A Calm Interlude

People forget sometimes how often the stock market is boring.  After the crazy volatility in 2020, 2021, and 2022, and even the first quarter of 2023, when you get a boring month like April after the craziness in 2022, it feels abnormal.  But its actually what was going on most of the time from 2012 to 2019.  If you go back for the past 30 years, I would say more than half of those years were "boring years" (1993 to 1997, mid 2003 - mid 2007, 2012-2019), where realized volatility was much less than what you saw in 2020 to 2022.  

If you look at what years were volatile, it basically comes down to 2 types of regimes:  bubbles and bear markets.   2020 and 2021 were a combination of a panic + bubble market, and 2022 was the popping of a huge bubble, which is always the most volatile (eg. 2001, 2008).  I still believe its a bear market, so this interlude of calm shouldn't fool anyone to thinking that the worst is over.  We're just going from a panic phase from a combination of a huge bubble popping and a big decline in bond prices last year, so any kind of stabilization on both fronts will be viewed positively.  This grace period for the stock market should not be misconstrued as a resumption of the bull market.  Systematic funds reallocating to both stocks and bonds is not a long term bull market driver.  Bull markets don't have much fuel when they are at these kind of lofty valuations, with the Fed still trying to fight inflation with Fed Funds 500 bps higher than a year ago.  If it is the start of a new bull market, then I will have to go back to the drawing board to figure out what's changed in current markets that make it so different from past markets.  

The economic fundamentals are weakening, and the soft data is clearly showing this, and the hard data is close to showing this.  There are leading signs of weakness in the labor market such as lower working hours, weakness in temporary work, which leads nonfarm payroll weakness.  Also the weakness in commodities is a lead on producer prices, which leads consumer prices.  It was just a month ago that OPEC announced a supply cut and crude went from 75 to over 80, and last week it filled that gap and crude has been trading weak relative to the SPX for the past 2 weeks.  

Counterintuitively, this coming economic weakness should be just weak enough to get the Fed to stop hikes after May, but not so weak that it worries equity investors into thinking that there is going to be an imminent hard landing.  A poor man's Goldilocks, if you will. 

One thing that gives me pause about shorting right here is that the price action is just too strong given the skepticism I see among the investing public out there, and we've still not gotten any "good" news that get bears throwing in the towel and bulls getting excited.  Recession seems to be the base case now for the majority of the analysts and fund managers I see on TV.  Sure, we had some tech earnings beats but they didn't really excite the bulls or scare the bears.  

You are going to need to see investors get more confident that Powell is done with rate hikes.  Although I don't think he will sound hawkish at this coming FOMC meeting, I also don't think he will be going out of his way to forward guide the market towards a potential easing by signaling a pause.  While I doubt he says that more tightening is necessary, he will definitely leave things open ended to keep the market on its toes and not get too comfortable by pricing the end of the rate hiking cycle.  So I don't think it will be the FOMC that ignites the last leg of this bear market rally. 

What probably needs to happen for the bulls to get excited and the bears to throw in the towel are both technical and fundamental.  Technically, you will need to see the SPX break out above 4200 to stop out the fundamental bears, who are right, but close to their uncle point.  Next, you need some fundamental news to create the reasoning for that kind of move.  My best guess is a softer employment report (somewhere between 50K-130K jobs?) and a weaker than expected CPI number in May would do the job, and take the SPX above 4200.  That would make bears nervous, and bulls feeling invincible, and comfortable knowing that Powell is done with hikes.  That's the point where you want to feed the ducks while they're quacking.  With where the VIX is now, SPX puts will be very attractive to own into coming economic weakness.

Why would I still be bearish when the Fed is done hiking?  Well, its the credit contractions that you will start seeing in the coming months that will slowly suck the oxygen out of the economy.  Its not a flashy bank contagion situation that's going to take this market down.  It will be from an old fashioned credit contraction led by banks reducing lending which feeds into more job cuts and less consumption, leading to recession.  It won't happen in a flash, but it will slowly build momentum and by Q4 this year, it should be a freight train of weakness and negative feedback loops.  Not much to do now, but wait for a fat pitch which I think is coming in the next 2 weeks.