Stupid Season

It must be that 6 month cycle working again.  Not many will remember this, but going into the earnings season in late July, ahead of the FOMC, the big worry was about bad earnings and a coming recession.  Fast forward 6 months.  The big worry was about weak earnings going into the new year, and a coming recession.  The market has climbed that wall of worry about downward earnings revisions, as all I heard in January was that earnings estimates for 2023 are too high from everyone that comes on CNBC or Bloomberg.  They were expecting earnings to disappoint and for stocks to go down.  Earnings disappointed, but stocks went up.  That is positioning at work.  People sell ahead of anticipated bad news, and buy ahead of anticipated good news.  No one is waiting for bad news to sell, when they know its coming.  That's the story for this earnings season.

Investors have not experienced this kind of chop market for a very long time.  You had smooth uptrends for most of the past 14 years, with every deep correction being over within a few months.  That is 14 years of investor conditioning to believe that the stock market always bounces back and eventually makes new all time highs.  Thus you get these fervent rallies when people think the market has bottomed, because it usually goes up for months on end.  

Its more than a year since the start of the bear market, and that belief in the stock market is still there.  I don't see the big outflows.   We've had 2 straight weeks of strong inflows into equity funds.  There is STILL a ton of speculation in shitcos, shitcoins, and meme stocks.  There are so many out there:  AMC, GME, CVNA, COIN, BYND, etc.  There is even an ETF that wraps up all of it in a nice little turd package known as ARKK.  All you need to do is look at the ARKK chart and you can tell that rampant speculation is picking back up.

The catalyst for all this movement?  Apparently it was because Powell didn't push back on the recent stock market rally and loosening of financial conditions by saying that financial conditions are tighter, and attempting to go for that soft landing.  Going for a soft landing = less likely to overtighten.  Powell is no longer looking for the market to feel pain to get inflation lower.  He thinks that inflation will go lower without much pain. It seems he has bought into the immaculate disinflation story that is getting quite popular these days.  That's why your seeing a strong rally in both stocks and bonds so far in 2023.  One rally looks sustainable.  The other looks to be running on hot air.  

Its hard to tell the difference between a mild economic slowdown and a deep recession at this point in the cycle.  We are just entering the fat cutting stage of the business cycle, as worker hours are reduced, layoffs announcements start up in a few bloated overstaffed sectors of the previous upturn.  Now is when investors and economists both get optimistic, as they see inflation coming down, growth slowing, but without the rise in unemployment.  This optimism is fueled by both the stock and bond markets going up, as it confirms their beliefs.  Fundamentally, the situation is worse than 6 months ago.  

July 28, 2022 (day after FOMC):  SPX 4072, 10 year 2.68%, Fed funds rate 2.33%

February 2, 2022 (day after FOMC): SPX 4179, 10 year 3.40%,  Fed funds rate 4.58%

The SPX is 100 points higher, the 10 year is 70 bps higher, and Fed funds is 225 bps higher.  The environment for the conservative investor is much more favorable, as he is getting 225 bps more on cash and 70 bps more on 10 year Treasuries than 6 months ago.  

The 2 main bear thesis are either:

1) Inflation will remain sticky, the Fed will keep their word, and not cut in 2023, and stay higher for longer, pulling down both stocks and bonds.  

2) Inflation goes down but the economy goes into a deep recession that hurts corporate profits and pulls down stocks but pushes up bonds.  

I am in camp number 2.  The disinflation is happening, but its not going to be immaculate.  This disinflation is happening mainly because demand is going down.  When the biggest asset in most people's portfolio, their house, is frozen, as transactions disappear in the face of higher mortgage rates and lack of demand at current prices, you will see sellers lower their offers.  That reverse wealth effect, combined with a bear market in stocks, is a toxic combination.  Don't forget that organic growth is meager now in the developed world, mainly due to low population growth and having squeezed all the economic growth possible from financial repression and low rates over the past 14 years. 

What you are seeing now is stupid season, when investors get enamored with the bullish side of the story, forgetting about the negatives.  These are the moments where you can take long term short positions.  Its what I've been waiting for while playing small.  Its getting very close to the time to go big on the short side.  I am not smart enough to pick the top, so I'll scale into the shorts, focusing more on heavily shorted and more speculative names at first, and then adding index shorts.  It is time to short the speculative, heavily shorted garbage, but I would wait a few days to short the SPX.  The strength in the bond market and the lower volatility means that you will see more inflows into risk assets as vol control and systematic funds add equity exposure.  It should mostly be played out by the end of next week.  

AAPL threw some cold water on this rally.  Rallies don't end on bad earnings reports.  The speculators are looking for blood.  Bear blood.  As I mentioned a few days ago, a strong rally after FOMC with Powell not going full hawk would make the bulls feel invincible.  That's where we are.  Its time to go to action on the short side, with any rally from here over the next couple of weeks likely to just be temporary, and all of it and more will be given back in the coming months.