Government Fueled Bull Market

Those who still think its a bear market are not facing up to reality.  You can hate on this rally because its based on multiple expansion and AI hype, but you can't deny it.  I've been skeptical of the stock market and have been wrong.  I've underestimated the risk appetite of investors, who's default move is to buy US stocks when nothing bad happens.  And I took my eye off the US government largesse, which is the gift that keeps on giving. 

When the US government keeps pumping so much money into the economy via $2 Trillion budget deficits, 8% of GDP, a lot of that liquidity ends up in the stock market.  All that interest that the government is paying out with higher rates is going straight to the rich.  They were comfortable holding all that cash when the stock market looked shaky, but now that you are back in a strong uptrend, FOMO takes over, and they are diving back into risk assets.

Also, don't forget the big COLA adjustments at the beginning of the year which boosted Social Security payments by almost 10% vs. 2022.  And with so many baby boomers entering retirement age and starting to collect Social Security, that will just serve to blow out the budget deficit even more. 

In a perverse way, the Fed rate hiking cycle has expanded the US budget deficit, providing even more cash to the rich at the expense of those who need to borrow.  In the long term, when the government debt to GDP ratio is so high, you can't solve an inflation problem by raising rates.  You need the government to spend less money and/or raise taxes.  Those are not happening anytime soon.  So the path of least resistance is higher financial assets and real estate prices. That's not likely to end until you get a huge bout of stagflation that shakes the masses into demanding changes and less fiscal profligacy.  Not going to happen for several years, if ever.  Populism is here to stay.  The US is well on its way to being the rich man's Argentina.  The US dollar will be the sacrificial lamb during this process which will happen over several years.  I expect the recent dollar weakness to continue as the Fed probably only has 1 or 2 more hikes left before it goes on cruise control.  

The FX market is also about supply and demand.  The US, more than the Eurozone, and China/Asia, has the biggest budget deficits as a percentage of GDP and thus need to issue the most debt.  While you would think that a Fed that is doing QT would shrink the excess liquidity provided by that debt, you cannot ignore the repo effect of those holding Treasuries, who use them as collateral to buy stocks and other risk assets.  So while there is no net cash being issued with these giant budget deficits, there is so much Treasury supply that is being used as effectively cash in the investing world that big budget deficits are in effect the government printing money to spend beyond tax receipts.  That is stimulation for the overall economy even with QT, as long as bank lending doesn't go into contraction.  But we're getting close to that point where banks are cutting back on so much credit that we could still see a recession despite the insane levels of deficit spending into a strong labor market.  Its still probably at least another 6 months before you see notable signs of economic weakness. 

Even as recently as 2 months ago, there was still some uncertainty about whether the bear market was over or not.  That uncertainty kept a lot of investors holding cash, waiting to buy stocks later at lower prices.  That never happened.  Instead, those holding cash have been left in the dust as the SPX/Nasdaq powers higher.  Remember when the majority of those coming out on CNBC and Bloomberg in March/April were touting cash earning 5% like it was the greatest thing on earth?  Well, you don't hear that line much anymore.  

You don't get this kind of price action in a bear market.  You don't get a 28% rally over 9 months, with the 200 day moving average going back to an upward slope, in a bear market.  The 2022 down trending market is over. 

Since this is a bull market, you have to play by bull market rules.  They are different than bear market rules.  At the most basic level, the market will be much more forgiving of buys than sells.  The market will give you a lot more time to sell the highs and a lot less time to buy the lows.  You will linger near the highs, not just stay there for a brief period like in 2022.  Remember those rallies in March 2022, July/Aug 2022, and Jan/Feb 2023?  The market didn't stay at the highs for long, before selling off again.  The market has changed.  That's the first step to making better decisions for the remainder of 2023.  

In a bull market, the downtrends are there to shake out the late comer bulls, to get the crowd scared.  They are brief, sharp, and a bit scary.  While I believe we are due for one of those downtrends in the next 2 months, I am not expecting it to last more than 3 or 4 weeks.  The days of the extended downtrends are behind us.  If I would have to make a comparison to the current market, it feels a bit like 2019, although not as bullish.  In 2019, you had a very strong bond market, with yields trending lower, and the global economy was doing better than it is now.  So my base case is a less bullish 2019 type of market.  

SPX 2019

SPX 2023 YTD

In 2019, you had a sharp 4 month rally off the December 2018 panic low, making a local high in late April.  That was followed by a very extended 1 month selloff in May.  And then you had a choppy uptrending market from June to October, until the rally went vertical again in November to close the year with a very big gain.  

While I eventually expect even higher highs, and a revisit of the SPX 4800 level this year, I don't expect that to happen until you get to Q4.  The stock market has a tendency to consolidate such sharp gains before resuming an uptrend, especially when these rallies happen during the summer.  August and September are relatively weak months for the SPX, so the seasonal patterns line up just as we have a very overbought market.  This is about as good of a short setup that you will get in a bull market.  While I don't have full position on right now, if we get one more rally after FOMC today and into Thursday, I will probably add some more shorts to get to a full position to ride out into August.  

The sharp move higher off of the 4390 low on July 10 looked like a good time to put on shorts, but this market has retraced only a small portion of that rally, showing immense strength.  I was expecting a bit more weakness off such a parabolic move higher going into MSFT and GOOG earnings on Tuesday, FOMC meeting today, and ECB on Thursday.  This market continues to surprise to the upside.  Perhaps we'll get one last its all clear rally after the Fed hikes 25 bps and ECB does the same.  If that were to happen, you probably get the SPX to break above 4600 later this week, which would have seemed preposterous just 2 months ago.  

Still not seeing enough weakness in Russell 2000 for my liking, but Eurostoxx and Dax are trading much weaker than the SPX.  If the Russell 2000 fails to keep up with the SPX in the coming days, that will increase my conviction on shorts.  I am seeing some early signs of less risk appetite among the big cap speculative stocks, but need to see more to go fully short.