Insanity

Sometimes you just have to shake your head.  It can feel like you are the one who's insane when everyone else is doing something else and making money at your expense.  That's what its felt like for the past 2 weeks.  I've been patient with the shorts, waiting for the bulls to regain their sanity, and they haven't.  Is it a new bull market, making me the one who's insane, or is it just a bear market rally, which is making the crowd insane.  We'll find out in the coming months.  

I'm not a Twitter trader, so I can admit to losing.  It's part of the game.  That being said, haven't seen that kind of mania in speculative stocks since last August, when I made the mistake of assuming that the market would linger near the rally highs around 4150-4300, covering shorts too early.  Of course, the market folded like a cheap lawn chair and went straight down for the next 45 days.  

On to the bond market.  2022 wasn't easy if you had any faith in the bond market, which I did and still do.  2023 should be quite a different story.  The coincident indicators are starting to show weakness, although employment remains stout, which keeps the soft landing crowd believing in stocks.  Leading indicators, however, are a horror show.  I'm noticing some interesting parallels between now and 2019 for the bond market, except this time, Powell is being stubbornly hawkish, not making a quick dovish pivot.  Here is a look at the leveraged funds position in 5 year and 10 year Treasuries back then and now:

5 year Treasury Futures COT Leveraged Funds Net Positions

10 year Treasury Futures COT Leveraged Funds Net Positions

Leveraged funds are hedge funds: a mix of CTAs, macro, and fixed income funds that use Treasury futures to either hedge their cash bonds or to make outright bets on rates.  They are trend followers, but they stick with the trend even when its going against them in the short term if the long term trend is still intact.  Of course, long term trends start from short term trends.  I believe we are at one of those inflection points in the bond market, as the long term trend has been down for over 2 years, since mid 2020 to late 2022.  But now, it looks like there is a battle going on, between the bulls and bears.  I lean on the bullish side as I am more bearish on the global economy than most, and less of a believer in the central banks' forward guidance, which changes quicker than people think.  

As you can see above, leveraged funds are putting on big short positions in both 5yr and 10 yr Treasuries, the shortest they've been since late 2019 in 10 yr Treasuries.  But the price action is running counter to their positioning, and that's when things get interesting.  I expect pension funds, mom and pop investors overweight equities and who sold their bond funds in 2022, to jump back in when the coast is clear.  That would be when the Fed pauses rate hikes.  And that looks likely after a final 25 bps in March.  

Back to the stock market.  The 2021 stock slinging daytraders and meme stock crowd is back, this time jumping on the TSLA bandwagon again, along with a slew of other bubble stocks like ARKK, COIN, MSTR, etc.  They can't get enough of the action, and are pushing these stocks back to where they were in November, before the big plunge lower in all things tech related from late November to late December.  Now you are back to levels where the shorts are looking quite juicy for a lot of these former bubble boys.  I haven't put on any big positions in these yet, as I'm waiting for the FOMC and ECB meetings to be behind us before feeding the ducks.  

I sense there is some caution among investors and EVEN these gun slinging speculators ahead of the FOMC and ECB meetings this week.  They remember all the times last year when Powell came out hawkish as hell and hammered the markets.  So they are bracing for impact and selling some stocks ahead of time.  With Powell all but guaranteed to do 25 bps, his hawkish rhetoric won't have the same sting as when he went 75 bps and went full hawk.  It would be totally toothless for him to do 25 bps and then talk tough.  Its like a guy with a toy pea shooter acting like Mr. Tough Guy shooting plastic BB pellets into the crowd.  It just doesn't have much effect, no matter how tough he sounds.  

So I think these never say die bulls will have a sense of relief once this week's events are over as well as earnings season and ramp stocks back up again, past SPX 4100, creating that fake breakout above resistance that every paper napkin technician can see in the charts.  Once you get that move above 4100, you will truly see euphoria and be able to put on long term shorts.  I was expecting to put out the shorts in the spring, not expecting so much enthusiasm so quickly after the December washout of spec names, but here we are.  You have to play the hand that is dealt, and it looks like I'll have to put on the long term shorts earlier than I expect this year.  Got out of most of my underwater shorts yesterday, and will get out of the rest today.  Leaving dry powder for next week for the long term shorting campaign. 

