Republicans taking the House (almost guaranteed) would be gridlock, so it will be almost impossible to pass pork stimulus in 2023-2024.  There is no more organic, secular growth in the US.  The internet was a once in a lifetime game changer.   Globalization and labor arbitrage on the scale that happened over the past 20 years will not be repeated.  There are no positive game changers coming in the near term horizon.  

We got OPEC+ cutting 2mb barrels of production at a time when oil is trading above $80/barrel.  OPEC+ is now using their price fixing skills to maximize revenues as much as possible without getting too much pushback and complaints from the rest of the world.   This is a negative for those hoping that inflation will come down quickly.  It also makes the Fed's job harder as it is now fighting both sticky inflation in housing/services as well as a potential rebound in energy prices due to OPEC price manipulation.  

I am a bit surprised that OPEC drew the line at $80/barrel but it seems like they see demand dropping a lot more than they are willing to admit.  The oil market is not as tight as all the energy bulls will have you believe.  Otherwise, OPEC would not need to do productions cuts.  Long term, I do expect oil prices to go a lot higher due to supply constraints, but cyclically, its not a bullish time for commodities.  

Bonds seem to have found a top in yields as the 4% 10 year yield area has lots of resistance, going back to 2009 and 2010, and is close enough to the terminal rate of this rate hiking cycle to attract fixed income buyers.  The stock market rally on Monday and Tuesday is largely based on the hopium of the Fed being less hawkish based on bad news like Credit Suisse, gilt market last week, and a disappointing ISM number.  But it looks like the stock market is running with that hopium a lot more than the bond market, which has given back most of its gains that it made earlier this week.  It once again reaffirms the belief that the stock bulls are still clinging to hopes of a "strong" bear market rally, like what you saw from June to August, while the bond bulls have mostly been extinguished and are reluctant to buy the hope of a Fed pivot until they actually see much weaker econ. data come through.  

Re-shorted what I covered on Friday into the rally on Tuesday.  Keeping it simple.  Covering on deep dips to free up cash to sell short term rips.  With nonfarm payrolls on Friday and CPI next Thursday, expecting investors to be reluctant to pay up going into those data points.