Doublethink

The US stock market is back to Goldilocks pricing as the SPX is now well above 4500 with 10 year yields below 4.5%.  The Fed gave the market an inch, and investors have run with it and taken a mile.  With gradual rate cuts priced in for 2024, investors are breathing a sigh of relief that the worst of the bond bear market is over.  With the high correlation of stocks and bonds over the past 2 years, investors are thinking a bond market that rallies will propel stocks even higher.  In the short term, I agree with consensus.  The tight positive correlation of stocks and bonds should continue for 1-2 more months.  But that should be the end of it as I expect the stock-bond relationship to return to the negative correlation that we experienced for much of the past 2 decades.

Powell is no Volcker.  Those who think Powell will keep rates higher for longer because of his legacy forget one thing:  Powell is no hero.  He's not made of the same stuff as Volcker.  Volcker actually had deep core beliefs about the value of money and keeping inflation in check.  Powell doesn't.  Powell is a politician and a power hungry one at that.  Powell's goals are similar to that of Greenspan's:  take as much credit as possible and deflect as much blame as possible to remain in power.  He wants to be Fed chair for the next decade, and he won't get that opportunity if he torpedoes the stock market and the economy in 2024 by trying to be the next Volcker. 

If he tries to act like a hawk in 2024, he's going to hand the presidency to Trump, where he'll promptly be fired when Fed reappointment choices are made in 2025.  Powell is not that dumb or clueless to put his own head on the chopping block trying to be Mr. Tough Guy.  That's why I am not enamored with trying to pick a top shorting the Mag 7 or NDX.  I'll make a few moves here and there for swing trades, but not for long term holds.  Despite growing overvaluation, its too early to fight it because the Fed is going to be more dovish than people think.  There will be plenty of time to short those egregiously overvalued megacap tech stocks at decent levels in 2024.  The next few months will frustrate bears as the economy deteriorates but the stock market doesn't go down.  

While my short to intermediate term view on the SPX/NDX are fairly neutral, my long term view is getting quite bearish.  It is difficult to keep time frames in separate compartments and not rush to make long term short trades when the market is at levels that are attractive for shorting.  But that's what will be necessary to avoid premature losses fighting the uptrend as the FOMO kicks into an even higher gear. 

We have re-entered the low volatility regime of 2013 to 2019, where the VIX would go down to these very low levels after big rallies.  In those low volatility regimes, you had up moves that grinded higher with shallow pullbacks, until the complacency built up over a couple of months, leading to a sharper pullback that led to a VIX spike to anywhere from 20 to 30.  

Unlike that ZIRP/QE period for most of 2013 to 2019, I don't expect this low volatility regime to last long.  The valuations are too high, bond yields are higher, the fiscal situation is much worse, and the public's allocation to US stocks is near an all-time historic high.  There will be less spending at the state and local level in 2024 as the Covid surpluses are run down.  At the federal level, there will be more taxes collected in 2024 as there were higher cap gains from both higher interest income on bonds and stock market gains in 2023.  The fiscal impulse is negative.  Credit creation has been minimal in 2023, which will feed into weakness in 2024.  The only thing holding this up is the fiscal largesse from huge budget deficits, but most of that money is funneling to the wealthy who are collecting much higher interest income thanks to higher rates on T-bills and T-notes.

These are fertile grounds for a bear market.  At best, they are conditions that lead to sideways to down stock market for several years.  In these times, you can't look too far ahead because there are huge dark clouds way out in the distance.  You have to bide time and stay patient as a bear.  Tops are a process, and take longer than most forecast.  Plus, I am sure that Powell will throw a wrench into the bears' plans with timely dovish actions in 2024.  

Over the past 3 weeks, asset managers have gone from being defensive to chasing the year end rally.  There are some signs of saturation in the megacap tech stocks.  Asset manager net long position in NDX futures is at a 6 year high.  

Hedge fund positioning in the megacap tech is back to all time highs:

 

 

This bifurcation between the megacap tech stocks with the small cap Russell 2000 is eerily similar to what was happening in 1999 as the Nasdaq index powered higher, dragging the SPX higher with it, while the Russell 2000 lagged.  What happened in early 2000 was a dramatic outperformance of small cap stocks over large cap stocks in the first quarter of 2000, getting the crowd excited with strong breadth, which was near the peak of the market.  I could picture a similar situation in early 2024 as the Fed becomes more dovish as jobs numbers come in weaker.  Under that situation, bonds would rally on the weaker economy helping the Russell 2000 more than the Nasdaq 100.  That would be the ideal scenario to fade the crowd getting bulled up as breadth improves.  

For the current market, we are getting close to good risk/reward levels to short long bonds.  Also close to good levels to short is crude oil, as it trades weak vs other risk assets and is in a seasonally weak time period.  It could be a buy the rumor, sell the news event for the OPEC meeting as many are expecting more production cuts.  SPX is still a no touch.  There are a few laggards which I am keeping an eye for shorts, like TSLA, but I'm holding my fire for now.