Setting Up for FOMC/ECB

Its amazing how you can hear a mouse squeal when the Fed is in their quiet period.  Next week, we get the one two CB combo of Fed and ECB on back to back days.  With the Fed, you have Powell who has softened his tone lately but has mostly let his lieutenants run their mouth, because well, they just want to sound like inflation fighters to boost their careers.  I can't imagine Powell doing anything to placate the bulls, but I have a consensus view, so probably close to a nothingburger at the FOMC meeting, don't expect him to go full hawk like he did at J-Hole or the Sep. and Nov. meeting, expecting more mealy mouth language that's more noncommittal, except that he'll probably say rate hikes are not done, even with the step down to 25 bps.  Remember, Powell's ego and reputation is on the line. If he wimps out here and goes dovish when stocks are in rally mode, he will lose some credibility.  That said, he can't deny that inflation is coming down more quickly than many expected, even though the labor market remains tight.  

With the ECB, you have the hawkish Lagarde who is talking smack to STIR traders in the Eurozone who are long and fading her. You had a huge bond selloff post ECB meeting in December, so that's going to be on the minds of bond investors this time around.  After a big rally at the beginning of the year, kind of neutral here on the bond market, but if I had to make a play, I would choose the long side.  Longer term, unlike stocks which look a bit rich, bonds are at decent levels and have room to go higher.  

The price action in stocks has been strong after earnings reports that have been weak.  It appears that investors are feeling more bullish these days, and you are probably getting CTAs chasing the move higher, as the SPX trades above its 200 day MA and hit a 1 month high.  The last buyers will probably be vol control funds which are just waiting for the volatility to go down a bit more before they pile in.  That could be the last push higher before this bear market rally rolls over.  A realized vol chart from @NewRiverInvest for a SPX/UST balanced portfolio.  Still elevated, but if it drops a bit more, you will see funds getting deployed in BOTH stocks and bonds. 

The resilience of this stock market despite terrible fundamentals and tight monetary  conditions is a bit surprising.  The $5+ trillion Covid helicopter money drop is the gift that keeps on giving for financial markets.  Liquidity came in like a fire hose, and the meager QT is taking it out with a paper straw.  The only plausible bull case for a long term investment in SPX at these levels is if the Fed goes right back to their 2008 playbook and cuts to zero with alacrity and goes back to unlimited QE at the first sign of deep job losses and weak economic data.  But to get to that point, ironically the stock market would have to drop a lot in a hard landing to get the Fed's attention and make them overreact to the weakness.  A soft landing isn't the best case scenario for stocks, that will only take Fed funds rate down to 2.5-3% level.  A hard landing inducing the Fed to overreact with their liquidity bazooka gun is the bull case. 

Stuck in the red on my NDX and SPX short positions.  Not willing to make Custer's last stand with these, so will hold for a couple more days and look to exit early next week before the FOMC meeting.  There is a good probability that you will have a relief rally unless Powell goes full hawk (unlikely, but not zero probability).  I will not be playing the long side even though I think we're probably going to rally late next week.  The risk/reward is just not good enough (rug pull risk is too high here).  That relief rally + the return of the corporate buyback window in February could boost this market higher for the next few weeks.  As positioning has been getting more long among asset managers in SPX and NDX, the rally will probably be small (up to SPX 4150-4200), as you've already made a big move off the December lows. 

Cherry Bomb Market

There are markets where up trends last for a long time, and there are chop markets where up trends are brief and don't have staying power.  It feels like we're in one of those cherry bomb markets.  If you have ever lit a cherry bomb firecracker, you know that the fuse is very short.  So once you light the fuse, you have to run.  On the long side, you have can't stick around and wait for much higher prices to sell.  If you hold the bags for too long, they explode in your hand, like a short fuse cherry.  In the past, the bombs had much longer fuses, so bulls had plenty of time to stay invested, ride the trends higher, and get out comfortably without rushing.  This is a totally different.  It punishes the late seller, and the graceful selling windows are much smaller and narrower.  A much less forgiving market for longs. 

This uptrend off the October low has been choppy with deep pullbacks, with the market topping out as soon as investors got comfortable with whatever piece of bullish data or news that came out.  

