tag:blogger.com,1999:blog-17154395302789246052024-03-19T08:39:47.145-04:00Market OwlMarket Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.comBlogger3012125tag:blogger.com,1999:blog-1715439530278924605.post-77284634227439252802024-03-11T06:26:00.001-04:002024-03-11T06:26:30.914-04:00Ripe for a Conflagration <p>The conditions are getting closer for a raging inferno. The weeds have grown like mad, with no fires to keep the growth in check. The Fed and US government are complacent, confident, and content with no major blazes in the past year. In particular, US politicians have passed the buck and blamed inflation on everyone but themselves. Same with the Fed. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9ogZiOp5-qqgkZoPClvhUbjCOvf83zU5M6ZwGfp_kgDtLM5XEye3h3Y6FxdrUue5CMZ01u8rvwCV-UmrC1MkS2u5K7dhG4r85_CXR4qc0oMy57t6WfD0T-aBxBE96YgTvrFvwn44Y38ip73dsWS_DFdM2qkOBmKakqkJHWeNPw9BcABwByi8X7XOdQZI/s600/inflagration.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="332" data-original-width="600" height="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9ogZiOp5-qqgkZoPClvhUbjCOvf83zU5M6ZwGfp_kgDtLM5XEye3h3Y6FxdrUue5CMZ01u8rvwCV-UmrC1MkS2u5K7dhG4r85_CXR4qc0oMy57t6WfD0T-aBxBE96YgTvrFvwn44Y38ip73dsWS_DFdM2qkOBmKakqkJHWeNPw9BcABwByi8X7XOdQZI/s320/inflagration.PNG" width="320" /></a></div><p></p><p>Looking at the SPX chart, we are in the late stages of a blowoff top. The launch angle of this rally is getting steeper, with limited consolidation. Ever since the market blew through 4800 in mid January, its been a steady, epic run, going up almost 400 points with no pullbacks lasting more than 2 days for the past 50 days. Let's look back at some past parabolic rallies that made new all-time highs with hardly any pullbacks. Maybe we can find a pattern.<br /></p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwCBGBtnBk7tBBakkhyphenhyphen3nbB0pqw7s65uqBku740Sdwee-mAYQcllfbCJAY1pj68-FmUr12Oz_fQNymLuLlfg4lbI5MtsUE3DAhCGRNMXv2nNHu_ZRYSAH58Uw5x13mHrdYvDGJrpcvMbrcvqEdEIV9ORV3aQQi3S6pBByErRn0S69esJI0kTBUuEhg7T4/s939/SPXMay2013top.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="524" data-original-width="939" height="358" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwCBGBtnBk7tBBakkhyphenhyphen3nbB0pqw7s65uqBku740Sdwee-mAYQcllfbCJAY1pj68-FmUr12Oz_fQNymLuLlfg4lbI5MtsUE3DAhCGRNMXv2nNHu_ZRYSAH58Uw5x13mHrdYvDGJrpcvMbrcvqEdEIV9ORV3aQQi3S6pBByErRn0S69esJI0kTBUuEhg7T4/w640-h358/SPXMay2013top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">May 2013 top<br /></td></tr></tbody></table>This one was a minor blowoff top, as the buildup wasn't that extended and there wasn't the euphoria or speculative excess seen in other parabolic moves. The trigger for the drop was a sharp rise in bond yields in May/June. The selloff only lasted a few weeks, and it was followed by further rallies throughout the year to make for a huge up year. <p></p><p> </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkUaYsdLv2ol5wmY4aasOdOq4S6w4tP6gFW32JGsEjN4RKVRaNrGVvP6DCTOvc9wvfey6g8EbtEoyZkHF8O9bxveKOBHU-bd-r28gvIJZCEpHwSsnt-engBaDslpJHV6Q5p9pd8RN_qGpXDSr9QhbOXqyQSk_kQeZP0BcykrhMunug7vvPYopPVwnOwjk/s949/SPXJan2018top.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="528" data-original-width="949" height="356" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkUaYsdLv2ol5wmY4aasOdOq4S6w4tP6gFW32JGsEjN4RKVRaNrGVvP6DCTOvc9wvfey6g8EbtEoyZkHF8O9bxveKOBHU-bd-r28gvIJZCEpHwSsnt-engBaDslpJHV6Q5p9pd8RN_qGpXDSr9QhbOXqyQSk_kQeZP0BcykrhMunug7vvPYopPVwnOwjk/w640-h356/SPXJan2018top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">January 2018 top</td><td class="tr-caption" style="text-align: center;"><br /></td></tr></tbody></table><p>This was a significant blowoff top, when VIX selling became popular as the VIX went under 10. In the final stages of this top in January, you can see the uptrend getting steeper. The post Trump tax cut euphoria as well as the relentless uptrend in 2017 got investors complacent and greedy in early 2018. A huge spike in the VIX caused the short VIX ETN XIV to get liquidated in a panic. There was no news catalyst, the market just collapsed on itself. The market traded sideways to higher for the next several months. </p><p> </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3keFIjsXpd8_3o0OfehATpbdwRDAt7xa63EsQbbCbKg_oboVzO2S4LEOuCJAN3IpVKh4CON6QJxLlNfcLuBNIr5uDR00lL1XmwckdJwkAKLZYp6gW7E6U1HXCxADpDuw2JBlPhfobuHssbmqDztsQNYhVj09w16KFlxNv2w4wL7lUOhDG-e71Yq3vVUk/s942/SPXFeb2020top.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="534" data-original-width="942" height="362" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3keFIjsXpd8_3o0OfehATpbdwRDAt7xa63EsQbbCbKg_oboVzO2S4LEOuCJAN3IpVKh4CON6QJxLlNfcLuBNIr5uDR00lL1XmwckdJwkAKLZYp6gW7E6U1HXCxADpDuw2JBlPhfobuHssbmqDztsQNYhVj09w16KFlxNv2w4wL7lUOhDG-e71Yq3vVUk/w640-h362/SPXFeb2020top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">February 2020 top<br /></td></tr></tbody></table><p>Who knows how much further the rally would have gone without Covid, but the market was vulnerable to a selloff as a breakout above 3000 in October 2019 resulted in a 10+% rally making all time high after all time high for over 3 months with hardly any pullbacks. Even without Covid, the market was ripe for a decent correction. <br /></p><p> </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNl4SRnR3Ev8EbbPvj5BfEXdPvp3N45m9zl15lEym06dsEKL7Ypx14S7RkxwlGHfXh33pv8kRIYCJcj7GjRP8IglP1dwYJhXHvxUsftPjsLp5WNeyIacFglsCrQjcoUBQuYjV3MPZxI0zgO9zaAPNot3fmREENYH6Fw9OXCNBIaeHNUXr8SCZWnn8uaPU/s946/SPXSep2020top.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="530" data-original-width="946" height="358" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNl4SRnR3Ev8EbbPvj5BfEXdPvp3N45m9zl15lEym06dsEKL7Ypx14S7RkxwlGHfXh33pv8kRIYCJcj7GjRP8IglP1dwYJhXHvxUsftPjsLp5WNeyIacFglsCrQjcoUBQuYjV3MPZxI0zgO9zaAPNot3fmREENYH6Fw9OXCNBIaeHNUXr8SCZWnn8uaPU/w640-h358/SPXSep2020top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">September 2020 top</td><td class="tr-caption" style="text-align: center;"><br /></td></tr></tbody></table><p>This was a minor blowoff top to new all time highs, 5 months after the Covid panic bottom. This rally was led by tech stocks and the speculation was quite hot in Nasdaq names. There was no catalyst for the selloff, although there were rumors of Softbank buying calls on QQQs and big cap tech stocks which could have caused a short squeeze in late August/early September. </p><p>If you go back farther, there are other instances of parabolic rallies in SPX, most of which ended with sharp pullbacks. On occasion, there were mild pullbacks with a several week consolidation period to digest the gains and get investors used to buying at higher prices. But those were the exception, not the norm. The general pattern for these parabolic rallies when they end is a sharp, steep pullback, not a gentle, calm selloff. <br /></p><p>The intermediate term(1-2 month) risk/reward is now getting more skewed to favor shorts over longs. At current levels, shorts are likely to only lose a small amount if wrong, but have possible big gains if right. On the other side of the coin, longs are risking big losses with small possible gains. Yet, despite conditions becoming more favorable for shorts than longs at the present time, I expect them to get even more favorable, i.e., a bit more of a rally higher before the correction. You still have CPI coming up and the Fed meeting next week, and I expect both to be fuel for bulls to get more bullish. Expectations seem to be leaning for a hot CPI number, as many are still in the strong economy, sticky inflation camp. Market pricing has come down quite a lot for rate cuts in 2024, with less than 4 rate cuts priced into the SOFR curve. That gives a lot of room for more cuts to get priced in if the data gets soft. The crowd seems to have fully bought into the soft landing, even some no landing scenarios and the STIRs pricing reflects this. <br /></p><p>There is a fly in the ointment for the bear case. Looking at futures positioning from the COT data, you have seen asset managers pullback from their extreme net long position in the past few weeks, despite the SPX going higher during that time. This is a bit unusual, as asset managers are usually adding to their net long positions as the market goes higher. </p><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhANPq0D2b_lgL73sqbtmZrKDXtDo_8XiwHkjM0RbeTzYOuBuvmV-zlmDtPmhmBnxxPjCLwL7DmIV8t0y7C1iteNNnSma9A2y0CdJsqgDqxjIbc223caNJW4dOgA4to_SA_cno6wBrAgiYCn9sWuWDCp8Hx8JHPTsQQHxG8EMX_-x8j0NZccMZrTbitAt4/s1102/SPXCOT03052024.PNG" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="677" data-original-width="1102" height="394" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhANPq0D2b_lgL73sqbtmZrKDXtDo_8XiwHkjM0RbeTzYOuBuvmV-zlmDtPmhmBnxxPjCLwL7DmIV8t0y7C1iteNNnSma9A2y0CdJsqgDqxjIbc223caNJW4dOgA4to_SA_cno6wBrAgiYCn9sWuWDCp8Hx8JHPTsQQHxG8EMX_-x8j0NZccMZrTbitAt4/w640-h394/SPXCOT03052024.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">SPX Net Positions for Asset Mgr and Dealers<br /></td></tr></tbody></table><p></p><p>Asset manager net longs were highest on Jan 30, when SPX was at 4951. With SPX at 5085 on Mar 05, their net long position have reduced by 51K contracts. You can also see dealers reducing their shorts from early January to March 05. For the best shorting opportunities, you want to see asset managers getting longer and dealers getting shorter as the market goes higher. Either a speculative blowoff top with steep gains in the coming days or asset managers getting longer/dealers getting shorter in the upcoming COT reports will provide more confidence in putting on shorts. </p><p>On Friday, we got a little glimpse of how fragile this market is with NVDA trading in a 100 point range on no news, as it sold off hard from extreme overbought conditions. The air is thin up here, especially for the most speculative AI related names. You can smell the dry tinder getting close to the smoking point, before you get the huge wildfire. There is a lot of dry underbrush that's been growing wild since the last fire, providing the fuel for the next conflagration. </p><p>I am still sticking with my late March/early April top prediction. You <i>still</i> see analysts on CNBC and Bloomberg fighting this rally, being cautious, which makes me wary of putting on shorts at the moment. I need to see asset managers all in on the long side before I go all in on the short side. Until then, I would only put on a small starter short position and nothing sizeable. Still long bonds, which I will look to close out in the coming weeks.<br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com4tag:blogger.com,1999:blog-1715439530278924605.post-60048155106636681642024-02-29T07:17:00.003-05:002024-02-29T10:24:58.815-05:00Tight Corporate Spreads<p>For those looking for an immediate bear market, its quite unlikely. Corporate bond spreads are getting tighter over the past few months. Ahead of previous bear markets or near bear markets (Aug 2015, Dec 2018), corporate spreads always were widening before the SPX downtrend started. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMgj1yFgRVqXzDx15GBwFQBu6qFP1wTM0irsW1eesffCbsiBKtFvZuu3-kl-IsyD5wqG08mWiG0Vs6Sqv0oprgPCtpfXcRiQo4n5ti33xZRAEEHlpyu2fOsOPnctcj4ZYy3tgGl0q4zDZoH_2jWdDHsdZ4lNNTsHW79aEcbsvINKpgbEu4KHFGHgdenjM/s1122/bondspreads02292024.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="490" data-original-width="1122" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMgj1yFgRVqXzDx15GBwFQBu6qFP1wTM0irsW1eesffCbsiBKtFvZuu3-kl-IsyD5wqG08mWiG0Vs6Sqv0oprgPCtpfXcRiQo4n5ti33xZRAEEHlpyu2fOsOPnctcj4ZYy3tgGl0q4zDZoH_2jWdDHsdZ4lNNTsHW79aEcbsvINKpgbEu4KHFGHgdenjM/w640-h280/bondspreads02292024.png" width="640" /></a></div><p>There are 2 exceptions however: 2011 when corporate bond spreads were already historically elevated before going even higher and 2020 when Covid happened. So based on this alone, it looks quite unlikely that there will be a credit event that triggers a big move lower in SPX. It doesn't preclude a short term panic lower like late Jan-Feb 2018, when corporate spreads were tightening but SPX went down big anyway because the index was massively overbought and going parabolic. </p><p>Despite tight corporate spreads, I am a believer that SPX upside is limited given current high valuations, the length of the rally (4 months since the last meaningful bottom), and future prospects for growth (poor). <br /></p><p>Usually what happens in a market like this is the market grinds higher, and suddenly, there is a sharp pullback, which causes corporate spreads to widen, with Treasury yields going down. Then, the market recovers the losses from the pullback as the crowd expects the Fed to turn dovish, and yields stay lower, and corporate bonds don't tighten as the SPX rallies from the pullback. This is what happened in 2000, 2007, and 2015. </p><p>Last week's blowout earnings from NVDA has helped to keep the parabolic trend intact, and its still a stock that I would avoid shorting given its strength relative to the market. I am a non-believer in the AI hype, and the current investment spending on AI from venture capital to big tech will likely fizzle out sooner than people expect as the return on that investment will be poor. The only real immediate impact from AI is its use in graphics, and that market is not big enough to support all this spending. Once big tech realizes that AI is more like the metaverse than the internet, they will do what META did a few years ago and stop spending. The biggest beneficiary of that AI spending is NVDA, so you can guess what will happen to NVDA's stock when that spending contracts. </p><p>With regards to the current SPX rally and when it will top out, my best estimate is late March/early April. These strong rallies usually go on for 4-5 months before a meaningful pullback, and this one will probably lean more towards 5 months because the current price action is not indicative of a topping market. What you need to see is more optimism about the Fed (with bond yields going lower) to get the excitement and euphoria going. That's still missing. I don't see this market going into a sustained downtrend based on a hawkish Fed. You need to see weaker economic data (lower jobs, lower inflation) to get the bond yields lower and higher anticipation for lower rates. Only after that happens, along with another few percent move higher in SPX can you think about shorting this monster. </p><p>Reduced my bond position, but will increase it again if I see yields go a bit higher. Still think the next big correction in the SPX will be accompanied by bond yields going lower, not higher. </p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com4tag:blogger.com,1999:blog-1715439530278924605.post-47654980033297252152024-02-21T06:59:00.003-05:002024-02-22T09:09:15.249-05:00Hot Air Balloon<p>The balloon keeps floating higher, the view gets better and better. But remember, this balloon is floating up on hot AIr. AI is the hot gas that keeps this going up and up. Eventually the balloon will run out of gas. </p><p>For much of January, we began to see divergences in the stock indices, as the haves (mostly tech growth stocks) kept going higher, while the have nots (most of the remaining sectors) went lower. We also saw the stock/bond correlation break down, with stocks going higher even as bonds kept going lower. Last week, the higher inflation prints finally put a little crack into the stock market. Although being down 1.5% from all time highs isn't much, looking at the big picture. Especially after the run the SPX and NDX have had over the past month. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEih5STpF-2c3ropMgJ24TAayfs9li9ymtdrCsp8zcVu76ITCd0gjfnLQ5zizma_C1yScadsRSIaV0ZLbCBMWgbU1Q21XkrflW53XWTo738_UEh3fLY9N_KtB8Lstx4UH9Fs4kUJu2f4gG9wALuzjKEY45NMYRli4vvj3Y3clGnIHO8IbwrmXB_HaroY2tI/s495/hotairballoon.jpg" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="332" data-original-width="495" height="215" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEih5STpF-2c3ropMgJ24TAayfs9li9ymtdrCsp8zcVu76ITCd0gjfnLQ5zizma_C1yScadsRSIaV0ZLbCBMWgbU1Q21XkrflW53XWTo738_UEh3fLY9N_KtB8Lstx4UH9Fs4kUJu2f4gG9wALuzjKEY45NMYRli4vvj3Y3clGnIHO8IbwrmXB_HaroY2tI/s320/hotairballoon.jpg" width="320" /></a></div><p></p><p>But the speculation and complacency are building. Look at the 20 day moving average of the ISEE call/put ratio (buy to open orders only), its at the highest levels in the past 5 years, which includes the most speculative market I've ever seen (2021). Its maintained this high level since late December. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiro8WcXUiWB3-v9X5nTslSuPuIxRyexNsf20ACACs53gcp17sC2KoeGsib4gLmSnVTC1mR0xL4txQH6wkdLV6I8QmGt6sxW3x7AouKOdpvYTtXrs8fx47-lNA05ol3vzVP8jUF4DAGoFXL3nMIbW153EqKItEeUpmJtJKx-Q8yLNYm6l_Y_VAa_LfEMK0/s1227/ISEEindex02202024.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="792" data-original-width="1227" height="414" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiro8WcXUiWB3-v9X5nTslSuPuIxRyexNsf20ACACs53gcp17sC2KoeGsib4gLmSnVTC1mR0xL4txQH6wkdLV6I8QmGt6sxW3x7AouKOdpvYTtXrs8fx47-lNA05ol3vzVP8jUF4DAGoFXL3nMIbW153EqKItEeUpmJtJKx-Q8yLNYm6l_Y_VAa_LfEMK0/w640-h414/ISEEindex02202024.jpg" width="640" /></a></div><br /><p>And the poster child of this market's speculative froth: SMCI. It went parabolic going into February opex as the options speculation went through the roof, and we got one of those bubble blowoff tops. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfNIf89ZGk7REnBGOgvfIuj0-xEnRO0xWyDm3piiQTOKaI8Tzoh6STF44VDaWpYFH19xqN8o9ve72GG1-sTKgmrTPYlz6P2k-Jes24VmzG3pnpXow9h9Zyk0kSqVpyDDinmOx5J9eEQuikxV4GqivCAepjFJ3xM40ofBV1NPX3Xx8qLFLDMHK5teXCq6E/s1267/SMCI02202024.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="641" data-original-width="1267" height="324" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfNIf89ZGk7REnBGOgvfIuj0-xEnRO0xWyDm3piiQTOKaI8Tzoh6STF44VDaWpYFH19xqN8o9ve72GG1-sTKgmrTPYlz6P2k-Jes24VmzG3pnpXow9h9Zyk0kSqVpyDDinmOx5J9eEQuikxV4GqivCAepjFJ3xM40ofBV1NPX3Xx8qLFLDMHK5teXCq6E/w640-h324/SMCI02202024.jpg" width="640" /></a></div><br /><p>The high call options activity, the optimism about the US economy and AI, historically high valuations, and a Fed that is on the cusp of an easing cycle are all dry tinder for the upcoming fire. All you need is one drop of a match to light a huge blaze in the market. The bulls will say that there is no better game in town, that the US government continues to run a high pressure economy with big budget deficits which feeds into corporate profits, and that fiscal dominance makes tight monetary policy less relevant. I would agree if those big budget deficits were happening along with strong growth in bank credit/lending, but its not. The US government has effectively crowded out the private sector with its inflationary deficit spending which has raised interest rates to the point that the private sector has pulled back on borrowing. And many banks are stuck with bad MBS and Treasury supply bought at low yields a few years back, and are in survive not thrive mode. Both the government and the private sector were on a credit binge from 2020 to 2022, and while the public sector has continued on since 2023, although at a lower, but still high level, bank credit growth has stopped growing. </p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBA259jeDi6W27Ctwf6bQpUm9Aqn0ODZdIjmROPZThgG08kvO6-Luy3pvh9QoZWa9LBCRN5ndwkJNd5IhpzNZ79qd-ypKXGZ73de_dasSXxc2HTG6JjAkdlll17-GeQXmukI41YQlbmp7QkjZdbw2d9SN21VaSvx5e6jGw3babvEaMr2MVckaTmU_Tm30/s1187/bankcredit02202024.