Cash is Popular

After the weak close last Friday and the continued weakness in the bond market, I was looking for a capitulation this week to clear the decks and allow for a reflexive bounce that could last 3-5 trading days.  But the bears just couldn't get the job done and equities showed resilience, bouncing hard despite the 10 year yield breaking out above 4%, a new YTD high.  I would not read too much into one day's trading action, but it does fit in with my view that when volatility is shrinking in the stock and bond markets, it makes it tougher to shake out the bulls, as they are emboldened by the less treacherous environment, relative to 2022.  This is a mirage, as there just hasn't been enough time since the Fed really got aggressive with rate hikes (Jun-Jul 2022) to torpedo the economy.  Its not easy to time the turn of these economic cycles, but best estimate here is that it will be around summer time when the economic weakness becomes apparent and starts to spook the stock market.  Until then, equity vol will be subdued, with all the liquidity still sloshing around.  

These days, with T-bill yields above 5%, its been common to see analysts tout cash as the best thing to hold here, which is rare.  Usually these analysts and pundits that come out on TV are almost always bullish on stocks and rarely ever recommend cash.  In many ways, I agree, but anytime I hear something this consensus, it makes me think of scenarios where holding cash will lead to underperformance.  The most obvious thing I can think of would be if risk parity starts to perform strongly in the next few months.   

Holding cash is the anti-risk parity trade.  For asset managers, holding a lot of cash is like rooting for both stocks and bonds to go down.  It is a conservative way to express a bearish view.  It makes me re-think my original 2023 thesis of a huge downtrend starting in May and ending in July/August that takes the SPX towards 3200-3300 in a wave of capitulation selling.  It could take longer for the stock market to crack than I originally expected.  But I expect it to crack due to the high valuations and earnings pressure that will come in like a lion in the 2nd half of the year. 

Many are recommending cash because it yields 5% a year, but that averages out to less than 0.5% a month.  Not a great way to outperform.  It could get uncomfortable for those holding cash if inflation cools off in the next 3 months due to base effects and lagged effect of M2 deceleration, and it looks like a soft landing.  That would boost both stocks and bonds and leave behind cash holders earning 0.5% per month.  And anytime there is underperformance in the investment management community, they have a tendency to chase to catch up, which could take the SPX back towards 4200-4300 before enough supply comes out to stop the rally.  

Short term, it will be the bond market that ultimately decides the direction of the stock market.  The only thing that can sustain an equity rally is if the economic data cools down, starting with the nonfarm payrolls report on March 10, and CPI on March 13.  I am leaning towards the employment picture being weaker than consensus, as other labor market indicators are pointing to a less bullish picture.  But I've been wrong for the past few months, and the nonfarm payrolls is a horribly inaccurate number, so anything can happen.  Same view on the CPI, as the January effect will no longer be there and leading indicators still point towards disinflation.  

The equity put call ratios have been perking up over the past few days, there is some concern these days among the fast money traders out there.  That is as the SPX has bounced strongly off the SPX 3900-3920 support zone.  Bears used up a lot of their fuel taking the market lower over the past 2 weeks.  SPX is short term oversold.  I am not bullish, but I wouldn't be holding a lot of shorts either.  Still short individual stocks, which I might hedge with a long SPX position if there is another selloff next week towards that SPX 3900-3920 area.  April was horrible last year, but historically has been a very strong month for stocks as tax season and consumers spending or investing their tax refunds provide a short term boost to the economy and markets.  The big move lower in the SPX is looking like a Q2/Q3 story.  A stock market that chops around between SPX 3900 and 4150 without any big moves for the next 2 months is looking like the most likely scenario.