Over the past 3 months, there have been 4 pullbacks after a good news pop as shown in the above chart.  The SPX didn't have staying power after each of those pops.  The investors who chased the rallies by buying on good news were punished.  The reason this keeps happening is because the big picture of tight liquidity conditions and earnings deterioration are still there.  In fact, we are getting closer and closer to the point in the cycle where leading indicators showing weakness start seeping into the coincident indicators and the hard data.  That's when the soft landing hopes dissipate and a re-valuation lower for equities is likely.  Maybe its because I'm a permabear, but I still don't understand how investors can get optimistic under these conditions.  

Its quite telling though that the optimists seem to be playing for short term move higher, not a long uptrend.  That means the active investors are looking to sell quickly and are not sticky investors, looking to hold for a long, big move higher.  Those are the worst owners of stocks.  They have low conviction, and sell quickly on a whim.  It appears those buyers of meme stocks, high beta tech, bitcoin, etc. are low conviction buyers looking for a quick hit and run play, hoping that the rally can last for a few more weeks so they can sell higher.  You don't see many new, highly convicted buy and hold investors jumping into US stocks.  Its all short term, technical based traders and investors that think they can jump in and out of the market and be nimble before the tide turns.  I don't like playing those games, because you have to deal with rug pull risk, which can come quickly and violently after bear market rallies.  

So what is the reason for the recent big rally in tech stocks and high beta names?  It appears to be a combination of being oversold, rally in bonds, and optimism that layoffs at the big tech companies will help to cut costs and boost profit margins.  Its almost as if all those workers were basically meaningless to the bottom line and were just dead weight.  I can't argue against that, but having fewer workers just means more work for those remaining, which isn't sustainable in the long run.  

Its not a good sign for equity investors to see oil creeping back over 80 and acting strong ahead of the Chinese re-opening.  The last thing this market needs is an uptrend in oil prices just as the higher interest rates really start kicking in to the real economy.  Nothing fundamental has changed from when the SPX was at 3800 in late December, and where it closed around 4020.  Its just been some price insensitive portfolio allocations getting jammed through at the start of the year along with neat excuses for the rally:  soft landing hopes (because yields are going lower while employment remains strong), weaker dollar, China re-opening, technical breakout above 200 day moving average, etc.  

Really specious reasoning out there which make the rallies more fleeting than if there were actual real fundamental changes going on that would signal that the worst is over.  Its just one of those listless periods where there are no strong drivers in the short term, so we chop around.  The hard data hasn't rolled over yet, so the soft landing hopes are still alive.  And bond yields are now much less volatile, as disinflation continues, so stock investors are finding comfort in that.  Expecting more of the same chop in the coming weeks, until the last gasp rally after the last rate hike in March.  From April onwards, I am expecting a 2nd leg down that will be brutal.  No need to think too far ahead, just try to ride the choppy waves in the meantime.  Staying on the short side of course. 

Remember, Its a Bear Market

I don't know what it was like in the 1970s during the high inflation period, but if I had to guess, this bear market looks similar to the 1973-1974 bear market, where SPX went down 49% from top to bottom in 21 months.  At the bottom in October, the SPX was down 27% from top to bottom in just over 9 months.  The bear market in 2000-2002, one which I actually experienced, with similar bubble characteristics, the SPX went down 50% from top to bottom in 28 months.  

SPX 1973-1974

SPX 2000-2002

Not saying that we're going to repeat those 2 previous brutal bear markets where the SPX was cut in half, but even a lesser bear market taking the market down a mediocre 35% from the top would take the SPX to around 3100.  

From both a technical and fundamental perspective, this is about as bearish of a market as I've seen since those dotcom bubble days.  Even in 2007, the SPX never got nearly as overvalued as it did at the end of 2021.  

Sometimes I think its just too obvious of a bearish setup, it must be a bear trap.  But then I look at the massive equity fund inflows for the last 2 years, and the ridiculous amounts of bullishness and bubble behavior in 2021 and it is a classic post bubble bear market here.  And the biggest and worst bear markets happen after bubbles. 

The first half of 2022 was a struggle to get rid of my bull market trading psychology built up over 13 years of a raging bull market.  It took time to embrace the bear market and adjust to the new reality that will be around for a while.  It was only after Powell went full hawk at Jackson Hole to fully realize that the SPX was now a short seller's market. 