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="571" data-original-width="1187" height="308" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBA259jeDi6W27Ctwf6bQpUm9Aqn0ODZdIjmROPZThgG08kvO6-Luy3pvh9QoZWa9LBCRN5ndwkJNd5IhpzNZ79qd-ypKXGZ73de_dasSXxc2HTG6JjAkdlll17-GeQXmukI41YQlbmp7QkjZdbw2d9SN21VaSvx5e6jGw3babvEaMr2MVckaTmU_Tm30/w640-h308/bankcredit02202024.jpg" width="640" /></a></div><p></p><p>When the government takes over the role of increasing the money supply rather than private enterprise, you naturally have less productive use of the new money that's created. That's ultimately creates an inflationary structure to the government dependent growth model that the US has embarked on since 2020. With an inflationary structure, yields naturally go higher and stay higher. We are still in a disinflationary cycle because of the lack of new credit from the banks, and due to most of the deficit spending going towards the old and rich, who have a lower propensity to consume their extra cash than the young, poor, and middle class. But if we get the banks lending freely after the Fed has cut rates to more palatable levels for small business (<3%), then you will get another inflation wave as the underlying cause of the inflation hasn't been addressed. </p><p>No, we are not going back to world of low inflation, ZIRP forever, and TINA investing. With higher inflation comes higher bond yields, and more opportunity to get yield without taking equity risk. There is a lot of private lenders who are getting 8%+ yields for relatively safe credits with good collateral. The extra competition for cash in a higher inflation world will put a lid on stock valuations. It makes little sense to pay a 25 P/E for stocks when you can get 8+% in much safer investments. People forget that loans/bonds are higher up on the capital stack than equities and thus usually offer lower long term returns than equities. The way equities offer better long term returns than bonds/loans is through lower valuations, not higher. </p><p>With US population growth running around 0.5% over the past several years, with an aging society and a labor force that's growing less than the population, there isn't that much organic demand for credit. Why would a small business borrow money at high rates to make investments when its business isn't growing nearly as fast as the borrowing rate? The tight labor market is a function of a workers to population ratio which is falling, not a strong economy. You can't even compare the US to where it was 25 years ago, during the dotcom bubble. The demographics were younger, the population growth was higher, and deflationary wave of cheap, high skill labor in China was just getting started. Now its an inflationary wave of less domestic labor, less cheap overseas labor, older population and less population growth. All negatives for economic growth. Yet you have so much optimism about the economy and the stock market at near all time high valuations. These are almost ideal conditions for a long bear market. At best, these are conditions that lead to a long term sideways market with minimal capital gains for equity investors for the next several years. That is the big picture view of the current market. In the short term, its more random but there are intermediate term signals mentioned above that are flashing amber lights. </p><p>Still a stuck long in bonds, which I will hold until I see a better setup to short stocks. NVDA earnings are coming after the close today. No lean on that, neutral on the name. I still think this AI bubble has one last burst higher left in it, it could come after the NVDA earnings, or it could come in the spring. But the bubble isn't at the popping point by looking at what I see in the financial media. From this point onwards, the big money will be made in shorting stocks in 2024, not being long stocks. But timing is always tougher on the short side so waiting for more ideal conditions and for the rally to get a bit older. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-58733138113344513052024-02-12T09:07:00.005-05:002024-02-12T09:07:57.332-05:00Feast or Famine Business<p>Trading is not a steady income business. Those that try to make it a source of steady income like a normal 9 to 5 job usually go the daytrading/scalping route. Without a doubt daytrading has the highest failure rate of all forms of speculation. There just aren't many edges out there on a day to day basis. The edges which do come regularly are dominated by HFT firms which easily beat out retail traders. If you are a retail trader, its an act of supreme overconfidence and hubris to think that you can outscalp these HFTs which specialize in front running and being the first in line on the bid and offer queue. Not to mention the slippage and transaction costs add up quickly the more often you trade. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0SQZE94XbgQT7U0kChfwuomjZ2FsKsoHjscemlHyUvXGNRG2XBrwcI01bTABJVci00ac-FAjS7mIJhZs9s-8E5AoFQePB6U8o6UCrBrxekAFNpVbVHJQ_DkiEuaU5ikkDKiUaIrbdtrEpB9ow3YUJickUZ64TyxqxrK8zPxUY6PiuxgHb0OJwAR4qgr4/s729/feastfamine.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="275" data-original-width="729" height="121" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0SQZE94XbgQT7U0kChfwuomjZ2FsKsoHjscemlHyUvXGNRG2XBrwcI01bTABJVci00ac-FAjS7mIJhZs9s-8E5AoFQePB6U8o6UCrBrxekAFNpVbVHJQ_DkiEuaU5ikkDKiUaIrbdtrEpB9ow3YUJickUZ64TyxqxrK8zPxUY6PiuxgHb0OJwAR4qgr4/s320/feastfamine.PNG" width="320" /></a></div><p></p><p>Trading is a feast and famine business. Its usually long periods of famine with brief periods of feast. Those that try to make steady income during the long periods of famine are trying to squeeze water out a rock. Those that are satisfied with making a steady income during feasting periods are minimizing the opportunity set available during those good times, making a little when they could make a lot. If you have been in this business long enough, you get better at recognizing what are tough trading markets and what are good trading markets. </p><p>Usually, the more volatile the markets get, the better it is for trading. The main reason for this is because markets often get volatile when investors are losing money and panicking out of positions. Predictability correlates with volatility but not always. Sometimes you get volatile markets that are unpredictable. For example, the bond market in 2023 was quite volatile but were hard to predict (Silicon Valley Bank going bust in March, long end panic in September/October). I remember seeing rampant call buying in TLT into a strong downtrend, thinking that it was unlikely so many options punters would make money buying in a market so weak. But they were right, which is uncommon. </p><p>Right now, people are making money, volatility is calm, and investors are not panicking. Its a tough trading market. But I stay in the game, keep watching the markets, put on trades, not trying to hit home runs or make steady income, but to get a feel for when its about to get good again. What trades I make during these tough times are probably slightly negative expected value (EV). But observing the market and making trades helps with timing the next big trade, the time when the markets get good again, when there are many positive EV trades. </p><p>Usually the longer the famine, the bigger the feast on the other side. While 2023 was a good market for investors, it wasn't a great trading market. Especially for those with a bearish lean. For those natural born bears out there, its about to be your time again. We have the ingredients for a bear market lining up. </p><p>1. High valuations and large asset allocations towards equities among individual investors.<br /></p><p>2. Investor optimism and complacency about the economy. Soft landing consensus.<br /></p><p>3. A bubble in AI with greedy investors bidding up other high beta assets like bitcoin.</p><p>The rally off the late October low is now 3.5 months old. Looking at past strong rallies like this off of V bottoms, the average length of the rally is from 4 to 5 months. So we are getting close to the end of this bull run. From a price perspective, this rally has exceeded my expectations. But that just makes for a even more lucrative short setup in the coming weeks. This is opex week, and with how relentless the uptrend has been, you are setting up for a Friday opex day climax top. I don't expect that to be the final top of this rally, but a 3 to 5 day post opex selloff coming off that climax top would not surprise. Something similar to what happened after June 16 2023 opex. <br /></p><p>The goal now is to keep a close eye on the market and participate but not lose too much money while waiting for the good times to arrive. Still long bonds and waiting for a climax top to short SPX. The AI bubble keeps growing, but its still too strong and too early to short. We have NVDA earnings next week, which could serve as a catalyst for the final blowoff top in the name. The sharpest moves occur at the late stages of a rally, so timing is everything when it comes to trying to pick tops in bubbles. I would like to see more 2nd tier and 3rd tier AI bubble plays flying higher to get more confidence that a top is near. We haven't seen that yet, so holding my fire for now. The AI skeptics are mostly gone, and nearly everyone believes is will be a huge breakthrough technology, almost like the 2nd coming of the internet. This usually the parabolic phase of the bubble where the sharpest moves higher happen. Probably in the 7th or 8th inning of this AI bubble, so not much time left for those playing that game. </p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-89859852565083292692024-02-06T06:31:00.007-05:002024-02-06T17:23:17.372-05:00Crocodile Jaws<p>The jaws are widening. SPX keeps going up, and the Russell can't keep up. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFydo1gVBWBD-YyqrcE6Blc_F9P6mGJXBtVnREYyE27fl-phqlK4dHhyVcujGW3eb2VBtBbyMNJaZyBPtcckSZtpou51keKpSx5jYdKv-suqVJOjepfnVWaRSPrr8jJialKSgdVC-I0UL8x9SXGVWLuq_ehT7O4piVhEvLCqyZfETnJ95yQxG5uKBQ-fI/s663/crocjaws.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="362" data-original-width="663" height="175" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFydo1gVBWBD-YyqrcE6Blc_F9P6mGJXBtVnREYyE27fl-phqlK4dHhyVcujGW3eb2VBtBbyMNJaZyBPtcckSZtpou51keKpSx5jYdKv-suqVJOjepfnVWaRSPrr8jJialKSgdVC-I0UL8x9SXGVWLuq_ehT7O4piVhEvLCqyZfETnJ95yQxG5uKBQ-fI/s320/crocjaws.PNG" width="320" /></a></div>The Russell 2000 lagging the SPX is getting egregious. The market is splitting wider and wider, into a small minority of haves, and a majority of have nots. We also got 2 more Hindenburg Omens on the Nasdaq in the past week. That's a total of 5 Hindenburg Omen signals year to date. When you see a cluster of these Hindenburg Omens show up, its a warning shot that the rally is on borrowed time. It can pullback right away, or it can pullback in a month, but there is usually a correction within 2 months at the latest. <p></p><p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh5eJU992eboCuphTd2xLpwi6Y8JT7VCtalGm8JcFi5ioWjqSYixQ_YvZOTbissrwHqxbO8Mrs5F9nJJxrxexGTo0bAaC84RUa-mM53upoUzKQ5owzVKejy9KjkWKPACH54CwTXRe6anR9Yfj8Nzao9VrA2DwuLVwzWSCAJykDuWRuwZLKLUdyIODCln3c/s693/IWMSPY02052024.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="362" data-original-width="693" height="334" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh5eJU992eboCuphTd2xLpwi6Y8JT7VCtalGm8JcFi5ioWjqSYixQ_YvZOTbissrwHqxbO8Mrs5F9nJJxrxexGTo0bAaC84RUa-mM53upoUzKQ5owzVKejy9KjkWKPACH54CwTXRe6anR9Yfj8Nzao9VrA2DwuLVwzWSCAJykDuWRuwZLKLUdyIODCln3c/w640-h334/IWMSPY02052024.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Russell 2000/SPX ratio</td><td class="tr-caption" style="text-align: center;"><br /></td><td class="tr-caption" style="text-align: center;"><br /></td><td class="tr-caption" style="text-align: center;"><br /></td></tr></tbody></table> </p><p>We are also seeing asset managers get more aggressive in adding SPX futures long exposure, as we are now at a 52 week high in asset manager net long positioning. Dealers also got more short, although not at 52 week lows in positioning. These are not outright sell signals, as rallies in bull markets can last for several months without a correction. But this adds to the weight of evidence tilting the odds in favor of a down move over an up move in the next 3 months.<br /></p><p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPaBQtuDE0ZFOXyOcZCYjd9ob-xA0QwTUOekkaSVYShY_ebyK7JEssX7Et7vup1nD6aXxwG07MMF5Lta4QTmhUEP_YQTbiqmJs9Dewk3Yvl47j_8ot6CzWNYErX7ZaW9GiRv1bILAPtoCSfotCLjJxTj7rgDhAnodh0bKcOA9LJHGzyZOnVtAp1ou-YhE/s1110/SPXCOT01302024.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="679" data-original-width="1110" height="392" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPaBQtuDE0ZFOXyOcZCYjd9ob-xA0QwTUOekkaSVYShY_ebyK7JEssX7Et7vup1nD6aXxwG07MMF5Lta4QTmhUEP_YQTbiqmJs9Dewk3Yvl47j_8ot6CzWNYErX7ZaW9GiRv1bILAPtoCSfotCLjJxTj7rgDhAnodh0bKcOA9LJHGzyZOnVtAp1ou-YhE/w640-h392/SPXCOT01302024.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">SPX Net Positions of Asset Managers and Dealers<br /></td></tr></tbody></table> </p><p>Two main things we learned over the last week: 1. Powell is going to try to delay rate cuts into at least May, if not longer 2. AI tech bubble is getting even bigger. </p><p>Powell is getting brainwashed by all the soft landing talk, about how its too early to cut in March from the investment community, and he followed through. Powell is known for lacking backbone, and he proved it once again, going with what Wall St. wants. Even when acted like the second coming of Volcker in 2022, it was only because Wall St. was going crazy over inflation and he had to do something about it. So Powell will let these higher rates deal a bit more punishment to small business. <br /></p><p>NVDA is now over 700. META went up nearly 20% in one day. The breadth is getting narrower as the haves keep roaring higher, and the have nots just stagnate or drip lower. One thing you have to realize about big tech stocks like META, GOOG, MSFT, AAPL, AMZN, NVDA, etc. are that they are not a net positive for other companies. They are a net negative. Big tech stocks back in the old days used to be drivers of economic growth. Now they are just rent seekers, parasites trying to push profit margins up as high as possible, seeking the maximum point on the profit curve. </p><p>META raising prices on ads, reducing or completely eliminating exposure for non paying accounts in favor of accounts paying the most ad money to Facebook/Instagram. META is trying to squeeze out as much ad money from their customers to the crying uncle point, because there are almost no alternatives in internet advertising. GOOG doing similar things, although not as egregiously as META. AAPL pushing out the same phones with just slight tweaks and charging more for it because their customers are addicted and/or don't know how to switch to Android. NVDA selling overpriced graphic cards and trying to bundle it with other services which are also overpriced. These companies are becoming kings of rent seeking, not innovation. MSFT and AMZN are basically a data center duopoly, and can push up pricing at will because its such a huge pain to go from outsourcing to making and running your own data center. </p><p>There is such a huge bubble in AI, where the hype is so thick that big tech companies are shooting first (investing in AI) and asking questions later. They don't have the slightest clue on how they will monetize whatever they develop with AI, but it sounds cool, and Wall St. loves it, so they keep doing it. NVDA is the main beneficiary of this shoot first mentality, but how long does this last for? Will companies continue to send billions to NVDA for overpriced chips to build up their AI capabilities when its all just money going down the drain? I know this sounds like a crazy comparison, but the AI craze reminds me a bit of META going bonkers about the metaverse back in 2020 when people were holed up in their homes. We know how that ended up.<br /></p><p>This bloated Mag 7 led rally is just rotten at the core. There is no natural economic growth behind it, just some additional deficit spending that puts a few more dollars in the pockets of the rich, the elderly, and lobbying companies. The current misallocation of capital from nilly willy government spending will haunt future generations. They all say how the economy is so great because of all the job creation. But they forget to mention that part-time jobs are where the growth is, and its coming from the poor needing 2 jobs to get by. Tax withholding data so far this year is showing total wages basically stagnant on a year over year basis. That data is much more reliable than whatever surveys the BLS uses to measure NFPs. Yet when we got the big jobs number on Friday, the Wall St. crowd went into a tizzy, celebrating the great unstoppable machine that is the US economy. Such a great US economy that small cap companies are massively underperforming large cap ones. <br /></p><p>The market is slowly grinding to a top, but the last missing ingredient is the excitement and exuberance you often see at tops. I see less denial than a week ago, but there is not the typical exuberance that one would expect at market peaks. Timing cycle patterns for the SPX still give this rally about 4-6 more weeks to run. So I'm reluctant to get short SPX/NDX until I see more overt signs of a top. I am still long bonds, and investors are overreacting to the nonfarm payrolls and Powell's reluctance to cut rates anytime soon. The bond market will rally big not when Powell decides to cut, but when the data and market conditions urges him to cut. We are not there yet, but with how bubbly the SPX is, I wouldn't be surprised to see a big risk off selloff in stocks coinciding with a strong rally in bonds in the coming months. