Waiting Game

Many people were surprised by how sanguine Powell is about inflation despite the hotter than expected CPI and PPI over the past 2 months.  Powell basically telegraphed his views in front of Congress a couple of weeks ago.  His default position is to cut 3 times this year, and to start in the summer.  Its going to take a lot of bad inflation data and hot jobs numbers to get him off that position.  

The knee jerk reaction from looking at a soaring stock market is that Powell is making a mistake by making financial conditions too loose.  But investors basically are living in a bubble of their own making.  For investors, the economy is secondary in importance to the stock market.  Since the SPX is making new all time highs on a regular basis and is on a rocket ship higher, investors think the economy is doing just as well.  Because they are getting richer.  But if you get down to the real economic numbers, its a mediocre economy.  Full time jobs are in a downtrend, something usually seen right ahead of or in recessions.  Retail sales are also flattening and going lower.  

I hate to admit it, but Powell made the right move to not waffle on his original position of cutting 3 times this year, even though you got hotter inflation prints.  The real economy is just not as strong as the stock mongers will have you believe.  

The most common reason I hear for continuing strength in the economy is the large budget deficits and fiscal dominance.  There is a bit of truth in that, but a lot of that fiscal stimulus is being offset by both the reduction in the Fed balance sheet and the reluctance of banks to lend and businesses unwilling to borrow at high rates.  Loan growth is non existent, and much of the fiscal budget deficit now goes to paying interest on the debt, which is money that mostly flows to the rich, who have a high propensity to save rather than consume that interest income.  Before 2020, a big portion of the increase in money in circulation was coming from increased bank lending.  That money was going to high propensity to consume/invest borrowers which boosted the economy more than the current setup of force feeding high interest to buyers of Treasuries and money market funds.  

Big fiscal deficits are not a cheat code for strong economic growth.  Unless its accompanied by central bank bond buying, it leads to crowding out of private borrowers via higher yields.  

That is why this bubble in the SPX and NDX is so puzzling.  Bubbles usually happen when the economy has been hot and growing rapidly, not when investors are confident in a soft landing and lower interest rates in the future.  But the high valuations, investor psychology, and rampant speculation in AI and bitcoin show we are clearly in bubble territory.  While bubbles usually end badly, they go on for longer than any rational person could assume.  Its why I've been cautious about shorting this market.  To short a super strong bubble like this, you need almost everything to line up perfectly to put on a good risk/reward short where you don't have to take too much heat.  Entering shorts too early and taking heat in this type of  market is asking to get squeezed and stopping out at the top.  

Here are some missing ingredients for a top which I am still looking for:

1) Asset managers in the COT data getting aggressively net long SPX futures.  While they are quite long, they have been reducing long positions as the market has been going higher.  That's not an ideal short setup.  

2) More good news from economic data.  You need to see the CPI and PPI numbers coming down, and coming in below market expectations.  SPX has been marching higher despite bad inflation numbers.  You want to see good economic data, Treasury yields going down, excessive optimism, and short term overshoots.  These bad inflation numbers are keeping investors somewhat cautious, which is not a good setup for shorts.  

3) Fewer investors looking for a pullback.  Some of the most reliable contras on Twitter are fighting this rally, and looking for a correction, which keeps me away from shorts at the moment.  I want to see more investors embrace this rally as it goes higher.  Not seeing that yet.  

From a long term perspective, this stock market seems nuts but you have to be data driven and process oriented.  The data is still not overwhelming enough for me to get short, and it may take longer than I originally expected (late March) to reach the top of this move.  We may need to see some more favorable economic data / higher confidence in the Fed cutting 3 or more times this year to get the euphoria needed to form a top.  That means we could be waiting till mid April to early May before we top out.  I'll let the data and positioning guide my views.  Definitely not going to take a stand here just because the SPX is higher than my initial price target to start a shorting campaign.  Powell gave the green light for further speculation with his dovish stance.  That could be the catalyst to get more investors excited to form a blowoff top.  Waiting for it patiently.  Still long bonds, but will trim some if they rally further in the coming days.