For 2023, anytime the market even gets a little bit excited and optimistic about stocks, it is time to short.  There are so many underwater longs that are looking to get out on a big rally that any rallies that take the SPX towards 4000 or higher are great opportunities to layer on shorts.  There is a lot of overhead resistance.  The psychology of the US stock investor has changed.  They are no longer looking to chase momentum and look for home runs, they are just hanging on, hoping for a miracle soft landing and/or Fed to come to the rescue, expecting it to rocket the SPX higher.  Hope is not a strategy.  

The bearish turnaround in the market on Wednesday seems to have surprised a lot of bulls.  The PPI came in weaker than expected, economic data came in weak and boosted the bond market, and stocks liked it at first, but then sold off aggressively to close at the lows.  The stock/bond correlation is changing.  Bonds are strong, and receiving a lot of inflows.  Stocks are choppy, and losing their bid even when bonds are strong, so that high positive correlation of stocks and bonds moving together is breaking down in 2023.  We are now moving from an inflation focused regime to a growth focused regime.  Those regimes are dominated by negative correlations for stocks and bonds, as bonds like it when economic data is weaker than expected, but stocks don't, and vice versa when data is strong.  The bad economic data is good news for stocks regime is near its end. 

Expensive and Tight

These countertrend rallies in bear markets are always tempting to investors.  So much money has been lost, its only natural to expect a mean reversion, especially when the previous trend higher lasted for so long.  Investors have been conditioned to expect the US stock market to bounce back from downtrends, and do it quickly, going up aggressively, like what happened after every big pullback since 2008:  2011-2012, 2015-2016, 2018-2019, and 2020.  But during each of those selloffs, the Fed was on the long's side, pumping up the markets.  Valuations were on your side as the market was not overvalued at each of those previous bottoms.  This time around, you don't have the valuation buffer to support stocks, and you don't have the Fed backstopping the market.  These are probably the 2 most important factors in investing in stocks:  1. valuations  2. monetary policy.  

The trailing P/E for the SPX is 19.5, which is well above the average of 15.5.  

Those SPX earnings are driven by near record profit margins, which historically are mean reverting.  Given how much corporate tax rates have been cut, how much corporate lobbying is entrenched in Washington, its so good, it can't get much better  type of scenario.  Given the populist lean among current politicians, I doubt they give even more tax breaks and tax cuts to corporations.  The political tide is slowly shifting away from corporations.  Corporate welfare is losing favor, even among Republicans.

Now let's take a quick look at monetary policy, in particular, the shape of the yield curve.  Here's the 2-10 yield curve, at -65 bps, showing a massive inversion, signaling a Fed that is very tight.  Inverted yield curves are both signs of a pending economic slowdown and a Fed that is too tight.  Both negatives for equities.  

 

With cash yields so high, the bar for equity investments is raised, as the competition is now 4.5% T-Bills which are risk free and provide future optionality.  Under current monetary conditions of short term rates that are high, with QT working in the background, with no fiscal stimulus impulse for the coming year, those are brutal conditions for equity investors.  

Recently, I've noticed many touting the improving technicals for overseas markets, the falling bond yields, weaker dollar, and the breadth thrusts in the stock market, but those are minor short term positives going against major intermediate term negatives of long term downtrend, high valuations, and tight money. 

If you are buying after a 200 point SPX rally from 2 weeks ago, 400 points above the closing lows from last October, you are betting on this bear market to either be over, or for a bear market rally to extend to lengths that are uncommon.  The financial markets are a probability game.  The high probability scenario is for the bear market to continue, as you have rarely seen bear markets bottom with valuations so high, especially under tight monetary conditions.  And betting on a continuation of a bear market rally after its been over 3 months since the last mini panic bottom is pushing your luck.  

Those that get caught up in the day to day movements can get enamored with short term strength, extrapolating it into the future, and buying into the suddenly positive news stories that permeate after a bear market rally.  These mini buying frenzies are often led by speculative garbage (BBBY, CVNA, AMC, bitcoin, etc.) which get bid up by speculators looking for quick gains. 