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com2tag:blogger.com,1999:blog-1715439530278924605.post-78110220930417630692024-01-29T06:49:00.000-05:002024-01-29T06:49:08.750-05:00Fighting the Last War<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvln_ogDtKVqotN5U61N_vSf6LVzkUGi_D4YOAcEdCe2tRjXQpXj7gK1cmj5DIDotzGqM9XaNB8hRvWZYL90tgeQiQhhjdyZP4U0CVZCFtpS4AowxK2F8PrLrd0chWFEKTXNZ9crF-uy5706b0CcV5zduCuBpYYTD9SKqbgE55j2gx3uvN-1_m3TuOjbs/s600/fightinglastwar.jpg" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="450" data-original-width="600" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvln_ogDtKVqotN5U61N_vSf6LVzkUGi_D4YOAcEdCe2tRjXQpXj7gK1cmj5DIDotzGqM9XaNB8hRvWZYL90tgeQiQhhjdyZP4U0CVZCFtpS4AowxK2F8PrLrd0chWFEKTXNZ9crF-uy5706b0CcV5zduCuBpYYTD9SKqbgE55j2gx3uvN-1_m3TuOjbs/s320/fightinglastwar.jpg" width="320" /></a></div>People tend to extrapolate the stock market to the real economy. <br /><br />When the stock market is strong, the economy is considered strong. When the stock market is weak, the economy is considered weak. The stock market is strong. The SPX is around all time highs. So right now, the bias in the investment community is to be positive on the economy. But its clear that the economy is slowing. If the economy was so strong, why would unemployment rates go up in so many states? Why isn't the Russell 2000 stronger than the SPX in an up market? The Russell 2000 usually outperforms when the economy is strengthening. <p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL6Cqbit5P5vE8_8MnK26GTObpsJ9xVfHJ5xq7jipl-lwsXAbZ9QfYVv5J7HqL5Pmfhr3jGH0O4MbvkNwWMewI40mhIuIAXn4CjR5fYOhDmodGnemWPL76CutgKT5Soa5AWNxPi3MBf6zZ-nHC343gqnZLBqn9-b-LnFqjSCG2AalrPTY1yk20gL5HPrs/s1362/stateunemployment.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="810" data-original-width="1362" height="381" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL6Cqbit5P5vE8_8MnK26GTObpsJ9xVfHJ5xq7jipl-lwsXAbZ9QfYVv5J7HqL5Pmfhr3jGH0O4MbvkNwWMewI40mhIuIAXn4CjR5fYOhDmodGnemWPL76CutgKT5Soa5AWNxPi3MBf6zZ-nHC343gqnZLBqn9-b-LnFqjSCG2AalrPTY1yk20gL5HPrs/w640-h381/stateunemployment.jpg" width="640" /></a></div><br /><p><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYJkVrOOxWuIcEGikm3032zGA54uv8fd4iByz88o-bgeL1UCRWuiNBsQ8gngz8p3Yw5hqlm_6HjEX0Rx5On-mS03d-_AKgGNOhahaKfIGfOjsABiK1G6X2sPqKfN5zmjWAzdTtftJRHxNFoM6WuJHwQ8_CbOzPSIW7eRhUxDmq04hha-hXRYgicHw6ONM/s682/iwmspyratio.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="314" data-original-width="682" height="294" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYJkVrOOxWuIcEGikm3032zGA54uv8fd4iByz88o-bgeL1UCRWuiNBsQ8gngz8p3Yw5hqlm_6HjEX0Rx5On-mS03d-_AKgGNOhahaKfIGfOjsABiK1G6X2sPqKfN5zmjWAzdTtftJRHxNFoM6WuJHwQ8_CbOzPSIW7eRhUxDmq04hha-hXRYgicHw6ONM/w640-h294/iwmspyratio.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Russell 2000/SPX ratio<br /></td></tr></tbody></table><p></p><p>The signs are there that the economy is slowing. But all I hear on CNBC is how the economy is strong enough that the Fed doesn't need to cut, that too many rate cuts are priced into STIRS. But that's flawed logic. The market rallied strongly in November and December because of increased rate cut expectations, not in spite of them. If you take away those rate cuts priced into STIRs and the rest of the yield curve, then the stock market weakens, and financial conditions tighten. </p><p>I rarely hear anyone say that the market pricing is about right, or that its not pricing in enough rate cuts because the economy will weaken in 2024. People are fighting the last war, inflation. There are more people worried about inflation re-igniting than about a hard landing. I still hear talk about how Jerome Powell doesn't want to repeat the mistake of cutting early like Arthur Burns. Are we still in 2022? I thought we found out a while ago that Powell is no Volcker. Disinflation is likely to continue. There are so many biases built into the CPI and PCE that understate inflation that's its not easy to get high inflation numbers showing up in the government stats. With the lagging effect of lower rents feeding into owner equivalent rents in the CPI, expect inflation to slowly go down over the next few months. </p><p>As for the jobs market, its hard to keep getting big jobs growth when the working age population is hardly growing. The post Rona catch up hiring done from 2021 to 2023 is behind us. Yes, the jobless claims numbers haven't gone up, and NFPs are still showing solid job numbers, but government tax receipts are weak for January, month to date. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipa8EbPw_nW4NmnLjMw8J9c6Y7XaQBoO-BGYbgymVCMvjgZBIuTtO1hsOYpusvKkwyBIakCbng2ld8zTiElk6DfNSuEegSZbp4e-QpNue6Z2JmdCm3nOGrCa8hINZgEhbagJxPmq1B7l-PucaExp_MlOiz19L_m22GMbNiXJgvqRlybqdZjtcBbzetUlM/s588/taxreceiptsjan282024.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="489" data-original-width="588" height="333" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipa8EbPw_nW4NmnLjMw8J9c6Y7XaQBoO-BGYbgymVCMvjgZBIuTtO1hsOYpusvKkwyBIakCbng2ld8zTiElk6DfNSuEegSZbp4e-QpNue6Z2JmdCm3nOGrCa8hINZgEhbagJxPmq1B7l-PucaExp_MlOiz19L_m22GMbNiXJgvqRlybqdZjtcBbzetUlM/w400-h333/taxreceiptsjan282024.PNG" width="400" /></a></div><br />You have seen quite a few layoff announcements this month. Its nothing alarming, but companies usually don't do layoffs if they think the economy is strong. <p></p><p>Could it be that the effects of the Covid stimmies are starting to wear off and the lagged effect of 525 bps of rate hikes are starting to slowly kick in? I heard so much talk about the lagged effect of Fed rate hikes in 2023, but now, when they should start to kick in, its crickets. Higher interest rates work quickly in the financial economy, but they work slowly in the real economy. Even if the Fed cuts 125 bps (what is priced into Fed funds futures for 2024), that doesn't really stimulate the economy. Its just less restrictive. It wouldn't keep the stock market from going down, if god forbid, we actually got this bubble market to pop and go down. 125 bps of cuts would still keep real rates positive, and 5 year corporate bonds would still be rolling over at more than 200 bps higher yields than 2019. </p><p>The Fed doesn't usually mess around with 25 bps paper cuts when jobs numbers are getting weak in a disinflationary environment. The Fed took its time in 2019 to cut because rates weren't that high, and the economy wasn't that weak. This time around, real rates are much higher, monetary policy much tighter, and I would argue the global economy is weaker now than back then. Back in 2019, at least you had Europe and China that were relatively strong compared to now. Those countries help contribute to disinflationary pressures for goods in the US. </p><p>I wouldn't be surprised if the Fed funds rate was below 3% by year end. That's 250 bps of cuts, most of which would come in the form of 50 bp increments. I could see the Fed doing 25 bps/meeting for 2 meetings in the spring, realize that its too little as stocks continue going lower, NFPs continue coming in weaker, forcing them to up the pace to 50 bps/meeting until year end. If they start in May, they could cut 250 bps in 6 meetings in 2024 under that scenario. I see that as being much more likely than the Fed dot plots of 3 rate cuts for 2024 as the economy just hums along without any worries. </p><p>We got some geopolitical worries hitting the overnight markets as crude oil went up, but has since settled back towards unchanged. Crude oil already rallied the past few days going into the weekend ahead of potential Middle East risk, so its not that surprising that there was little reaction from crude oil. After the trauma from higher oil prices in 2022 after the Russian invasion Ukraine, you still see overreactions to any piece of news coming out from the Middle East. Geopolitics is now always considered a concern for investors, even though it had no real effect for the two decades prior to 2022. </p><p>Its a heavy event week with big tech earnings lined up, QRA and FOMC on Wednesday, and nonfarm payrolls on Friday. With the SPX in a strong up trend going into these events, I don't expect much selling after any of these events. If there is a dip, it will be brief and immediately bought up. As is typical for an <a href="https://marketowl.blogspot.com/2023/12/event-trading.html">event packed week</a> in a strong uptrend, the odds favor the bull side for both stocks and bonds. I bought some bonds late last week, looking to hold for the next few weeks. No position in stocks at the moment, but the COT data came out bullish with dealers covering shorts into the rally, and asset managers selling. It jives with what I am hearing on CNBC, which is skepticism about this rally. Its going to take time to form a top, definitely not seeing signs of a top yet in the positioning data. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com6tag:blogger.com,1999:blog-1715439530278924605.post-85835250957037547712024-01-24T07:15:00.000-05:002024-01-24T07:15:14.349-05:00Split Market<p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYJmiRppc18Ti9OCZy8zsNwvuA1GzFl8KwU6c1Crt0vyHhYJpifrMQpKoPTvFi6BLeO4HGkjISPQp5y7MpzumiIVy2lWgHZJw68b6DyvZ_HGiUr216ZL7i3mlQm5ieRSLpWR3wky3bQ7G4NWVqQW3-gDnQrAjn0YkkRCqreVqnNwJ5dVQLY-94lar3Qz8/s498/crackkenya.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="364" data-original-width="498" height="234" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYJmiRppc18Ti9OCZy8zsNwvuA1GzFl8KwU6c1Crt0vyHhYJpifrMQpKoPTvFi6BLeO4HGkjISPQp5y7MpzumiIVy2lWgHZJw68b6DyvZ_HGiUr216ZL7i3mlQm5ieRSLpWR3wky3bQ7G4NWVqQW3-gDnQrAjn0YkkRCqreVqnNwJ5dVQLY-94lar3Qz8/s320/crackkenya.PNG" width="320" /></a></div>Its a tale of two cities. The haves and the have nots. The tech stocks are doing great. The rest of the market has been mediocre. In particular, small cap stocks have been lagging badly. Tech stocks are the anointed ones in this environment, as they are valued based on AI hype and its halo effect, while the rest of the stock market has to deal with reality. The reality is that the fundamentals and lackluster earnings growth don't support higher valuations for most of the market. <p></p><p>For a big chunk of the Russell 2000, higher yields are a big drag on earnings, as they are less profitable or unprofitable, with weak cash flows, making them more reliant on debt. The S&P 600 (small caps) has a net debt to EBITDA ratio that's 3 times that of the S&P 500 (large caps). <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuKsDjd1LKQnfrke396eSLNyBynEOSNTKRB5F2Yov4K-M3Bj0V4NvOAJ_6UJ9jvhXiQ9RpEtBw9ZJb73XgS2T-twCZPN2-tnQ_Eg8N6bOrMKEMkCKB4npFisj_q0RSOmuR2-EBbAh20ONszrd-U9Cx-1Rr8lLqsfp57glUQkSwucJRyZlUzC1YDJNzMvs/s761/smallcaplargecapdebt.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="411" data-original-width="761" height="346" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuKsDjd1LKQnfrke396eSLNyBynEOSNTKRB5F2Yov4K-M3Bj0V4NvOAJ_6UJ9jvhXiQ9RpEtBw9ZJb73XgS2T-twCZPN2-tnQ_Eg8N6bOrMKEMkCKB4npFisj_q0RSOmuR2-EBbAh20ONszrd-U9Cx-1Rr8lLqsfp57glUQkSwucJRyZlUzC1YDJNzMvs/w640-h346/smallcaplargecapdebt.PNG" width="640" /></a></div><p></p><p>There is no free lunch in running the economy hot with big budget deficits. Higher inflation leads to higher yields which increases the cost of debt capital. It also leads to higher wages which increases labor costs. When interest expenses and labor costs go up, that squeezes profit margins, forcing nonprofitable or barely profitable companies to borrow more. Increasing leverage makes the bottom of the capital stack, equity, riskier, which is reflected in lower stock prices and valuations. </p><p>We've reached a point where the benefits of higher revenues coming from a stronger economy are less than the costs of higher interest and labor expenses. Its why the stock and bond market correlations have gotten so positive. This is a symptom of higher inflation coming from fiscal dominance, as expansive fiscal policy initially helps the stock market (2020, 2021), but this leads to tighter monetary policy which ends up hurting the stock market (2022). When the lagged effect of tighter monetary policy slows down the economy and reduces inflation, the stock market front runs the loosening of monetary policy by going up, even as earnings growth is weak. This is where we are in the cycle, as stocks front run the rate cut cycle, expecting a soft landing. But the variable this time are the large budget deficits and the need to keep issuing $2T+ of Treasury debt each year to keep the game going. The Fed either lets long end rates stay high to keep the economy from overheating and inflation in check, or they go back to QE and low rates to keep the economy from going into recession, risking a resurgence of inflation. </p><p>We are in an interesting spot where the lagged effect of higher rates is hitting small caps and small businesses, while the rich keep getting richer as the SPX goes higher and they collect 5% on their excess cash, most of it coming from the government's huge interest expense. Its a torturous trickle down effect where the rich with excess cash get paid higher interest from the government and corporations at the expense of small businesses having to pay more interest on their borrowings. Since the rich are so flush with cash, as stocks keep making new all time highs, and collect lots of interest, that money finds its way into the stock market. Its a virtuous cycle fed by the government running big deficits. </p><p>So what breaks this virtuous cycle? A couple of scenarios would do it. </p><p>1. Enough small businesses and small cap companies start cutting back on labor to protect their profit margins, leading to higher unemployment, and less revenues and thus lower earnings. More corporations have to start feeling the pain from higher interest and labor costs for this to happen. </p><p>2. Inflation makes a comeback, rebounding to higher levels, keeping the Fed from making big rate cuts. This is what most people seem to fear more than a surge in job losses. Although my view is that job losses are much more likely than another inflation surge in 2024. </p><p>With the SPX making a big breakout towards new all time highs, investors don't have much concern about either of the above scenarios. A soft landing is the base case for most. While there is quite a bit of skepticism about the rally and it going up too far too fast, its based mainly on the belief that the Fed will not cut rates as much as the market expects. I've written in the past few blog posts about this consensus belief, which I believe will be wrong as the economic data comes in weaker in the coming months. Since investors are skeptical about the magnitude of the Fed cuts coming, that's a positive catalyst that still remains to fuel this market higher. You should only consider putting on a longer term short position in US stocks after the consensus starts to buy into the Fed cutting rates more aggressively this year. There is still that wall of worry out there about rates staying higher for longer. </p><p>We've seen the Russell 2000 lag the SPX badly since the start of the year. Here's a look at a couple of other times where the Russell 2000 lagged the SPX so much during a strong uptrend. They both eventually resulted in a sharp correction of 10% within a few months. </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-NrdkOF94WPujEaQxv4-FVjyH6VbsRUGh6452kPIclUAtCdrwQZ4x3w55-pJpdETDerpk8umacFBaKMv3C7KJ2d7kxwRCdcmYLFGlVT-kAUuD9X9O8CD0lutrQAUsvYK5Ordvjoxu1itw98yrCS9NhvI7phuk4FTUJwk7VJritr2dtnt5LcbxT8ZFIMg/s954/Sep2014top.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="804" data-original-width="954" height="540" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-NrdkOF94WPujEaQxv4-FVjyH6VbsRUGh6452kPIclUAtCdrwQZ4x3w55-pJpdETDerpk8umacFBaKMv3C7KJ2d7kxwRCdcmYLFGlVT-kAUuD9X9O8CD0lutrQAUsvYK5Ordvjoxu1itw98yrCS9NhvI7phuk4FTUJwk7VJritr2dtnt5LcbxT8ZFIMg/w640-h540/Sep2014top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">September-October 2014 correction<br /></td></tr></tbody></table><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZaEMMfNajtarXS3RZ6CT_SvNnwKvt5a8Ohay3DZfgct6hkRe0CfvoiGm1Tav02RUivJf4q-PFF8FOOPxudYu_IlqHV7NbPpwaZdMNCTbKLeA-IRfYY5EM5gv1kqhYeo0akq-LE1vRvWUVjhDxsz7nJVxVgXxXApeGXfEJYdGyZ-IGqvE5oWTbdyPDV50/s951/Jan2018top.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="799" data-original-width="951" height="538" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZaEMMfNajtarXS3RZ6CT_SvNnwKvt5a8Ohay3DZfgct6hkRe0CfvoiGm1Tav02RUivJf4q-PFF8FOOPxudYu_IlqHV7NbPpwaZdMNCTbKLeA-IRfYY5EM5gv1kqhYeo0akq-LE1vRvWUVjhDxsz7nJVxVgXxXApeGXfEJYdGyZ-IGqvE5oWTbdyPDV50/w640-h538/Jan2018top.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">January-February 2018 correction<br /></td></tr></tbody></table><br /><p>Timing these tops is hard, as it takes months of this SPX-RUT divergence to eventually lead to the SPX breaking down. Things like the Hindenburg Omen which flash warnings of a split market of lots of new 52 week highs and new 52 week lows as the SPX makes new highs have started to fire up. A couple of them on the Nasdaq composite over the past week. Along with the high valuations and general complacency out there (low put/call ratios, high CTA equity exposure), a deep correction is waiting in the wings. The key will be not to get short too early, as momentum in these type of up markets last longer than most people expect. </p><p>SPX is gapping up again, this time to another all time high, as SPX is around 4885 as I write. Given how effortlessly its gone up since breaking 4800 on Friday, it looks like a break of 5000 is going to happen within the next 30 days. This bubble reminds me a bit of 2000, when the Nasdaq broke out above 5000, as there was a frenzy for tech stocks. I distinctly remember semiconductor stocks flying higher in February of 2000, a month before the bubble top. Right now, semiconductors are the hottest sector in the market. History doesn't repeat, but it does rhyme. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com5tag:blogger.com,1999:blog-1715439530278924605.post-73148133055706538172024-01-18T06:10:00.000-05:002024-01-18T06:10:00.084-05:00Brainwashed by the Fed<p>If you repeat a lie enough times, eventually people begin to believe it. That is what the Fed has done with both its higher for longer mantra, and now brainwashing the financial community into believing its dot plot of 3 rate cuts for 2024. Since when has the Fed been an accurate predictor of future rate moves? Its counterintuitive, but the STIRs market has been more accurate in predicting future rates than the group that actually makes the interest rate decisions. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9ga76BLmRQj3KrlR5tsjyhYabRFJTLqVvtOmupAMOE5EUkk3I_g1cS2Q7GyXDWkSsAM6lG1vjwU58nUwwh5i0dh8bPYoVIhwKFxP3aSBwYVCb8qm0zWhsdAI2p2bQIp9QLZTNWmcpRL0RepQcD0BO6DR1bVEZ6-nrdrgQJ9OdaaCrPkpFxUQWhK_D6Mg/s593/josephgoebbels.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="330" data-original-width="593" height="178" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9ga76BLmRQj3KrlR5tsjyhYabRFJTLqVvtOmupAMOE5EUkk3I_g1cS2Q7GyXDWkSsAM6lG1vjwU58nUwwh5i0dh8bPYoVIhwKFxP3aSBwYVCb8qm0zWhsdAI2p2bQIp9QLZTNWmcpRL0RepQcD0BO6DR1bVEZ6-nrdrgQJ9OdaaCrPkpFxUQWhK_D6Mg/s320/josephgoebbels.PNG" width="320" /></a></div><p></p><p>Stocks and bonds are all just one market now. The correlation can hardly get more positive between the two. The consensus view is that the STIRs market is pricing in too many rate cuts (150 bps) for 2024. Its been the recent weakness in the bond market that's infected the stock market, leading to horrible breadth. Russell 2000 has lagged badly since the start of the year, just as the crowd was warming up to small caps, and expecting them to outperform in 2024. You are also seeing the VIX make higher highs even though the SPX is hardly going down. It all looks like a possible perfect storm, but I just don't see it happening. People are too pessimistic about the rate cut path. <br /></p><p>Investors are worried that the Fed will disappoint the market expectations of 150 bps of cuts this year. I'm in the minority view that 150 bps is the minimum amount that the Fed will do if there is a no landing scenario (very unlikely given weak global growth in Asia and Europe, lower fiscal impulse in the US). In a soft or hard landing scenario, the Fed is likely to cut in 50 bps increments, not 25 bps as most expect. It will only take 3 meetings to get 150 bps of cuts in that case. That can be done over a period of 3 months. In past economic slowdowns, the Fed has almost always made chunky rate cuts of at least 50 bps increments. There is nothing to make me believe that they'll stick with 25 bps moves when unemployment is rising and inflation is falling. </p><p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtR8Fl-tHvHwKiO5P5VKIZYvNL_ipAQKFMWysyWF2KPaXCRl2hpJAmzOdEftnVgRXXwkSHmsBoykhisSf7ykH56YgsGU86PPKjDkHa_hAYHZLJb8RH7I_tgWsnXG2WlccTPVgfD4RdgnbNpE7f4_n7oH78o448XHkoXr7C5g6qyXwqs0o41_oLNBGY8xc/s1031/Fedfunds01182024.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="504" data-original-width="1031" height="312" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtR8Fl-tHvHwKiO5P5VKIZYvNL_ipAQKFMWysyWF2KPaXCRl2hpJAmzOdEftnVgRXXwkSHmsBoykhisSf7ykH56YgsGU86PPKjDkHa_hAYHZLJb8RH7I_tgWsnXG2WlccTPVgfD4RdgnbNpE7f4_n7oH78o448XHkoXr7C5g6qyXwqs0o41_oLNBGY8xc/w640-h312/Fedfunds01182024.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fed Funds rate probability for Dec 18 2024 FOMC<br /></td></tr></tbody></table><br /></p><p>Just as rates rising didn't have much of a restrictive effect on the US economy, rates falling won't have much of a stimulative effect. So I can definitely see a situation where the medicine of a few rate cuts is too weak, forcing the Fed to give the patient even stronger medicine in the form of 50 or 75 bps cuts at a time. </p><p>You see some leading indicators which seem to have bottomed, but much of it is coming from the steepening of the yield curve and reduction in credit spreads, basically financial conditions. Financial conditions are overrated as an economic leading indicator when there is so much fixed debt outstanding that is unaffected by interest rate/yield moves. Too many are jumping the gun and trying to front run the turn in the cycle. There just is not that much pentup demand in manufacturing (inventories not low enough), as we never got the recession cleanse that was needed to restart a strong up cycle. The excess savings of the bottom 50% is gone (wages not keeping up with inflation), and many have to pay back student loans, which just restarted a few months ago. </p><p>The job market is slowly loosening, with fewer temp work (leads permanent work in the cycle), meaning higher unemployment and fewer wage increases for 2024. The key is profit margins of small businesses, which are likely getting squeezed as the Rona stimmies are now gone but the higher rates on loans remain. With lower profit margins at small businesses, they either have to cut workers or reduce working hours. Both will slowly feed into less wages and lower consumption. Just looking at how weak the Russell 2000 has been so far this year, as well as for most of 2023 (vs SPX). That gives you an idea of how smaller companies are doing in this higher rate, higher labor cost environment. </p><p>You likely won't be seeing a recession, just because of the huge government deficits driving nominal GDP growth, but the weakness of small businesses and reticence to make big investments ahead of the maturity wall coming up in 2025 will lead to a noticeable growth slowdown, IMO. Its being ignored for now because rates came down so hard in November and December, and the stock market went up so much. Probably the best sector to be invested for the year will be in defensive sectors like consumer staples and utilities, as you are going to get a slower economy leading to chunky rate cuts by the summer, and people are not positioned for that. The Fed has even stated that even without labor weakness, they will make rate cuts as long as inflation is falling. <br /></p><p>With the recent rise in yields, bonds are getting interesting here for a swing trade, as I don't see yields able to keep rising ahead of a rate cutting cycle which is being underestimated by the majority. The bond market is sending a strong signal when the yield curve keeps steepening despite the widespread belief among the financial media that too many rate cuts are priced in. </p><p>Because I don't think yields will keep going higher, I am a reluctant short here in SPX. This trade was mainly a play on the seasonally weak January opex week as well as the somewhat overbought nature of the market last Friday. I will be looking to close out my short by Friday, as some of the January opex weakness has been brought forward this week. Also, don't want to hold a short position going into tech earnings season starting next week. Once we consolidate this month, I am expecting a strong February for stocks and bonds as weaker economic data starts to come in, moving investors more towards my view of a more aggressive rate cutting cycle than is being priced in. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com5tag:blogger.com,1999:blog-1715439530278924605.post-15046252955623325402024-01-11T06:58:00.001-05:002024-01-12T05:18:49.848-05:00A Market Made for Ray Dalio<p>My framework for 2024 is the underestimated Fed dovish pivot. This makes me bullish risk parity (long stocks and bonds) for the next few weeks, buying on dips in bonds as 10 year yields go above 4%, and when SPX gets down towards 4700. Downside will be contained until there are more believers in the Fed dovish pivot, and fewer believers of higher for longer in 2024. It will take several weeks for the migration to play out, as our monkey brains can't handle going from bearish to bullish so quickly. Many are still in denial in the bond market. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghRptZ687PBKDVDfJA5sYUk7klMXTrZK6QkXErKQLa5LBLkKTQMP4e-2OND5H71BGN06UdazkIgQp5qprHdmhSrEtjLCGEPHfBlvyV4rGr_ILyATKmXPmXORjeWiPqroCSxNiCE2eN1YNcFd6rT_6whRVvrbh1_Ubtds2Ix9DmSbrG9vGANW52l5YLoDI/s480/raydalio.jpg" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="360" data-original-width="480" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghRptZ687PBKDVDfJA5sYUk7klMXTrZK6QkXErKQLa5LBLkKTQMP4e-2OND5H71BGN06UdazkIgQp5qprHdmhSrEtjLCGEPHfBlvyV4rGr_ILyATKmXPmXORjeWiPqroCSxNiCE2eN1YNcFd6rT_6whRVvrbh1_Ubtds2Ix9DmSbrG9vGANW52l5YLoDI/s320/raydalio.jpg" width="320" /></a></div><p></p><p>Its a type of market that Ray Dalio would love. Collecting 2 and 20 by just holding long bonds along with the SPX, and calling it an all weather portfolio. <br /></p><p>That 10 year yield chart is amazing. It is what you would say is the mother of all capitulations in US Treasuries. All you heard was talk about bonds in September and October. You even had someone on CNBC calling for 13% 10 year yields! Charts can play mind games on investors. Past price action really influences how investors view the future. Its not just about price. Its about path that changes our views. Let's play this game on the 10 year yield chart: </p><p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_6F-o0tIqY3oUEkuNiCm8Z0QWZrU0WEyH1qh_SIA5wGY10gJUs6URfRWyzsSQ2RXP-6sFDbPCmaOKh5RvA8F-DWBlb1F0yG2Gdc1cNC8F2LfgbCK-DnzLOwNL64aHXYR9wKIcca8-uk0UTbqm2aL255OsOeyz_z25vooJVMdcctlnus4YAsumedMPykI/s1140/TNX01102024.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="530" data-original-width="1140" height="298" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_6F-o0tIqY3oUEkuNiCm8Z0QWZrU0WEyH1qh_SIA5wGY10gJUs6URfRWyzsSQ2RXP-6sFDbPCmaOKh5RvA8F-DWBlb1F0yG2Gdc1cNC8F2LfgbCK-DnzLOwNL64aHXYR9wKIcca8-uk0UTbqm2aL255OsOeyz_z25vooJVMdcctlnus4YAsumedMPykI/w640-h298/TNX01102024.PNG" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Actual 10 year yield chart since start of 2023</td></tr></tbody></table><br /></p><div style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAUuajRPvIY40RIReMOvgHoxG7Vkycu3Mat_2ZnBdqLkGh9StlDNgD2Kjh4zwqIABwwIbC4Y3DOrPe5ghUn0gbKAgwAmeMG18vjZ_EJvFBCCo1xH-OE6vBoxEr2B65v2iLqQ5yVt83EVCCn0PIH-xg5h5m_6CfENRORIr3hz0c3Xydh-IZfQcwqgGHy94/s1140/TNX011102024fake.png" imageanchor="1"><img border="0" data-original-height="530" data-original-width="1140" height="298" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAUuajRPvIY40RIReMOvgHoxG7Vkycu3Mat_2ZnBdqLkGh9StlDNgD2Kjh4zwqIABwwIbC4Y3DOrPe5ghUn0gbKAgwAmeMG18vjZ_EJvFBCCo1xH-OE6vBoxEr2B65v2iLqQ5yVt83EVCCn0PIH-xg5h5m_6CfENRORIr3hz0c3Xydh-IZfQcwqgGHy94/w640-h298/TNX011102024fake.png" width="640" /></a></div>Fake 10 year yield chart since start of 2023: September, October, and November 2023 changed. <p>I believe most people looking at the first chart would think that the move down in yields is overdone, and that yields are due for a further bounce higher. Most people looking at the second chart would think that yields made a double top around 4.30% and that yields look to be trending lower. </p><p>These are the mind games that financial markets play on our monkey brains. By simply reversing the psychology and doing the opposite of what feels right can be an edge. Of course, you need to see how speculators are positioned, as well as what the investment community is thinking to get a bigger edge. Here is what the latest JP Morgan bond survey shows: </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMLZ0k2AkGjw8bm1T-dkQ9hnSAbp5DrdKBBzJPHSBZXACRKsPCaV9qqtfeA_hQb9M0wcCaDsR2ahVB6uTqrI57nID2SIXz4cbE0R9iSX4MFTqk6swDU5dJ4cQC9k1Jr-sR0lpMZI8Xd6ovoh2F71x4BglC5Qrmtb3Y-eJrhjSgtQTvjEK7Z-hDERwyfjI/s1200/jpmduration20240106.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="675" data-original-width="1200" height="360" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMLZ0k2AkGjw8bm1T-dkQ9hnSAbp5DrdKBBzJPHSBZXACRKsPCaV9qqtfeA_hQb9M0wcCaDsR2ahVB6uTqrI57nID2SIXz4cbE0R9iSX4MFTqk6swDU5dJ4cQC9k1Jr-sR0lpMZI8Xd6ovoh2F71x4BglC5Qrmtb3Y-eJrhjSgtQTvjEK7Z-hDERwyfjI/w640-h360/jpmduration20240106.jpg" width="640" /></a></div><p></p><p>JP Morgan clients' net long positioning dropped the most over 1 week since 2020. It only took a 20 bps rise in yields to get bond investors bearish again. <br /></p><p>The bond market has an asymmetric payoff profile at the moment. Its because of the Fed's new dovish bias and upcoming rate cut cycle. We know with a fair amount of certainty what core CPI will do over the next few months, because of the lagged effects of owner's equivalent rent (biggest weight in CPI) and other butchered calculations which foreshadow future CPI readings. With rents having come down a lot in 2023, and owner's equivalent rent lagging real rents, you will likely have core CPI coming in low month over month until the summer. Some of this is priced in, but the Fed is laser focused on the data, especially data confirming their now dovish bias, so with lower CPI readings, they have an excuse to cut rates. At 5.33% Fed funds, real rates are quite high, meaning they have a lot of room for rate cuts even if the economy remains steady. That's the Fed backstop for the bond market right now. Especially the short to intermediate part of the curve, from 2 yrs to 7 yrs. </p><p>This Fed backstop wasn't present in 2022 or 2023 because the Fed had a hawkish bias due to the zeitgeist on high inflation at the time. But investors have a hard time turning on a dime. Especially when a market like the US bond market, has been in a bear market for nearly the past 4 years. As a result, I see a lot of denial on CNBC and Bloomberg, about future rate cuts. Many don't think the Fed will cut 5-6 times, like the SOFR curve is pricing in at the moment. They are still somewhat stuck in the higher for longer theme that the Fed repeatedly bashed into the brains of investors in order to tighten financial conditions. The consensus I see among the "pros" is similar to the Fed dot plot, which is 75 bps of cuts for 2024. In my view, 75 bps is the absolute minimum they will do this year, if there is a no landing/delayed landing/inflation rebound scenario. Even in a consensus soft landing where growth is slowing and jobs numbers are going down, they will cut much more than 3 times, more likely the 5-6 times that the SOFR curve is pricing in. </p><p>Its this denial about the coming fast and furious rate cutting cycle even without a hard landing which makes me nervous about getting short SPX too soon. Yes, the market went up a lot over the past 2 months, so its likely to consolidate its gains instead of rocketing higher at these high valuations. But I don't see a lot of downside in the market until the <i>majority</i> of investors abandon their higher for longer bias and accept that the Fed will cut rates even without much of an economic slowdown. The closer we get to the March FOMC meeting, the more certainty will come to the crowd that this is no longer a "higher for longer" Fed, but a "find any excuse to cut" Fed. When the consensus of "pros" (not SOFR traders, but loudmouths on CNBC and Bloomberg) shifts to my view on the Fed's rate cutting cycle, that's when I'll be looking to aggressively short SPX. Until then, I am only willing to play the short side for quick swing trades. </p><p>The broadening out of the stock market rally has already fizzled out. The Russell 2000 has badly lagged the SPX over the last 2 weeks. It has given back all of its massive outperformance since the FOMC day rally in mid December, and is now underperforming SPX by over 2% over the past 4 weeks. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjD8dp0XH7HdooajfvX3GDErZEe-cAdurUb5-DUeHtdUS-bVz78DQGWvVPpumzk9_7dAFjnDMwtXBmbogjE-i9IG-cg-wPGXBXAT-yLlTlKHX-AT5tx-sJLAIF_yypRFogtNIeXw1eCfAYFkrUQiaQJ_bnhh27uObn6aKDl1qTzc42PGrrucdXXk5MnJik/s1694/SPXRUT01102024.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1694" data-original-width="1350" height="640" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjD8dp0XH7HdooajfvX3GDErZEe-cAdurUb5-DUeHtdUS-bVz78DQGWvVPpumzk9_7dAFjnDMwtXBmbogjE-i9IG-cg-wPGXBXAT-yLlTlKHX-AT5tx-sJLAIF_yypRFogtNIeXw1eCfAYFkrUQiaQJ_bnhh27uObn6aKDl1qTzc42PGrrucdXXk5MnJik/w510-h640/SPXRUT01102024.jpg" width="510" /></a></div><p></p><p>This has made me revise my view on how the next few months play out. I was expecting a chase for high beta in small caps for the first quarter but that doesn't look like its going to happen. Instead, we are likely to see you typical grind higher with breadth deteriorating towards a final top, as the economy slowly weakens. The economy is just not strong enough to justify rampant speculation in small caps, many of which are nonprofitable and/or have weak balance sheets. So no blowoff top with a big move higher in Q1. Its going to be your typical grind it out top, with no climax moments. That's going to make timing the top a bit tricky, as these grind it out tops take longer to play out, and are more frustrating to trade. Going into the year, I was thinking March as the month that the market makes a climactic top. But now, its probably April or even May when it makes a meat grinder of a top. </p><p>Still long SPX, but trimmed some yesterday and will likely sell the rest today. I put on a long position in Treasuries for a short term trade going into today's CPI, which I will close out either later today or tomorrow. Anything above 4% 10 year yields is a low risk long entry point at this juncture. If the CPI comes in lower than expectations, I may begin to put on SPX shorts, as SPX 4800 is going to be tough resistance as its near all time high territory, and the chart looks short term overextended. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com8tag:blogger.com,1999:blog-1715439530278924605.post-69124476103144624352024-01-05T07:14:00.001-05:002024-01-05T07:14:04.035-05:00Wingsuit Landing<p>Everyone is talking about a soft landing. It is the zeitgeist of the moment. The current environment reminds me of those wingsuit jumpers who dive off cliffs and high places, gliding down like a flying squirrel. It looks way more fun than your ordinary sky diver who just drops straight down towards the ground. I actually don’t have a strong argument against a soft landing. The ingredients for a soft landing are present:</p><p>1. Large budget deficits (6-7% of GDP) in a low unemployment environment.</p><p>2. Energy and commodity prices which are stable to lower.</p><p>3. Fed policy pivoting to preemptive rate cuts in a non-recessionary economy.</p><p>4. Inventories de-stocked to normal levels.</p><p>5. Strong balance sheet for the top 50% as home prices remain high, and most have low rate mortgages from 2020-2021 refis.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXi4Mcv3DbKbJkdzZZOwugbHN_-tf_TGENKaj__uu6PwKvX9T-8ufVMYVLJGvD9GOqd8HyadZGH6AIRae4m6euEdS8egtyR6PQWAYsWBSAINz7wwF1IWHcPtySAKR8iaRgWcejFL24BVV-27ksUWrhRv18JPiYbIK-zJd1b2O8NcvCd6j9_YbZDT6SuBY/s614/wingsuitlanding.