Never lose the forest for the trees.  Stay with the long term trend and fade the short term countertrends, in both bull and bear markets.  Added to NDX and SPX shorts this week. 

Deer Hunting

Was in wait and see mode, relaxing, but they pulled me back in with that rally ahead of CPI.  Now that the number has come out, basically inline with consensus estimates, the market moves on to real fundamentals of earnings season and a dose of reality that falling inflation doesn't improve corporate earnings.  And an inline CPI number just means that the Fed will do 25 bps hikes for the next 2 meetings, which isn't exactly a bull catalyst.  

There is no point diving in to the CPI inflation underlying details, there are enough geeks out there who will do that and lose the forest for the trees.  What matters is what the market is thinking on inflation, and its no longer scared of it.  Its now quite sanguine and thinking that inflation will glide down to lower levels for several more months.  I don't disagree, but there is no more big positive catalyst for declining inflation.  The market has caught up to that disinflationary story line. 

Big picture, remember that monetary policy is really tight and Powell seems to be happy with that, and not willing to go for that soft landing by doing an abrupt dovish turn.  Powell still wants to be remembered as an inflation fighter, and he has room to act like a tough guy with nonfarm payrolls still coming in strong.  He wants to get rid of that money printer label, that Mr. Transitory label.  He's trying to rebrand himself as a hawk, and he'll try his best to fool the market into thinking that, and in the process, assure that the US stock market feels some serious pain before he pivots. 

I am sensing investors are about to make another mistake by getting bulled up on the China re-opening story, getting excited about emerging market and European stocks.  They fail to realize that China hasn't done a money spew like the US during Covid lockdowns.  There is some chunky stimulus to keep the property bubble from turning into a total disaster, but not enough to reinflate the bubble.  The bubble psychology in China for real estate is gone.  Its not coming back.  Not with the horrible fundamentals of oversupply with a shrinking working age population.  The long term story is the bursting of the Chinese real estate bubble, which is much more important than some temporary blip higher in services demand post zero Covid, which everyone loves to focus on.  It figures, considering how most investors' time frame these days is measured in days and weeks, not years. 

I wrote on Monday that I was looking at shorting NDX/SPX when SPX got towards the 3940-3980 range.  The market has gotten there and exceeded that level, and I've used the rally to put on a small short, with plans on adding more if we grind higher in the coming few days.  Expecting a range for the SPX between 3800 to 4000, with NDX lagging SPX in the first quarter.  There could be a slight overshoot beyond that range for a brief period, but expecting the majority of trade to happen in that range.  Not time yet to go elephant hunting, just hunting deer at the moment.  By spring time, it will be a different story and time to go for big game. 

A Fallow Period

Its the beginning of the year.  Everyone wants to predict what will happen in 2023.  But you can't force your views on the market.  People want to make the big call, for a big move, with time frames to match, like weak 1st half, strong 2nd half, etc.  You can't put a time frame for big moves during a period of range bound trading with little edge.  

Sometimes there just isn't much to do.  Or even to talk about.  Sure, I could talk about the big move on Friday in the bond market, and in stocks, on a relief rally that NFP didn't come in hotter on wages and jobs number, and due to a weak ISM services.  But I don't believe that storyline.  People won't tell you this, but over 90% of the explanatory power for Friday's moves were beginning of the year funds flows waiting for the NFP and ISM services to come out to pile into bonds and stocks (to a lesser extent) no matter what.  Its time sensitive and price insensitive money flows.  The kind of flows that moves markets.  Its of course a much better story to talk about a possible soft landing with wage growth weaker but jobs number strong (i.e. Goldilocks according to the media)  causing a surge of money to go to bonds and stocks.  That's not sustainable IMO. 

While the day to day movements are volatile, the week to week movements have been tame.  It almost seems as if the stock market has just became a 0DTE casino where bettors come in the morning and leave in the afternoon, win or lose.  Since I'm not smart enough to guess what the intraday movement will look like, I stay away from those daytrading games.  Before you had the HFTs dominating these markets with their front running and predatory algos, there were good daytrading opportunities even in index futures and big cap stocks.  But since around 2014-2015, its gotten tougher as the algos have gotten more advanced and the dumb money has been squeezed out of the short term game.  