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="347" data-original-width="614" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXi4Mcv3DbKbJkdzZZOwugbHN_-tf_TGENKaj__uu6PwKvX9T-8ufVMYVLJGvD9GOqd8HyadZGH6AIRae4m6euEdS8egtyR6PQWAYsWBSAINz7wwF1IWHcPtySAKR8iaRgWcejFL24BVV-27ksUWrhRv18JPiYbIK-zJd1b2O8NcvCd6j9_YbZDT6SuBY/s320/wingsuitlanding.PNG" width="320" /></a></div>With everyone focused on the short term, macro is always at the forefront. Thus, this soft landing thesis is talked about quite often. Based on my read of sellside research reports and listening to CNBC and Bloomberg, the consensus for 2024 is a soft landing, with a lean towards weak growth. This is not the kind of backdrop that usually forms bubbles, but here we are. The SPX forward P/E ratio is the highest outside of the 2021 everything bubble period over the past 20 years. This is with Fed funds rate at 5.33%, with a 10 year yield close to 4%. <div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2TpayKMozT_Ij6YOwlqXzlaFatYglC1I9Y6SOks8s0h5ect_OHOxiF6KtAq9e9ArMQGRf3ECAXdgac6jfnKl2ByuoXWdKIDeQkqCzy_SuHE_1C8Jm_0DEhlPJMTfXF7VEjpKxIe4NBL32lx3b7Vzsrs6Ye1iB8bcs_vW68oM0BccrymhwVkY1MGQ23wA/s1434/48D826AD-BEA6-4331-B32D-6DA7255DC635.jpeg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="827" data-original-width="1434" height="370" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2TpayKMozT_Ij6YOwlqXzlaFatYglC1I9Y6SOks8s0h5ect_OHOxiF6KtAq9e9ArMQGRf3ECAXdgac6jfnKl2ByuoXWdKIDeQkqCzy_SuHE_1C8Jm_0DEhlPJMTfXF7VEjpKxIe4NBL32lx3b7Vzsrs6Ye1iB8bcs_vW68oM0BccrymhwVkY1MGQ23wA/w640-h370/48D826AD-BEA6-4331-B32D-6DA7255DC635.jpeg" width="640" /></a></div><br /><div>With all the talk about a soft landing and the Fed’s dovish pivot, investors are forgetting about price. The most important part of the market. The stock market is richly valued. This is for a developed economy with a naturally low growth rate. Without lots of fiscal stimulus, the US economy cannot grow much. If you do have a lot of fiscal stimulus, inflation will be high, causing long term yields to go higher, which lowers the present value of future cash flows. Its almost a no win situation for the stock market at current valuations. Unless we are at a permanently high plateau for stock valuations, buying the SPX today will underperform cash sitting in a money market fund for the next several years. You cannot totally eliminate the possibility of being at a permanently high plateau. Anything is possible. But a permanently high plateau for valuations would be the first time ever in US stock market history. And given the historically high equity allocations among households and an aging demographic, its very likely that equity allocations go down, especially with bonds now offering decent yields. </div><div><p>The stock market is not the economy. But you would think it is based on what you hear on CNBC. Its the backdrop for almost every conversation about the market. In October 1987, when the Dow crashed 19% in one day, the US was not in a recession. GDP growth was strong. In February 2018, when the VIX went from 14 to 50 in 3 days, the US was not in a recession. GDP growth was strong. Stocks can go down hard and the VIX can spike without a weakening economy. The common trigger for these sharp drops in stocks is a big run up higher into all time highs and rich valuations. The current setup is not quite there yet, as the SPX has not hit an all time high, and the run up is not as steep as 1987 or 2018. But if the SPX keeps rallying for the next few months, the setup will be ripe for a sharp drop and a vol explosion. It won’t be as dramatic as 1987 or 2018, because the rise is unlikely to be so steep. But it will cause some damage. More than March 2023. More than October 2023. </p><p>2024, being an election year, will have a lot of political headlines which will be a convenient rationalization for any selloffs. Don’t buy into any of it. The winner of the election, whoever it is, will not be able to cut spending. They will not be able to raise taxes. That’s all that matters for the market. The stock market loves the government overspending while cutting/not raising taxes. Rising budget deficits are a boon for stocks. No matter how much the permabears spin it as a negative. There will be no fiscal austerity, even if the bond vigilantes have a fit. Congress and the White House didn’t even blink an eye when the 30 year yield went from 4% to 5% last fall. Nothing will stop the deluge of Treasury issuance. Nothing. </p><p>Sure, the market hates uncertainty, and there is a subset of chicken little investors who think Trump will hurt the market. But after what they’ve seen of Trump and Biden the past 8 years, the election will be viewed a positive catalyst in their eyes, not a negative. This Goldilocks theme based on a soft landing, Powell dovish pivot, and the near certainty of more government cowbell with either Trump or Biden winning in November, what is there to fear? Mainly one thing: the return of inflation and the ghost of Arthur Burns. An economic slowdown is not the real fear. It can be dealt with by bazooka stimmies from the Fed and US government. The real fear is inflation picking up again during the Fed cutting cycle. Commodities are underpriced compared to the growth of the money supply over the past 4 years. It won’t take much for inflation to surge back up on the back of higher food and energy prices and a weaker dollar. </p><p>In a low inflation environment, like what you had from 2000-2020, bonds are the best hedge for equity downside. In a high inflation environment, like what you have since 2021, commodities are the best hedge for equity downside. As the economy gets more financialized, like the US, stocks and bonds become more positively correlated, so bonds become a poor hedge for stocks. This will lead to more volatile markets than in the past, because of that lack of hedge from the fixed income side. But the current market is pricing volatility as if it was a similar environment to the 2010s, when you had bonds act as a positive carry risk off hedge, when that's no longer the case. 2022 was a wake up call. Inflation is a bigger long term problem than a potential recession from higher rates. </p><p>We are getting a nasty little pullback off the end of year rally, as the post FOMC day gains have all been erased. I started a long in SPX slightly above 4700, thinking that the bulls would defend that zone, but it fell easily. This is just a short term trade, and it still has merit, because I don't see a sustained selloff in bonds at the moment. But I won't hold this for more than a week or two at the most. Once again, stocks have a hard time rallying when yields are going higher. Ten year yields are back above 4%. Nothing has changed. The bond market is in control here. </p><p>After this pullback in bonds from the year end rally, I am neutral to positive for the next few weeks due to the impending rate cut cycle, seasonal weakness in most commodity markets, and the skepticism that I see among Wall St forecasters who still think too many rate cuts are priced into the SOFR curve. It is this wall of worry about higher for longer that the stock and bond market will likely be climbing for the next couple of months. This makes me more constructive on stocks as well, since the stock and bond markets are connected at the hip these days. </p><p> We have nonfarm payrolls and apparently the higher than expected ADP
number and lower than expected jobless claims numbers have both bond and
stock investors nervous. These economic data releases are overblown in
their importance, so I wouldn't jump to any conclusions based on this
jobs number. Powell seems hellbent on going for a soft landing so he'll
ignore strong data and cling to anything supporting rate cuts, like
lower CPI, lower job openings, etc. Its all about politics now for the
Fed, even though most people will think that's just a conspiracy
theory. </p><p>The Fed will find almost any excuse to cut rates this year. Those clinging to the higher for longer thesis are playing last year's playbook. This year will be the year of Powell the "Caveman Lawyer". Eventually the SPX will form a long lasting top, once you get the majority of investors to completely buy into the coming fast and furious rate cut cycle. It probably will take a few more hints from Powell and company for the message to be understood, loud and clear: they are coming with preemptive rate cuts to prop up Biden and stop Trump. I could care less who wins in 2024. But the Fed is definitely going to be rooting for Biden and helping him out as much as possible. Powell and Yellen are on the same team now. </p></div>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com2tag:blogger.com,1999:blog-1715439530278924605.post-92214466395876538132023-12-29T07:39:00.003-05:002023-12-29T09:52:17.405-05:00Its an Art Not a Science<p>The stock market is irrational. Its based on numbers, but its not math or science. There are no set rules. There is no iron law in finance. Its an art that people try to make into a science. This isn't physics or math. The closest thing that comes to mind is fashion. There is no real logic when it comes to fashion. Its based on feel, personal taste, emotion, societal trends, etc. The thing about fashion is that it really doesn't matter how you feel about your clothes, its how others feel about your clothes. That's the stock market. It doesn't matter what you feel. It matters what others are feeling. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFHcQwzirBSxuIyyNwkJihEwsgVN1iyBnxx6byJd1ADW468mfWijrD-G3hRL5ZuRLFiqpX_AO0LduIQF5upyQ-VUY2QRSsTib4P5qTtvaN-w-MjA4hBWV_gGxMA3hbXxVDIeph_s6S2IUAv_wt-V3VLZOfkZyzKLC2-pDPsEC01_bjeDko3sOmKE_J3UI/s762/stockmarketart.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="561" data-original-width="762" height="236" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFHcQwzirBSxuIyyNwkJihEwsgVN1iyBnxx6byJd1ADW468mfWijrD-G3hRL5ZuRLFiqpX_AO0LduIQF5upyQ-VUY2QRSsTib4P5qTtvaN-w-MjA4hBWV_gGxMA3hbXxVDIeph_s6S2IUAv_wt-V3VLZOfkZyzKLC2-pDPsEC01_bjeDko3sOmKE_J3UI/s320/stockmarketart.PNG" width="320" /></a></div><p></p><p>Having a quantitative mindset, it was bewildering to see how investors would get more excited about the stock market the higher it went. The rationalization, the excuses, the reasons for the moves. They are arbitrary but are quickly clamored onto like indisputable facts by the crowd. There is no wisdom of crowds in the stock market. That's BS. Its the madness of crowds. Its herd behavior coming from our primal instincts, that evolved over tens of thousands of years when survival was always the priority. That way of thinking, the emotions and actions that all evolved when there was no stock market, when there was no crowd gambling on a huge scale. </p><p>Trying to put logic or numbers into this game is like trying to put a square peg into a round hole. Its an art, and it will always be art, even when AI or machines take over. There is no science here. The stock market is just a huge, glorified casino. In fact, its less quantitative than a casino, where the odds are set. In the market, the odds are unknown. Its this mystery that keeps the hope alive, that provide fertile grounds for snake oil salesmen and subscription sellers. The day that I start a substack to try to sell subscriptions is the day that I admit that I no longer can beat this game, and can only make money selling dreams rather than living the dream. </p><p>Its an illogical game, but there are patterns to it. Arbitrage has been sucked out of the market and there is very little alpha in that space. The main edge in markets is finding patterns and playing them over and over again. Those patterns are derived from human psychology and they repeat. Some patterns are long term, some are very short term. But they repeat. Successful speculation is about finding the patterns and anticipating the next move to come in the pattern. There are seasonal patterns, patterns around events, etc. Some patterns are higher probability than others. And the probabilities change and are unknowable, but intuitively, you can sense what patterns are reliable and which ones are less so. But to do so, you have to stop thinking about what's going on in your head. But what's going on in the head of those moving the market. </p><p>First order thinking is what you are thinking about the situation. Second order thinking is what you are thinking about what others are thinking about the situation. First order thinking doesn't help you much in this game. Its second order thinking which is the foundation for market analysis. No one cares about what I think. No one cares about what you think. I'm not the one who's going to drive the next move. I want to know what the big money is thinking and what's their next move. </p><p>The current bull run in stocks is puzzling from my view of how markets should be valued, but it really doesn't matter what I think. If others are in a risk seeking mode, and past patterns of risk seeking behavior play out, we are not done with this uptrend. That doesn't make me want to play this uptrend at the current time, even though the probability is high that the market will be higher 2 months from now. Its the risk/reward thats not attractive here. There is more downside risk in the short term than upside risk, even though its more likely to go up than down. </p><p>These big bull runs, which we are currently on, tend to last 4 to 5 months before facing its first real test/correction. Since this rally started at the end of October, that means a rally that likely lasts until late February to late March. This also jives with the psychological importance of the Fed and the first rate cut, which looks like will happen at the March FOMC meeting. Its a classic buy the rumor, sell the fact setup happening over several months. This will be the framework with how I trade the market for the 1st quarter of 2024. Its too early to think about shorting for longer than a couple of days, so I'd rather not play that game. </p><p>No imminent trades at the moment, but I will be buying dips in SPX and Treasuries in January, as I expect the uptrend to continue into March. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-3760148984279435832023-12-18T06:50:00.002-05:002023-12-19T18:00:01.405-05:00Late 1999, Late 2020 Flashback<p>Its getting bubbly out there. Parabolic moves in heavily shorted names like UPST, CVNA, COIN. A huge squeeze higher in Russell 2000, up over 20% in less than 45 days. This is feeling like late 1999. Like early 2021. The difference this time versus the previous two times is the economy. The economy in late 1999 was on fire. Same with 2021. Now? You have the market not excited about earnings, but about the Fed. That's a whole different type of euphoria, something that will have a shorter lifespan. Also the fact that we had a bubble burst just 2 years earlier makes it much less likely this bubble will get as big or last as long. People have short memories, but not <i>that</i> short. <br /></p><p>In 1999, you had the Russell 2000 lagging the SPX and NDX for the previous 18 months, and then went on a huge heater, massively outperforming the SPX from late 1999 to early 2000. </p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_4-6sLlVvto2mFdVwNEV0XZA_eGKugo881DhPF9JPi9BF_4SlmjZ-KfPMo_Csk1eYMSC3UtUoTv2_ljC6OtFEhYHiM9O45JH5WTd4SPUQq6hahuJaU5z32EzjQjQ86gpeydohl9HU_-EmJP7PsbdMtvYUjGdJW6244cdRqaFYtlJGg3HUdjDJwjmCxrs/s1181/rutspx19992000.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="508" data-original-width="1181" height="276" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_4-6sLlVvto2mFdVwNEV0XZA_eGKugo881DhPF9JPi9BF_4SlmjZ-KfPMo_Csk1eYMSC3UtUoTv2_ljC6OtFEhYHiM9O45JH5WTd4SPUQq6hahuJaU5z32EzjQjQ86gpeydohl9HU_-EmJP7PsbdMtvYUjGdJW6244cdRqaFYtlJGg3HUdjDJwjmCxrs/w640-h276/rutspx19992000.png" width="640" /></a></div> <p></p><p>In 2020, you had the Russell 2000 lagging the SPX and NDX for the previous 18 months, and then went on a huge heater, massively outperforming the SPX from late 2020 to early 2021.<br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI6aIdrkeDgiVwN6THWPSKaUZZ0JNNOs8AtnWtrLQISxIs_VxFP3tF5sUrgxqqnBJBoWUbpX8zN3BkCwU05l3Cz30xtbZF4a_Qu73IhUOhd88iURLIP9X1lB3pRwhZdzhsWzIVvlW7sJ2m1TE3g1FyJFH6fQtGiVMKM6-yq7qCvSsIriTUwK8a4NKSNf8/s1179/rutspx20202021.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="505" data-original-width="1179" height="274" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI6aIdrkeDgiVwN6THWPSKaUZZ0JNNOs8AtnWtrLQISxIs_VxFP3tF5sUrgxqqnBJBoWUbpX8zN3BkCwU05l3Cz30xtbZF4a_Qu73IhUOhd88iURLIP9X1lB3pRwhZdzhsWzIVvlW7sJ2m1TE3g1FyJFH6fQtGiVMKM6-yq7qCvSsIriTUwK8a4NKSNf8/w640-h274/rutspx20202021.png" width="640" /></a></div><p> </p><p>In late 2023, you are starting to see the Russell 2000, which has been lagging the SPX for the past 18 months, go on a huge rally, massively outperforming the SPX over the past 2 weeks. </p><div class="separator" style="clear: both; text-align: center;"></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJU58iAHu3eLNAHCZCibSTwW6k6vKmfvd37HbKihuRUExLkmZxzDDctLysI4rWYaa-hU5-C0W2yRMvBtC6H1i8VTbO_9lir-IK1ZXnwV9L61UdsI8qK-1GPpcgJ7tYJ2uZkEfXnK82UcM_M6WbanY7bNUrcs3i83B9yKRUDoNhI_HsXqoY58QO4hXusrg/s1172/rutspx2023.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="512" data-original-width="1172" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJU58iAHu3eLNAHCZCibSTwW6k6vKmfvd37HbKihuRUExLkmZxzDDctLysI4rWYaa-hU5-C0W2yRMvBtC6H1i8VTbO_9lir-IK1ZXnwV9L61UdsI8qK-1GPpcgJ7tYJ2uZkEfXnK82UcM_M6WbanY7bNUrcs3i83B9yKRUDoNhI_HsXqoY58QO4hXusrg/w640-h280/rutspx2023.png" width="640" /></a></div><p>It is human nature to feel FOMO, when others around you are getting richer. Investors and traders then try to catch up by playing more aggressively, going into riskier stocks with more beta, to get more bang for their buck. It happened in late 1999/early 2000, in the later stages of the dotcom bubble. It happened in late 2020/early 2021, at the peak of the SPAC/bitcoin/meme stock/everything bubble. And it is happening again here. </p><p>But can the economy stay strong enough to keep the animal spirits going, to keep the soft landing hopes alive? That will be the question for the first quarter of 2024. There are some who believe that the higher stock and bond prices will feed back into higher consumption by the wealthy, which will boost the economy in early 2024. There is some merit to that thesis, but relying on the wealth effect as the main pillar of future consumption is not something I would put too much money on. Plus, you have already front loaded so much of the Fed pivot rally in the past few weeks, that there isn't that much squeeze left to play for, unless things get really crazy. And as I mentioned earlier, due to recency bias, and being burned the last time, I just don't see things getting as crazy as early 2021. </p><p>One thing I do have conviction on is that Powell will cut way more than what the dot plot predicts for 2024. But with 150 bps of cuts already priced into the SOFR curve, its not a great risk/reward at current levels. You probably make money buying SOFR Dec. 2024 futures and hold them to expiration, but it could be a bumpy ride for the next few months. I would have been much more confident betting on lower short term rates if Powell didn't signal a pivot, as that would have left a lot more potential in the trade. As it is, its not a compelling trade at the moment. </p><p>A factor that people are not thinking about enough is how the 2024 election and the looming Trump nomination will have on the Fed's reaction function. The Fed will have an easy trigger finger on cuts in 2024 to try to help Biden (and hurt Trump). I know there are still those who believe everything they hear from the Fed and believe they won't be political and will follow the data, but I'm cynical on how the Fed operates. Their default position is to be on the side of easy money in the first place, so even a slight bit of motivation to keep Trump out of office will have them leaning towards more cuts than fewer. Plus, with the stock market front running these rate cuts so aggressively with a big rally, I could picture a scenario where stocks actually go down after the rate cuts start. This will hurt consumer sentiment as the election gets closer, which will encourage the Fed to be even looser and do more rate cuts. I can imagine a snowball effect of the stock market being disappointed with just a few rate cuts and having a temper tantrum, inducing the Fed to cut even more. </p><p>It's interesting that in 2022, even with surging inflation, everyone was so skeptical about the Fed hiking rates a lot after they signaled no rate cuts until 2024 just a year earlier. After brainwashing investors and Wall Street with higher for longer for the past 12 months, now almost everyone seems skeptical about the Fed cutting rates a lot in 2024, even though Powell has already pivoted and started talking about cuts. I see the current situation as a mirror image of 2022, with the Fed likely to surprise dovishly throughout 2024, steepening the yield curve in the process. The economy is just not going to be as strong as 2023 due to the lower fiscal deficits on both the state and federal level, and with the resumption of student loans and the end of the employee retention fraud that many were taking advantage of. Employment should get softer, as less bank credit and shrinking margins at small businesses will lead to job cuts. </p><p>Short to intermediate term, its not an easy spot here for shorts or longs. I put on a small short on Thursday and Friday in SPX and NDX, but those trades I intend to close out this week. I may even play the long side for a quick trade ahead of the seasonally bullish last week of the year. For longer term trades, I'm inclined to play small ball or just not swing until I see a fat pitch. My best guess is that you will grind higher into the first rate cut in March, but not a huge amount of conviction. Because things have been pulled forward so much, it wouldn't surprise me if we had a sharp pullback before March. Its probably not a bad time to just park money in money market funds at 5% and wait for things to play out for the next couple of months. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com7tag:blogger.com,1999:blog-1715439530278924605.post-2371084830079765582023-12-12T06:09:00.000-05:002023-12-12T06:09:48.048-05:00Event Trading<p>The market hates uncertainty. There is an edge that comes from that human tendency. Whenever you go into a hyped up event (FOMC meeting, hyped up nonfarm payrolls/CPI data releases, earnings announcements, elections, etc.), there are patterns that emerge. In order to predict how markets react around these events, you have to make a basic assumption. The assumption is that active traders/investors are usually long financial assets. Its rare for even hedge funds to be net short equity or bond exposure. And long only funds cannot short. I made a post about <a href="http://marketowl.blogspot.com/2010/07/event-days.html">event trading</a> several years ago and it still holds true. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAyeV6agRehGEEDe6yh8Qb8mn_B4rene9JffOzmenH6gYvr6IHo2qEvfWzKF6JJg2Cg0dqyZKeeW3AGHfcgtXoL8dQUxKkJpyneN9jRhUUvlsXaznImwf-lJOEfxEHIP4o-jTcVsH2Prw5xSSocKKFmAekr5D-BEx0R-muGbKcotoWjVtqzh50PFRmMTQ/s529/mainevent.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="343" data-original-width="529" height="207" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAyeV6agRehGEEDe6yh8Qb8mn_B4rene9JffOzmenH6gYvr6IHo2qEvfWzKF6JJg2Cg0dqyZKeeW3AGHfcgtXoL8dQUxKkJpyneN9jRhUUvlsXaznImwf-lJOEfxEHIP4o-jTcVsH2Prw5xSSocKKFmAekr5D-BEx0R-muGbKcotoWjVtqzh50PFRmMTQ/s320/mainevent.PNG" width="320" /></a></div><p></p><p>Let's go into how active investors/short term traders behave around an event. </p><p>1. They often reduce their net exposure. The more feared the event, the more exposure that is reduced. Since they are almost always net long, it means they reduce their longs. The result: you often see a pullback ahead of an event, from several days before, for big events like an election, to just a few days before, for smaller, less feared events like economic data releases or FOMC meetings. <br /></p><p>2. Since investors and traders have already reduced their exposure ahead of the event, usually at least a day ahead of time, there is a lack of selling pressure from active traders right ahead of the event (a few hours ahead) and after the event. This often explains the common upward drift ahead of FOMC/NFP/other hyped up event for the few hours ahead of the release. Here is a recent example: </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIoUDP177CGV7cQeOP8A6YMztJIHtjLyXX3aT03Yybaf7nSZ9YVLvi42OqBVmC2x8I5sn3v1N9YFQFLIq3JG-8SO1uB1GlXD0nWukrGjQoi0hjN33jNBj5S2QFwM8H-5ekCyfV5RjnUo4U8rmthXaxds9ZrZ5d5M2X-Vs_hidbLbRRH3OQV-lr9Q9BTLQ/s928/SPX11012023.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="490" data-original-width="928" height="338" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIoUDP177CGV7cQeOP8A6YMztJIHtjLyXX3aT03Yybaf7nSZ9YVLvi42OqBVmC2x8I5sn3v1N9YFQFLIq3JG-8SO1uB1GlXD0nWukrGjQoi0hjN33jNBj5S2QFwM8H-5ekCyfV5RjnUo4U8rmthXaxds9ZrZ5d5M2X-Vs_hidbLbRRH3OQV-lr9Q9BTLQ/w640-h338/SPX11012023.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">FOMC Meeting November 1 2023<br /></td></tr></tbody></table><p></p><p>3. The intermediate term trend (2 to 8 weeks) ahead of the event is usually resumed after the event. The exceptions are very big events where investors AND traders prepare several weeks ahead of time (e.g.: Presidential elections). In those cases, the long to intermediate term trend (3-6 months) is usually resumed after the event. </p><p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhr7cB8h45sHN7Cy0lF7RIkpGY8_35nRgCFxkuBjkPKIXKF5CWRL487gNBaJ3XKpOqQK-G5V4XmLBTLQpbd_0CwlfaWZCfm31SF-eYa6NuKRn-x54L6Bet38o78xKnBWoWKQUYNKLKMMjUiH3ATJNCdlBwpcNjml8FBlreT35nh0itvbA0wxBiQpNNvzBs/s1163/SPX05042022.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="531" data-original-width="1163" height="292" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhr7cB8h45sHN7Cy0lF7RIkpGY8_35nRgCFxkuBjkPKIXKF5CWRL487gNBaJ3XKpOqQK-G5V4XmLBTLQpbd_0CwlfaWZCfm31SF-eYa6NuKRn-x54L6Bet38o78xKnBWoWKQUYNKLKMMjUiH3ATJNCdlBwpcNjml8FBlreT35nh0itvbA0wxBiQpNNvzBs/w640-h292/SPX05042022.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">FOMC Meeting May 4 2022 / CPI Release Sep. 13 2022<br /></td></tr></tbody></table><br /><br /></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_DP5oBzZnO1cwv0QzYLXDbBlOJ7uLhshlAWMMZDCroeS-XJo6IYJiI6SYyd17xOOUoP9MgFagI66k8fA8Pex-6EAlvoY2Gd_O0ExElTt8Glogj2G_275rrflJsyn6sA44gr3RCNlzb0KJ6cNi2j48p4P_T3QTy2TYiEkmqxRT4nIpIlGfM15unXyscNk/s1166/SPX11042020.jpg" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="522" data-original-width="1166" height="286" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_DP5oBzZnO1cwv0QzYLXDbBlOJ7uLhshlAWMMZDCroeS-XJo6IYJiI6SYyd17xOOUoP9MgFagI66k8fA8Pex-6EAlvoY2Gd_O0ExElTt8Glogj2G_275rrflJsyn6sA44gr3RCNlzb0KJ6cNi2j48p4P_T3QTy2TYiEkmqxRT4nIpIlGfM15unXyscNk/w640-h286/SPX11042020.jpg" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">2020 Presidential Election November 4 2020<br /></td></tr></tbody></table><p></p><p>4. For most events, since active investors and traders have reduced their positions ahead of the event, after the event, you usually see a rally. Especially when active investors and traders have been building up long positions in a rally for the previous month. <br /></p><p>5. In the long run, the market pays a risk premium to those that are willing to take on long exposure ahead of events, especially feared events. That premium is usually paid out in the form of an immediate one day rally after the event, for economic data releases, or for several days after the event, for really big events like a 2020 Presidential election. </p><p>We have a CPI release this morning and the "feared" 30 year Treasury auction at 1:00 PM ET. Considering how bad the 3 and 10 year auctions went, expectations are low for the most important Treasury auction of the month. Add to that, the FOMC meeting on Wednesday, and you have a slew of events that the market will be faced with. Since we've had a strong uptrend in both stocks and bonds going into this week's events, its likely that they will rally after the FOMC meeting is behind us. </p><p>Bigger picture, the SPX is in the middle of a late stage bull market rally where fundamentals are ignored and valuations are very high. It presents a great opportunity for the short side in 2024. For those inclined to play the short side, save your ammo and don't burn capital trying to play for a pullback. Its not worth it to short it here, both from a seasonal perspective and a technical perspective. The brutal selling in September and October needs to be completely forgotten and gone from the rear view mirror before the risk/reward for a short is compelling. When the timing is ripe for a short, it will be a whopper of a short. The potential energy building up on the short side is<i> immense</i>. But if you short too early, you won't be able to hang on for the ride to the other side of the mountain. I can't bring myself to chase longs in this bloated market even though I think it goes even higher. I still see too many consistently wrong Fintwit posters skeptical about this rally. <br /></p><p>Probably will have to wait until March or April for the SPX to top out. Until then, keep powder dry and protect capital. </p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-23578407005694869952023-12-07T08:11:00.006-05:002023-12-07T08:20:11.913-05:00From Eagle to Pigeon<p>The United States economy is just not dynamic anymore. The United States used to be a manufacturing powerhouse, and was subject to the whims of the capitalist boom and bust cycles. It used to be like an eagle soaring high and swooping low. Now its more of a pigeon that just walks around, with short bursts flying higher, and then back to the ground, where it lingers. The amplitude of the ups and downs of the business cycle has gone down. But the average height has also gone down. The highs are lower, and artificial, a result of massive fiscal stimulus, while the lows are less dramatic, also because of massive fiscal stimulus. Its not as bad as Europe, where the government is such a huge part of the economy that the business cycle has essentially turned into a flat line, at a very low level. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMHo0LcdWyphuzxqqGYy94wcess_sjA2S3SPl44zNgxcdbGyylCjGkgcmWlWqA76Usz-7IJ7edHVzWWY9tLu_TU20nXb2IZruLy3zY3m2oqs9_yeqn3JmZPWOQ5CCx7r3sddzXE8fqclxzSo7tBEGbjE_9ygQhfUyQ34YTmo9oxvO6oxFmp2fIgtgvlC8/s573/pigeoneagle.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="573" data-original-width="407" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMHo0LcdWyphuzxqqGYy94wcess_sjA2S3SPl44zNgxcdbGyylCjGkgcmWlWqA76Usz-7IJ7edHVzWWY9tLu_TU20nXb2IZruLy3zY3m2oqs9_yeqn3JmZPWOQ5CCx7r3sddzXE8fqclxzSo7tBEGbjE_9ygQhfUyQ34YTmo9oxvO6oxFmp2fIgtgvlC8/s320/pigeoneagle.PNG" width="227" /></a></div><p></p><p>One of the benefits that you get with an aging population and more services and less manufacturing is a less cyclical economy. Old people don't spend much money on stuff, other than food and fuel. It spends a lot of money on services, such as health care, hospitality, and restaurants. Old people keep getting government money for nothing, and keep spending it on services. Services for doing nothing. And that story is being repeated millions of times (more millions each year as baby boomers retire). That's inflationary. But it also helps to keep the economy out of recession. <br /></p><p>The old boom bust cycle was based on manufacturing being a big portion of the US economy. Now, manufacturing is minor, almost an afterthought. Offshoring has dramatically changed the US. Sure, you hear talks about re-shoring, but much of that is government subsidized and not "natural". The US is not cost competitive with Asia when it comes to most manufacturing. Labor costs are just too high. In the past, when you had a manufacturing heavy economy, the cycle of overbuilding, overcapacity, overproduction, and big inventory builds would make an economy vulnerable to a recession. Sure, rate hikes sped up the process of tipping over a vulnerable economy, but the underlying forces of the economy were very cyclical. You had almost exclusively variable rate mortgages. More variable rate bank loans rather than long term fixed rate bond issuance. </p><p>Now, you have an economy that's mostly services. Manufacturing, construction, and transportation/warehousing are less than 20% of the US share of GDP. With such a small share of GDP in those cyclical sectors, there needs to be big down moves in those areas to drive the economy into a recession. That's unlikely when you didn't have the overinvestment and overconstruction in the first place. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-qTabeFRjts4vpXfmisqMbO5Vfq0lXvavNjGuVfeld3v2pbN9e4Ggq96xyG7yEodcDtL8BPfz_8pqN8dzNX3ODDC6Eqeq4rY5knuyf62KKsnydfo1MKzSP-yBITCUbuG81iu5NqNrFktVpgGvJsUicvYi5VgTwVE-Mps-iHlkUeXINBARgiqgik4UDkM/s711/ShareofGDPManufacturing.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="665" data-original-width="711" height="598" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-qTabeFRjts4vpXfmisqMbO5Vfq0lXvavNjGuVfeld3v2pbN9e4Ggq96xyG7yEodcDtL8BPfz_8pqN8dzNX3ODDC6Eqeq4rY5knuyf62KKsnydfo1MKzSP-yBITCUbuG81iu5NqNrFktVpgGvJsUicvYi5VgTwVE-Mps-iHlkUeXINBARgiqgik4UDkM/w640-h598/ShareofGDPManufacturing.png" width="640" /></a></div><p>The US economy is now a less cyclical, lower growth economy. The biggest source of growth in the US is the government. Government spending is the growth driver of the US. Its not AI. Its not data centers or high tech. Its pork. That's the sad state of what was once a very dynamic economy that had lots of competition and much more laissez faire markets. Now you have an economy that's become more rent-seeking, more financialized, with less innovation and lower productivity. Corporations have formed oligopolies, which requires less investment spending, and more spending on lobbying and regulatory capture. </p><p>The foundation of America is slowly rotting and government spending is like the paint job covering all the mold and mildew underneath. Killing the business cycle is not a good thing. Economists like to think of recessions as being negative, and booms as being positive. But boom and bust cycles are what keep the herd fit. Imagine what those zebras and wildebeests would have evolved to if there were no lions and hyenas. They would probably be fat, slow, and unable to run away from predators. The business cycle is like the lion in the African plains. It weeds out the weak and unfit. <br /></p><p>Staying out of recession because of big budget deficits isn't a sign of strength. Its a sign of desperation and weakness. The politicians have little tolerance for short term pain. The same goes for most of the public, who absolutely loved the huge stimmies in 2020 and 2021. </p><p>All these calls for a slowdown/mild recession in 2024 are using the old playbook for the old America. The new playbook needs to account for the elephant in the room: the government. The government has unlimited cash and can never go bankrupt. It can
always just spend more money. This acyclical factor that keeps getting
bigger is what has kept the US out of recession since the big rate
hiking cycle in 2022. The US has evolved into an economy that's reliant on huge fiscal budget deficits for growth. Keeping track of projected government spending in 2024 at the state and federal level is probably your best guide to what to expect in the economy. It seems like the consensus FY 2024 budget deficit projection is around 6-7% of GDP. That's a lot of money going from the government to the private sector. It will be less than 2023, thus you will get some economic slowdown, which you are seeing, but it also means getting a US recession in 2024 is not as likely as many think. </p><p>The move over the past month was based on the Treasury reducing their planned coupon issuance, and also the dovish shift at the Fed. Even if the Fed isn't outright saying they are done and will start cutting in 2024, the fact that they aren't pushing back strongly tells you a lot. First, it tells you that Powell is no Volcker. He's not playing for legacy, to avoid being Arthur Burns, to be like Volcker, as many postulate. He's playing for longevity. He is power hungry. He wants to get re-elected Fed chair in 2025. He's not going to get that done by being Mr. Hawk in an election year, and making Trump the next president. Trump will get a lackey for Fed chair who will be dovish, no matter what. He doesn't trust Powell, and will fire him in 2025. </p><p>The Fed trajectory for 2024 is all based on politics and I fully expect Powell to surprise dovish throughout 2024. I expect preemptive rate cuts, an attempt at a soft landing, and the Fed put whenever the stock market has a temper tantrum. And I don't expect an economy as weak as many are projecting, especially for the 1st half of 2024. So you will likely be seeing a much steeper yield curve as the Fed policies will be inflationary. Treasury bonds are usually a good investment right before a typical Fed cutting cycle, but I don't think that will be the case in 2024. Sure, you could get to 3.50%-3.75% in the 10 year yield if the stock market panics, causing Powell to panic cut. But I don't expect a sustained move lower in yields like you would have seen in past cutting cycles. Its because the market will sniff out that inflation and big budget deficits is a secular story and will price in higher long bond yields to compensate for the future supply. <br /></p><p>You are getting your garden variety pullback off a huge upward thrust. I still see very little edge playing the SPX here, but I do expect it to break out above 4600 before year end. I am surprised at the bond market strength, and it probably means you are not going to get much of a pullback in SPX this week or next. While you could play for a quick bond short here tactically, I don't see much upside as I expect yields to remained contained for the next several days. With the Fed going from hawk to dove, the animal spirits are returning and the volatility is dying. Its not worth it to fight the rally in stocks at this stage. You probably need to wait till spring of 2024, when we are on the doorstep of a preemptive rate cut before you can aggressively short SPX/NDX. Right now, I'd rather be a buyer of dips than a shorter of rips. But not that good of an opportunity, so mostly on the sidelines. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com0tag:blogger.com,1999:blog-1715439530278924605.post-17464484217068488352023-11-28T06:13:00.001-05:002023-11-30T06:49:23.593-05:00The New Game<p>Markets change. This isn't your 1999-2000 late cycle market, or your 2006-2007 late cycle market. Markets of the past put a lot of weight on the business cycle, as recessions would lead to stock indices falling into bear markets. So investors were focused on getting ahead of the business cycle, by selling before the recession, near the peak, and buying during the recession, near the bottom. That's the old game. The old pattern. Front running the business cycle. Selling stocks when its late cycle and after the Fed has finished its hiking campaign, ahead of the recession. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1-2EtMADSZK_IBl3UBvDsAz7ldV5gy68mhq25Eu9-Oxh9vyIcbUJSpGLilaUKkUun_q23Bx2VpJdkiPWIfgmX-NnwDWQIuNmYQsv-pwaDW_AGZSQLozwhq4TgpDk-C7r_Ambf0CXy6lANgbrZUuKzL9K_svyHW-HEvZrSW523KcxlVEK54CgtNtXpwAg/s566/newgame.