It took a few years of flat to down results for daytrades for me to admit defeat in the intraday game.  I still dabble in single stocks for daytrades, but not SPX.  SPX and NDX are solely swing or position trades, which is where the sweet spot is for my style.  Yes, great daytrading opportunities made a brief comeback in single stocks in 2020 and 2021, but that's over.  We're definitely back to the same HFT dominated intraday flows which are tough to beat.  

For the Treasuries space, this is the fallow period.  A range bound market that doesn't get too bearish or too bullish, but is still dangerous to play because of the above average volatility that happens on a whim.  For example, the moves in the global bond markets were savage in December, when the market shot up on a cooler CPI, squeezing shorts, only to get hammered by a hawkish ECB and then a few days later by the BOJ loosening up yield curve control.  By any measure, the moves were overreactions, as the first week of 2023 has taken back most of the bond market moves happening in the last 2 weeks of December, without any meaningful changes, other than the calendar year.  If you were in the middle of the battle with long bond positions while the market was trading super weak, you were feeling some heat.  

For the index futures space, this is a much to do about nothing type of market.  Lots of day to day volatility, but not going too far on a week to week basis.  Definitely not the type of market that is great for longer time frames.  You aren't seeing extremes on either side, so its hard to put on a meaningful position with conviction.  

Here are the forces that are at play:  beginning of the month inflows into international stocks and bonds, lifting prices in those markets, while you see outflows from crowded, overvalued tech stocks from both retail and institutions.  They are not a sign of a trend change, just short term strategic flows coming from institutions that are putting cash to work, insensitive to price so they are moving markets.  Its not going to last much longer, as these type of flows are time sensitive and usually get done within the first 2 weeks of the year.  So at this point, its not really playable, except to fade it if it goes on for a few more days and gets extreme.  Some of the money being thrown at the emerging markets because of the China reopening theme is getting close to a short term extreme, near short term exhaustion points.  

Really, its a stretch to try to find good, high risk/reward opportunities at this juncture.  Things just feel too neutral.  In SPX/NDX, it feels like the crowd is leaning a bit bearish, but that's warranted given the weakness over the past month.  But even that bit of bearishness has gone away after the nonfarm payrolls/ISM services boosted sentiment.  The crowd is still not bullish enough to safely put on long term short positions.  Positioning is still leaning a bit too bearish after the heavy December outflows from equity/bond funds for me to want to put on equity shorts.  And I'm not even bothering to look for longs, as that's a dangerous game in this type of post bubble market that hasn't gone down to reasonable valuations.  There is still a lot of fat left in this bloated pig to shear off.  

As for Treasuries, with a Fed likely to raise at least 2 more times to 4.75-5.00%, possibly a bit higher, its not a great risk/reward trade at this point when 10 years are trading below 3.60%.  The curve is just too inverted (2s-10s at -70 bps) to expect a big rally in bonds without a Fed signal of a pause or a big shoe to drop, neither of which are likely to happen in the next 2 months.  So Treasuries are probably range bound here, trading in the range built up in December, just like the SPX.  Its a boring call, but everything feels neutral, and I don't expect a catalyst in the next 2 months to take this market out of this range bound trade.  Thinking SPX 3740 to 3980, UST 10 yr yield 3.40% to 3.90% until March.  Only interested in the short side for SPX/NDX around 3940-3980.  Interested in the long side if UST 10 yr is 3.90+%, small interest on the short side if US 10 yr is 3.40+%.  

This may be an exciting time for day traders due to the big intraday swings, but its a boring time for position traders.  Not pushing it here, letting the markets come to me, even if it means doing little for several weeks.  

By the way, if I'm not putting out posts in the coming weeks, its because there is not much to talk about and nothing to do.  When you don't have an edge, its best to just keep quiet.

Turn of the Year

Its not common to see bonds trade with more volatility than stocks but that's been the case for the past 2 weeks.  Ever since the BOJ tweaked their yield curve control levels, bonds have been in a free fall, exacerbated by fund managers looking to cut their bond losers and not wanting to show them in their year end portfolios.  The fear of hawkish central banks took over.  But as soon as it turned into 2023, its been nonstop buying in the bond market, especially Europe, which fell the steepest over the past 2 weeks on a hawkish ECB.  Its a battle between the disinflationary forces which are becoming more apparent and the stubborn hawkishness of the perpetually lagging central bankers. 