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="296" data-original-width="566" height="167" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1-2EtMADSZK_IBl3UBvDsAz7ldV5gy68mhq25Eu9-Oxh9vyIcbUJSpGLilaUKkUun_q23Bx2VpJdkiPWIfgmX-NnwDWQIuNmYQsv-pwaDW_AGZSQLozwhq4TgpDk-C7r_Ambf0CXy6lANgbrZUuKzL9K_svyHW-HEvZrSW523KcxlVEK54CgtNtXpwAg/s320/newgame.PNG" width="320" /></a></div><p></p><p>The new game has moved 2 steps ahead. It's not so much about getting out of stocks ahead of the recession. Its about getting out of stocks just ahead of a big increase in bond yields, even as the economy is hot. Bond yields have now become more important to the stock market than economic growth. That is what the 2022 bear market was all about. Investors assumed that much higher rates would then lead to a recession, ignoring lag effects and fiscal policy. With no recession in 2023 and SPX going much higher despite higher rates, most forecasters were wrong. They don't want to be fooled again, so they've given up on their hard landing call, and have tilted towards a soft landing view. <br /></p><p>Higher rates have done little to hurt the US economy, so many assume that it will do little to hurt the economy going forward. Thus, their consensus view of higher for longer and a soft landing in 2024. But the fiscal support that was there in spades in 2022 and most of 2023, will be fading in 2024. Most of the fiscal largesse is going to cash rich buyers of Treasury debt, who have a much higher propensity to save than consume. There will still be a big deficit, but less stimulative than previous years. All of this while banks are issuing fewer new loans, slowly choking out growth in future years. <br /></p><p>Investors don't have patience to wait anymore. What is happening now is assumed to be a good guess for what will happen in 6 months. After having egg on their face for calling for a recession due to higher rates and monetary tightening, they are now jumping on the lower inflation numbers and calling for a gentle path lower in rates. Once again, jumping the gun, thinking that lower rates will immediately mean a mild slowdown, with little pain. With the Fed taking their foot off the break gently, they assume that the economy will have a feathery, soft landing that will keep corporate profits growing and job losses at a minimum. </p><p>In this new game, its all about bond yields. Investors now try to stay long throughout the easing cycle, even if its during a weak economy, and get out during the start of the rate hiking cycle, just before bond yields surge higher. Modern day markets are infatuated with liquidity and monetary policy. Its more important than the business cycle, and the ups and downs of corporate earnings tied to that cycle. The market would rather have a weak economy with monetary policy getting easier than a strong economy with monetary policy getting tighter. The simplest way to measure monetary policy is through the change in bond yields. </p><p>The game has changed because of what happened after 2008. From March 2009 to January 2022, over a span of just over 12 years, SPX went from 666 to 4818. That is a 623% return, not including dividends, over 12 years, with ZIRP almost through the whole time period. Investors have been shown one of the biggest divergences between the real economy, where growth has been low, and the stock market indexes, where growth has been high. That has never happened before. </p><p>Its human nature to always fight the last war. Recency bias. The bias among investors is that low rates and QE lead to high stock market returns. But what market historians forget is that valuations were very low in March 2009, and super high in January 2022. It was not just ZIRP and QE that created huge returns. It was the much lower valuations after the GFC that was the potential energy unleashed by recklessly loose monetary policy. So while investors still have the same playbook, with expectations of great returns when the Fed eases (e.g.: 2019, March 2020 to Dec. 2021), the potential energy is no longer there. Valuations are very rich. Household allocations to equities are historically high, and only surpassed by the bubble period in 2021. In fact, this time, instead of a coiled spring, its a stretched out spring with no potential energy. </p><p>That being said, its not like 2000-2002 or 2007-2008. This time around, fiscal policy is much looser. Big budget deficits are mostly going towards enriching the top 10%, who are big financial asset owners. When you have so much interest income, subsidies, and pork thrown at the rich and lobbying corporations, they won't feel any pressure to hold a fire sale or issue more equity to re-liquify. Even in a recession. With such profligate fiscal policy aimed at shooting more dollars at the wealthy, I don't see how you get a 40-50% drop in the stock market. Anything is possible, but the US is clearly on an inflationary path, and that's incongruent with extended deflationary stock price movements. We could still get another bear market, but I think it will be like the 2022 bear market, a 20-25% drop without a surge higher in volatility. <br /></p><p>With the current high valuations, returns will be muted, and organic growth and productivity are very low. All future growth will come from the money printer coming straight from the US Treasury, if the Federal Reserve doesn't play ball. If the Fed also joins the party, then the dollar will be wrecked. T-bill fueled deficit spending is essentially fiscal QE, because T-bills are essentially treated like cash. Most of future real growth will come from under-reported inflation via CPI hedonic/substitution manipulation lower of the inflation rate. </p><p>In this cycle, there will be two local maximums. One at maximum economic growth, which was in late 2021. The other local maximum is when the hopes of a soft landing reach their highest, right before the Fed begins its easing cycle. That's likely to come sometime in the spring of 2024. The timing will be the hard part, as the Fed will wait till the last minute to reveal that they are on the cusp of cutting rates. That's going to be the last gasp higher for this bloated stock market, and will likely mark the beginning of another roller coaster ride lower. </p><p>Volatility has made a round trip from 12.50 to over 80 and back down to 12.50 over the last 4 years. Low volatility environments encourage overreach by investors looking to sell options premium, more leverage use, and slow grinds higher. Its not a conducive environment for buying puts, even though they are cheap. This is the kind of market that's best to just avoid if you are a trader. Don't see much to do here. Perhaps a small short in bonds and crude oil as potential short term plays. There is nothing juicy out there. Laying low in the weeds, like a sniper. Long periods of boredom which could be interrupted by short periods of sudden action. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkJKQ4fNL2Aj9VKxBjla24dDwS4OPeB9IrYRG3SOwDW4Jyh7Dhyxie2jDd6X3meEiThVfsmg9bqTvaoWmELmfrlWl_MUoQbapb9PluR1chyphenhyphen204q7Dar35jbLaf3W9DDJQ1rbOWcGhu2M7GNCcM1XqMhYPmk9q9ELyES9gaCivZyMWK2D0ej50jEOpDG0Q/s1161/VIX20182023.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="731" data-original-width="1161" height="402" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkJKQ4fNL2Aj9VKxBjla24dDwS4OPeB9IrYRG3SOwDW4Jyh7Dhyxie2jDd6X3meEiThVfsmg9bqTvaoWmELmfrlWl_MUoQbapb9PluR1chyphenhyphen204q7Dar35jbLaf3W9DDJQ1rbOWcGhu2M7GNCcM1XqMhYPmk9q9ELyES9gaCivZyMWK2D0ej50jEOpDG0Q/w640-h402/VIX20182023.PNG" width="640" /></a></div><p><br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com0tag:blogger.com,1999:blog-1715439530278924605.post-57301251761427526062023-11-21T07:00:00.003-05:002023-11-21T07:00:52.170-05:00Doublethink<p>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.<br /></p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhp2o95lgyNsyAjY36ZJSU-zxtL8tYkh56KLla7HzLFl8ZvDL8GjMTTt_QzLnX9WR7PK-AtMuyUA6TA25p9bu0jTKlXMGRlEMUW4t1pRHe-OkqkxftIKGStnD0m9HNMVepW_Xy6CQfEQl3knkcIgmjP7u0wwdmY9myOYTDTYg1_WwaWu9mO77DU8OX6c7I/s850/orwell.jpg" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="400" data-original-width="850" height="151" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhp2o95lgyNsyAjY36ZJSU-zxtL8tYkh56KLla7HzLFl8ZvDL8GjMTTt_QzLnX9WR7PK-AtMuyUA6TA25p9bu0jTKlXMGRlEMUW4t1pRHe-OkqkxftIKGStnD0m9HNMVepW_Xy6CQfEQl3knkcIgmjP7u0wwdmY9myOYTDTYg1_WwaWu9mO77DU8OX6c7I/s320/orwell.jpg" width="320" /></a></div>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. <p></p><p>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. </p><p>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. <br /></p><p>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. </p><p>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. <br /></p><p>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. <br /></p><p>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. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlB9jbrLVTAm9JuQTYSSbE8lk-I9FmM_MZn7PMUTDvUkfimYRtuRYJNlZZGyCWwIY70Nmt0li0HVI4D4gUOlwfULoDBw0WD2oExU2S63F5w6gVEsnIyrcng_DEYp5DciGuh8o-VLyfRPZPNg1my2APQ-wwLqXtJ0GRwxCpzKnhI-_0kMUKClhdgahnTL8/s1447/NDXfutures11172023.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1434" data-original-width="1447" height="634" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlB9jbrLVTAm9JuQTYSSbE8lk-I9FmM_MZn7PMUTDvUkfimYRtuRYJNlZZGyCWwIY70Nmt0li0HVI4D4gUOlwfULoDBw0WD2oExU2S63F5w6gVEsnIyrcng_DEYp5DciGuh8o-VLyfRPZPNg1my2APQ-wwLqXtJ0GRwxCpzKnhI-_0kMUKClhdgahnTL8/w640-h634/NDXfutures11172023.jpg" width="640" /></a></div><br /><p>Hedge fund positioning in the megacap tech is back to all time highs:</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhov4O3M15jDOv4ahvBV7jC5ROAlPlrCygY_kcJ7FHPBADbq0rZtXgRuO4J05OuG761EXyYMcC1LH7CARx6U372Qbk3gI-2QEdvi0t4Zu4hyphenhyphenYRPa4V63goT8HxdkKDsWjtY8kGBj5sXTQFyrOHk__hURXP1qMdZP4-ZyHepFc5uUy-Jjshyphenhyphenc4FjFXMJc8w/s697/megacaptech.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="687" data-original-width="697" height="394" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhov4O3M15jDOv4ahvBV7jC5ROAlPlrCygY_kcJ7FHPBADbq0rZtXgRuO4J05OuG761EXyYMcC1LH7CARx6U372Qbk3gI-2QEdvi0t4Zu4hyphenhyphenYRPa4V63goT8HxdkKDsWjtY8kGBj5sXTQFyrOHk__hURXP1qMdZP4-ZyHepFc5uUy-Jjshyphenhyphenc4FjFXMJc8w/w400-h394/megacaptech.png" width="400" /></a></div><div class="separator" style="clear: both; text-align: left;"> </div><div class="separator" style="clear: both; text-align: left;"> </div><div class="separator" style="clear: both; text-align: left;">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. </div><div class="separator" style="clear: both; text-align: left;"><br /></div><div class="separator" style="clear: both; text-align: left;">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. <br /></div>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-43776831809635751952023-11-14T06:40:00.002-05:002023-11-14T06:40:18.047-05:00Elevator Down<p>2023 defied the skeptics who were forecasting a recession and bonds got crushed again. Those that played the long side in STIRs and 2 yr futures got hurt the most. Even though the yield curve steepened, there were more losses on a risk adjusted basis from holding long positions in SOFR and 2 yr Treasury futures than in holding longs in Treasury bond futures. It was all due to the extreme negative carry of holding leveraged long positions in STIRs when the yield curve is inverted to this extent. It is costly betting on short end yields going lower. But if you get the timing right, the move can be explosive, as could be seen in March when the regional banking "crisis" caused 2 year yields to drop 1.25% in less than 10 days. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLfQKMnPX5pl5T4FdsJtnYUUlv9ec1MbkJ9k373ERCqz8t8FlqCgreS6sArvRNLiwyPxIyJvHjNPCjNVepfc-SJ5ddqxcqJEcxTHmVzBjFCVIZkgQ8fRr1kvUxX0fUNkqe1gONbDzp9RZNMOS6JFPV2VpJcP20ej6em7pxCVe3X0VSRR1KzZZU-9ZxfF8/s802/elevator.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="461" data-original-width="802" height="184" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLfQKMnPX5pl5T4FdsJtnYUUlv9ec1MbkJ9k373ERCqz8t8FlqCgreS6sArvRNLiwyPxIyJvHjNPCjNVepfc-SJ5ddqxcqJEcxTHmVzBjFCVIZkgQ8fRr1kvUxX0fUNkqe1gONbDzp9RZNMOS6JFPV2VpJcP20ej6em7pxCVe3X0VSRR1KzZZU-9ZxfF8/s320/elevator.PNG" width="320" /></a></div><p></p><p>The pace of rate hikes and rate cuts are not symmetrical. Historically, the Fed takes the stairs up when hiking rates, and the elevator down when cutting rates. This time, with the Fed viewing the current Fed funds rate as being sufficiently restrictive, the bar to cut rates is lower than people think. Sure, you hear higher for longer being repeated over and over again from the Fed and the parrots in the media. But following the Fed's forward guidance has been a short cut to the poor house. I put very little weight on the Fed's insistence that they will keep rates higher for longer until they reach their 2% inflation target. When the economy goes south, they <i>always</i> put more importance on jobs than inflation. If you get a weaker jobs market in 2024 and inflation is similar to what it is now, they will cut rates. If they try to fight the market by not cutting, the SPX will force their hand by panicking lower. Either way, the market will get what it wants if the jobs market is weak: rate cuts. <br /></p><p>You have 85 bps of rate cuts priced into SOFR Dec 24 futures. That is pricing in a small chance of a big drop in rates. With the current Fed funds rate at 5.33%, even if there is no recession, a mere slowdown in growth would be sufficient to get the Fed to cut at least 50 bps next year. The Fed hates to price in cuts into their dot plots, because they always want to sound optimistic about the economy, which justifies higher rates. But even the dot plots have 50 bps of cuts in 2024 as the median forecast. There is limited downside, lots of upside in SOFR futures for 2024. In a hard landing scenario, where you have more job losses than expected, the Fed could easily cut rates down to 2.5-3% within 6 months. That would take SOFR futures to 97.0-97.5. They are currently trading 95.45. <br /></p><p>There are some that think inflation will remain sticky and keep the Fed from cutting rates until late in 2024 or not all. Inflation won't be a big issue because inflation is only relevant when its rising strongly. With the CPI hedonic pricing manipulation, lagged effect of housing which will reflect the much lower rent growth in 2023 in the 2024 numbers, etc., CPI inflation will likely be trending stable to lower for 2024. Although the secular forces for higher inflation are strong, cyclically, inflation is coming down as you have a slowing economy with weak bank credit/M2 money supply growth. The lower inflation in 2024 should not last long, as I am sure politicians will pump more stimmies in due time, probably starting in 2025. <br /></p><p>Next year, its going to be all about jobs. We are getting to a point in the cycle where corporations will have to make a choice about taking high interest rate loans or working with less capital. If they continue to borrow despite higher rates, then you won't have job losses. But if they decide its more economical and profitable to run leaner with less capital and less labor, then they will borrow less and start cutting workers. Interestingly, I saw a recent projection based on an employment model that points to higher unemployment rate over the next several months. </p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtpspVx4FwuVqfhz_pijObacHofuJC0yJ40SQ4P7ECXuvpylssVQuMSFOu39P-u4oZvwLvJg50HeIsFDnie2JflAy2c3S39isHsiIlL4vHm-OzDgtzpFFUeVTs5aoyTqrsTYQJum7ysSetU-ZC08Dz8McjWePENHy31b2Fi8sQ967QysNH8gB2tHiILb0/s1110/Unemployment.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="701" data-original-width="1110" height="404" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtpspVx4FwuVqfhz_pijObacHofuJC0yJ40SQ4P7ECXuvpylssVQuMSFOu39P-u4oZvwLvJg50HeIsFDnie2JflAy2c3S39isHsiIlL4vHm-OzDgtzpFFUeVTs5aoyTqrsTYQJum7ysSetU-ZC08Dz8McjWePENHy31b2Fi8sQ967QysNH8gB2tHiILb0/w640-h404/Unemployment.jpg" width="640" /></a></div>Based on how weak the Russell 2000 has been, its fairly obvious that small corporations, and especially those that aren't even public, are having their margins squeezed by the higher cost of capital. Companies aren't welfare institutions. Their goal is to maximize profits, not create jobs. If margins are getting squeezed due to higher rates, they will cut costs. And the biggest cost is labor. <br /><p></p><p>Even with inflation data coming in hotter than expectations, Powell didn't really talk hawkish. He was just mealy mouth and seemed like he didn't want to pound the market lower anymore. I know its popular to say the Fed is clueless, but they are getting reports of the economy slowing. Its not yet flowing into the economic data which is lagging, but you can see the weakness from how bad the breadth is in the market. <br /></p><p style="text-align: left;">Its only a matter of time before you see those job cuts start to ramp up. Its coming. The nonfarm payrolls number will be the biggest market moving data for 2024. And unlike 2023, I expect the numbers to come in weaker than consensus for the next several months. I'm sure the BLS will still be busy counting part time jobs as if they are full time jobs, and calling that jobs growth, but the info on the ground will tell a completely different story. Labor hoarding is a thing of the past. You don't continue to hoard labor when you are bleeding cash and interest rates are high. <br /></p><p style="text-align: left;">With a weakening jobs market, the move in short term rates is straight forward. But the move in equity markets will be trickier. I expect a bull steepening move, with short rates going down much more than long rates. The SPX is more sensitive to long bond yields than short term rates, so a bull steepening is actually not that great for stocks. And of course the lower consumer spending that comes with a weakening jobs market is going to hurt earnings. So its 2 forces going against each other: lower bond yields, which is good, but weaker earnings, which is bad. So I don't have a strong view on how the SPX will do in 2024. Going long SOFR and 2 yr futures looks like a much cleaner bet on a weaker economy and an imminent Fed cutting cycle than shorting the SPX.<br /></p><p style="text-align: left;">Last thing to remember is that the Fed is political. In particular, Powell's job is on the line based on the result of the 2024 election. It appears Trump is going to be the favorite to win, as a weakening economy and preliminary polls showing him leading Biden in the battleground states give him the edge. Powell will be motivated to stimulate the economy as much as possible ahead of the 2024 election, trying to keep the stock market as high as possible to help Biden. If Biden wins, Powell gets re-nominated. If Trump wins, Powell will be fired. Powell is no dummy. He knows this. The weakening jobs market and stable to lower CPI will give him cover to make aggressive rate cuts in 2024. <br /></p><p style="text-align: left;">Bottom line, the dominoes are lining up for a big reversal of the rate hiking cycle in 2024. Higher for longer has been repeated for so long by the media and Fed officials, it's become a mantra. If you repeat a lie for long enough, eventually people believe it. It means that people aren't positioned for a big move lower in short term rates. You don't benefit from a big move lower if you are in money market funds or T-bills. The most effective way to make money in this situation is to make a leveraged long bet in the STIRs market. With the heavy negative carry in holding leveraged long positions in
STIR products, you have to wait for the right timing to put on the
trade. I don't think there is much time left, maybe till the end of
this year, to be able to put on longs in STIRs at good levels. A couple
of bad NFP reports should ignite the short end of the yield curve.