In the meantime, the stock indices have vacillated between weakness and strength, with that Santa Rally missing but no plunge into deeper negative, even with the weak bond market.  I hesitate to read too much into the price action in the last 2 weeks of 2022, and the first 2 trading days of 2023, but there are hints of a shift in investor psychology.  You are seeing the stock-bond positive correlation that's been prevalent in 2022 fade away as the focus moves from inflation to economic weakness.  In a high inflation environment, both stocks and bonds suffer as yields move higher.  But in a weak economic environment which is likely for 2023 and 2024, stocks suffer from lower corporate earnings while bonds benefit from weaker inflation due to weaker growth and an expectation of future rate cuts.  

Investors are still overweight equities and are still emotionally holding out hope for a recovery after a bad 2022, just because that's what's always happened since 2009.  The resilient nature of the SPX is what keeps investors hooked and hoping for a recovery out of the blue, as has happened so often the past 13 years.  But their intellectual side is telling them that stocks are still overvalued so they aren't very willing to add more.  They are underweight bonds after the last 2+ years of a steep bear market and are slow to embrace the better values found with the higher yields.  But their intellectual side is telling them that bonds are the go to asset class in a disinflationary, weak growth environment, even if it feels scary to fight the Fed, ECB, and BOJ who are still hawkish.  Lastly, investors are overweight cash as it's finally yielding a good return and stocks and bonds have been such poor performers in 2022.  They are comfortable holding cash.  Almost too comforting, which usually doesn't work out in the financial markets.  But the thing about cash is that it historically performs the weakest in the long term vs stocks and bonds, so its not something that investors will want to hold on forever.  

From my vantage point, 2022 was quite an unpredictable year because the Fed totally changed its behavior, turning into super hawks, and its something that took many by surprise.  Those trading based on pattern recognition and past historical data were hammered.  At the same time, as an institution, the Fed is the same political animal that follows what the politicians and market participants think.  As soon as the worry over inflation fades away in this disinflationary environment, as growth weakens and the economy enters a full blown recession, the words from politicians, economists, investors, etc. will be screaming policy error, begging for rate cuts, and putting immense pressure on Powell and the crew to deliver.  Its hard to imagine now, when they are still hawkish, saying they won't cut rates in 2023, when the unemployment rate is still very low, and the worries about inflation are still there, but fading.  But you get paid in the market when you can accurately predict change and make the proper bet that will pay off in such a scenario.  

The highest probability scenario in 2023 is the one where the economy gets much weaker than many expect, so weak that it will force the hand of the Fed, despite losing more credibility as they have to go back on their guidance of no rate cuts for 2023.  In that scenario, the Fed will probably start cutting sometime in the summer, perhaps July.  The stock market will have been plunging for several weeks due to an intransigent Powell who's trying to gain an inflation fighting reputation and admiration like Volcker, only to be making another policy mistake, keeping rates too high for too long and causing an economic mess.  

In this environment, being overweight bonds, underweight stocks, and holding some cash for optionality is the optimal portfolio mix.  But that's not how most investors are positioned.  Most retail investors are overweight big cap tech, with almost no fixed income exposure.  That's probably the worst portfolio for 2023, with already the first day of 2023 highlighting that fact.  Its a worse version of the post dotcom bubble period from 2000-2002, because this time, housing is much weaker, organic growth rates much lower, and productivity gains going in opposite directions from that period (up in 2000s, down in 2020s).  It feels like being long tech stocks now is akin to being long tech stocks in early 2002, looking cheaper after a big selloff the previous year, but still facing another big swoon in the coming year.  

In the first week of the year, I haven't made any big moves, holding some Treasuries, no real position in stocks, and waiting for the right time to add.  Looking to add more bond exposure (short end of the yield curve) and add some short tech stock exposure (hopefully after a bounce sometime this quarter) when the time looks ripe.  Both would be for longer term positions that could be held for a few months, so I see a lot of opportunity in those trades, something that you can ride for a big move.  Looking for the stock-bond correlation to turn negative with a vengeance as soon as the Fed finishes their last rate hike, mostly likely to happen after the March FOMC meeting.