With CTAs loaded up short in short term interest rates, and the Street
still believing in higher for longer, the setup is ripe. </p><p style="text-align: left;">SPX is grinding higher despite the bond market's weakness since the horrible 30 year bond auction. Still not seeing the put/call ratios go down much even with the steady move higher. From watching CNBC, there is still a wall of worry out there, which is only slowly being climbed. The Moody's ratings warning on US sovereign debt was only good for a few hours of weakness, and the beach ball bounced up again. The price action is strong. The leaders, the Mag 7 are performing. Monthly opex is this Friday. The forces pushing this market higher should remain strong until later in the week. Staying long with a moderate long position. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com12tag:blogger.com,1999:blog-1715439530278924605.post-29004916419136391792023-11-07T09:41:00.002-05:002023-11-08T08:50:49.558-05:00US Fiscal Expansion and the Dollar<p>It sounds absurd, but the immense amount of government spending in the
US with huge budget deficits is actually helping the dollar get stronger
vs almost all the world's currencies. Logically, it makes no sense for
the value of a nation's currency to go up vs more fiscally sound
countries. Shouldn't more dollars in circulation from all that
government pork spending/lower tax revenue make the dollar less
valuable? It can only happen in a world where the US is the reserve
currency. A similar thing happened in the early to mid 1980s when the
US government ran big budget deficits, which kept the economy hot, and
thus interest rates high. The USD kept going up during that time,
because of interest rate differentials and a growing use of the USD as a
reserve currency due to expanding world trade. This time, its mainly
due to interest rate differentials. There is a belief in the market
that the US will be able to keep interest rates higher than all the
other developed economies because of its Argentina-style fiscal policy.
If Argentina tries to run this policy, its currency gets crushed and
interest rates soar because of the high inflation. </p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4vAl12cixFa7zNuH6dMxmFe5WnkkFPd8_n5DGPt9amscZvBPldlbpTkAtf_iZnV_Zy2s7OL06zIH4_dpxezWietAYwhCbAN6xRQPy4f7IZqEgsDWUTJc16osHzCUJg08p74ZLsaQdpiWJKZe4iOmH2N20ydIyGvB1PfB3lx8yPvgD6OWsnf53WcoGEiU/s1161/usd11072023.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="794" data-original-width="1161" height="438" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4vAl12cixFa7zNuH6dMxmFe5WnkkFPd8_n5DGPt9amscZvBPldlbpTkAtf_iZnV_Zy2s7OL06zIH4_dpxezWietAYwhCbAN6xRQPy4f7IZqEgsDWUTJc16osHzCUJg08p74ZLsaQdpiWJKZe4iOmH2N20ydIyGvB1PfB3lx8yPvgD6OWsnf53WcoGEiU/w640-h438/usd11072023.png" width="640" /></a></div> Eventually, water finds its level. Currencies don't permanently have
more value when the government decides to go crazy and go on a spending
binge on the nation's credit card. The dollar went sky high and then
straight back down in the 1980s. By the way, there was no recession
during this period, as the government was running big deficits at the
same time there was a productivity/labor boom as more women entered the
labor force and computing power skyrocketing. <p></p><p>The circumstances between now and the 1980s is totally different. There
is no productivity boom. And its the opposite when it comes to the
labor force, as its not growing, which is inflationary. It used to be
commonly believed that aging demographics was deflationary, mainly due
to what happened in Japan. But Japan had deflation not because of an
aging population, but because it had low M2 money supply growth, a trade
surplus, keeping its currency strong, and from importing cheap goods
from China. When you have fewer workers, and more retirees that receive
government benefits while doing nothing but consuming, that reduces the
ratio of labor output to money in circulation. That's inflationary.
That leads to wage inflation. That's what's happening in the US.
There is no free lunch from huge fiscal expansion. It is at the root of
almost every high inflation episode in human history. </p><p>Inflation will be a long term problem for the US because there is no political will to cut back on spending, reduce Social Security/Medicare benefits, and to raise taxes. The mantra is still deficits don't matter. Ironically, people cared more about the national debt and big budget deficits in the 1980s and even 1990s, when it was a much less serious problem. Now, when its a big problem, the public just doesn't care. They want their stimmy checks and government cheese. At the same time, they complain about inflation. They can't connect the dots. So the politicians continue to pander to them and hand out freebies for votes. <br /></p><p>The Fed is effectively the central bank for the world, and its forcing other central banks to follow its course or have its currency devalued. Japan is a prime example of a country that has decided to go at its own pace, ignoring the Fed's tightening monetary policy, which has resulted in the market crushing the yen. Europe, Australia, Canada, South Korea, etc. have decided to follow the Fed's tightening to a certain extent, allowing their currencies to depreciate more gradually. But they pay a price for this. Those economies are more interest rate sensitive than the US, mainly due to variable and short term fixed rate mortgages being the norm in those countries. In particular, the other developed economies outside of the US have a larger percentage of bank loans based on LIBOR/SOFR type money market rates, and less long term funding from bond issuance. Thus, you are seeing a much slower economy in the developed world outside of the US because they decided to follow the Fed. Either keep interest rate differentials small and really slow down the economy, or face a brutal currency devaluation like Japan. </p><p>The fight against inflation started by the Fed and followed by many other central banks has been more effective at slowing growth and killing inflation overseas than in the US. European inflation numbers are heading down quickly, and likely to easily go below 2% in 2024, opening the door for Europe to start rate cuts before the US. Europe is also suffering more from the higher rates as the policy transmission has been much quicker and pervasive. Germany is already in a recession, and will likely soon be followed by many others in Europe. There has been and will be less fiscal expansion in Europe and Asia vs the US, which contributes to the growing GDP gap. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOwWUjZOKEK_7umxquvASKHo_8Q1xqxeZAmjsUQDRwzC_aRpu23y-IdJ_gNBGXUhUa_TZ3aNCtPDedbcIg85WTdetJsJX9GSIyD-8OxzqnkNH7X6QC9eTx1n9fasDT8l9KtoqjpT3fnvBQ7UBbV8np7kuGM-sUw_Rmcpgdx60GuziBREM0uFhfuuQDslE/s558/lagardeowl.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="558" data-original-width="473" height="200" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOwWUjZOKEK_7umxquvASKHo_8Q1xqxeZAmjsUQDRwzC_aRpu23y-IdJ_gNBGXUhUa_TZ3aNCtPDedbcIg85WTdetJsJX9GSIyD-8OxzqnkNH7X6QC9eTx1n9fasDT8l9KtoqjpT3fnvBQ7UBbV8np7kuGM-sUw_Rmcpgdx60GuziBREM0uFhfuuQDslE/w169-h200/lagardeowl.PNG" width="169" /></a></div><p></p><p>We are now at the point where the monetary policy is starting to be felt in Europe, as the PMIs are very weak and signs point to a very hard landing with Lagarde in the cockpit wearing an owl costume. Its looking like the US recession people were calling for at the beginning of 2023 is going to happen to Europe at the beginning of 2024. Remember, about 40% of the S&P 500 revenues come from overseas. Most of that is from Europe and Asia. While I don't expect the US economy to do as poorly as many predict in 2024, I do expect the European and Asian economies to be even weaker than consensus.</p><p>Last week was all about Yellen trying to play Fed chairman by manipulating the supply of bills and coupons. Its like rearranging the deck chairs on the Titanic. There is only so much you can do to "improve" on a horrible situation. The coupon supply will still be huge and hard to digest at these yields unless you get more weak econ. data and more dovish cooings from Powell and co. We've seen time and time again when the going gets the tough, the authorities come to the rescue. Yellen and Powell caving to higher bond yields was the story for last week. Considering how much hedge funds reduced net equity exposure in October, you had a lot of dry tinder soaked in gasoline waiting for a match to ignite it. Yellen and Powell were the matches. </p><p>When you see such an explosive move like you did last week, something that blew me away, its usually got some staying power. I doubt its the start of a huge rally that lasts several months like in March, but more like a 3-4 week rally that takes us to strong resistance near the top of the range, up to around 4450-4500. </p><p>For the bond market, in a rare occurrence, the call options punters were right to bet on a big bounce in TLT. I don't have much confidence in the long bond sustaining a long rally, but will not short it until you get closer to the August highs in 10 yr yields around 4.30%. At current levels, I see very little edge in a short term trade. Overall, still leaning bullish on stocks and neutral on bonds. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com3tag:blogger.com,1999:blog-1715439530278924605.post-27088506265743036962023-11-02T07:10:00.000-04:002023-11-02T07:10:20.769-04:00Out of the Cash Bunker<p>Many were safely huddled into their cash bunker, hunkering down for a wave of bad news. When investors pre-sell ahead of events, the desperate sellers are gone, and only price sensitive sellers who are bagholding from higher levels are willing to provide supply in the face of a surge of demand for stocks <i>and </i>bonds. I did not expect a V bottom off that weak Friday close last week. Its been straight up with almost no dips as you have gone from SPX 4100 to 4250 in nearly a straight line over 3 trading days. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEitIQvWSf-0pKgDCAG2v-jdSzBNFtXtP-vZTKc1uhhrdcahuS8zdgXg6Z4tQw-Wojd_mE7o2_1N7DSQiz4_ym4p7ijTcbyeG-zr7vr6JXvTGwmlqIE-G7eTV_PuhFxdU1hyphenhyphena8_1GAx48KifQteXIZm_3NEj4lJJQJBo_POUUxvVXVeS3RaPZu19r_Asvm4/s555/bunker.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="356" data-original-width="555" height="205" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEitIQvWSf-0pKgDCAG2v-jdSzBNFtXtP-vZTKc1uhhrdcahuS8zdgXg6Z4tQw-Wojd_mE7o2_1N7DSQiz4_ym4p7ijTcbyeG-zr7vr6JXvTGwmlqIE-G7eTV_PuhFxdU1hyphenhyphena8_1GAx48KifQteXIZm_3NEj4lJJQJBo_POUUxvVXVeS3RaPZu19r_Asvm4/s320/bunker.PNG" width="320" /></a></div><p></p><p>Hindsight is 20/20, but its now clear that many investors cleared house last week selling off their beloved tech names, as Nasdaq was under the most pressure, and you got technical sellers panic selling as we broke below the much touted SPX 4200 support level. Reasons to sell were numerous and well known: </p><p>1. Geopolitical risk in the Middle East ahead of the Israel ground invasion into Gaza<br /></p><p>2. Bad price action after tech earnings </p><p>3. Technical breakdown below 4200</p><p>4. Upcoming QRA where Treasury were expected to announce a huge increase in coupon issuance (Yellen chickened out)</p><p>5. Fed meeting where most were expecting a hawkish pause</p><p>The above 5 reasons to sell are all behind us and the markets are now 150 points higher leaving behind many investors in the dust. I, along with many other investors are now begging for a dip to buy, but as is often the case, the market usually doesn't oblige, and keeps going higher until the move is over, after which the dips are toxic and to be avoided. <br /></p><p>Given that the feared events are mostly behind us, there are only 2 left: AAPL earnings, where expectations are very low, and nonfarm payrolls, which will be anticlimactic just after the QRA and Fed meeting, and will be long forgotten by the time the FOMC meets again. Plus, it appears the job market has cooled down if ADP and tertiary data points are to be believed. So the NFP is not going to be a game changer.<br /></p><p>Add to that, historically the biggest stock buyback month coming in November and you have a potent mix of underinvested fund managers who will be chasing the indexes looking for a year end rally. I don't think this rally will make it to year end, but the setup is there for it to make to November opex on November 17, which gives over 2 weeks for this thing to test the upper boundaries of the range, which could be as high as 4450, but more likely to be 4350-4400. I would not underestimate the short squeeze and chase potential of this stock market at this time of year. Unfortunately, I am among those in chase mode, but its better to chase early than to chase late. </p><p>The bond market has calmed down and for the time being, the supposed negative catalysts (QRA, Fed meeting) are behind us and it looks like it could rally a little bit more, which would set up a nice shorting opportunity. Still overall bearish on bonds as there has been too much speculation and talk about bonds being a great buying opportunity when the supply demand fundamentals remain poor and with too many people bearish on the economy. Too many are expecting a weakening economy to bail them out of bad bond positions. But the supply/demand situation continues to deteriorate with the Fed doing QT and the Treasury issuing loads of coupon notes/bonds. Despite the missed call on recession in 2023 by the majority, most of the same people are expecting the global economy to crack at any time under the weight of all these rate hikes. But that's a tall order.<br /></p><p>Higher borrowing costs in the US have less effect when the biggest interest expense for households, their mortgage, is fixed at low rates for the vast majority. And most of the accumulation of new debt over the past 5 years has come from the government, which doesn't have a borrowing limit. And politicians are in no way looking to self-impose a limit on their pork spending and handouts. That is the core problem right now, fiscal profligacy. The government spending is out of control, and they are unwilling to cut spending or raise taxes to control the deficit. This is something that a recession doesn't fix, but only exacerbates. </p><p>I doubt you will get that whoosh lower in stocks and a "credit event" that so many bears are waiting for when consumer balance sheets are so strong. You probably need to keep these higher rates for at least another year or two before you see real cracks starting to form. And with the Fed and ECB basically done, they will try for that soft landing, loosening financial conditions, keeping credit spreads lower, extending the time that it takes for the higher rates to cause a recession. </p><p>I am bullish for the next 2 weeks, but that's about it. This is not a strong bull market where you can just hold on to longs and take your time to sell, with prices lingering at the highs. Its not a bear market or a bull market. Its a range bound market, and you can't overstay the long or short side over the coming months. The bears overplayed their hand a bit in October, pushing down the indices low enough where you can get a big short squeeze and chasers to come out of their bunkers to push prices even higher. But I don't expect it to last as I don't expect the bond market to accommodate such a move higher by not going back down. </p><p>The price action over the past 3 months has clearly shown that this is a not a bull market you can trust. You can't buy dips recklessly and wait a few weeks to sell higher. The SPX has spent a lot of time lingering at lower levels, making U bottoms, giving investors a lot of time to buy the lows. That's not bull market price action. The drops haven't been steep, and volatility has been contained, so you can't call it a bear market either. We're range bound, between SPX 4100 to 4600. </p><p>We have another gap up today, on the afterglow of Treasury announcing less than expected coupon issuance, and with FOMC out of the way. It looks like too much of a move in such a short period of time, so I'm holding off on adding to longs, but it feels like it wants to go much higher over the next 2 weeks. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com6tag:blogger.com,1999:blog-1715439530278924605.post-84878066043122784262023-10-27T06:11:00.000-04:002023-10-27T06:11:41.461-04:00Catching the Falling Knife<p>They are not making it easy for bulls in this market. You have to fight and claw your way for small gains, big gains remain elusive, and rallies have not lasted for long. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIenKR-Od4JI4kGlYqyDgOH5RTFbzh9xFv1YWjAuzmDl94Rd6BFb30YwRDStYk1bxs4iKZR4O-LoWApSGt_pWM6Wbzuen0JrSr7kTd4wP4Hj2jwzi6Y6xCWc1MPl_F6Hi1sucgwdzDEx3ZQ1OEyzXVWdj4A3Ff2YLx11c7rN24h6l2B_sNsfR5fqAMHuY/s546/fallingknife.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="546" data-original-width="415" height="200" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIenKR-Od4JI4kGlYqyDgOH5RTFbzh9xFv1YWjAuzmDl94Rd6BFb30YwRDStYk1bxs4iKZR4O-LoWApSGt_pWM6Wbzuen0JrSr7kTd4wP4Hj2jwzi6Y6xCWc1MPl_F6Hi1sucgwdzDEx3ZQ1OEyzXVWdj4A3Ff2YLx11c7rN24h6l2B_sNsfR5fqAMHuY/w152-h200/fallingknife.PNG" width="152" /></a></div><br />What I have seen so far this week isn't all that encouraging for longs. You had a clean breakdown below the much touted SPX 4200 level, yet you didn't see a big jump in the put/call ratio, and in fact, you have seen quite a bit of call volume this week. The ISEE index measuring the options bought to open ratio of calls to puts shows the complacency.<br /><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDC5TVSrxGzqRfjUFHjoqOLfxDOqPE0E-KkjxC2qBJvu4_tpL82Djo7NDk4VS3sWvtoFafaIQTZAJl_a9F9hyAYcEF8U9IGoRU172KnA8YiAOXaelIkdeokNmacCyZCdKpdr_T1ZLtvKZon0Uwt5X1y0f1VPSsgs4yJ8IvP0lvylNzD9lwKekUJNPxifI/s856/ISEE10262023.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="550" data-original-width="856" height="413" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDC5TVSrxGzqRfjUFHjoqOLfxDOqPE0E-KkjxC2qBJvu4_tpL82Djo7NDk4VS3sWvtoFafaIQTZAJl_a9F9hyAYcEF8U9IGoRU172KnA8YiAOXaelIkdeokNmacCyZCdKpdr_T1ZLtvKZon0Uwt5X1y0f1VPSsgs4yJ8IvP0lvylNzD9lwKekUJNPxifI/w640-h413/ISEE10262023.PNG" width="640" /></a></div><p></p><p>Its concerning to see this while big tech earnings lead to intense selling of tech stocks. The COT futures positioning data comes out later today, so that should reveal how much positioning has changed since the selloff started last week. Bulls need to see asset managers significantly reducing longs to have more confidence in buying the SPX. So far, you haven't see enough fear and panic to get a tradable bottom. </p><p>The complacency extends over to the bond market, where investors seem to feel more sanguine and bullish than they are on stocks. It boggles the mind to see the option traders come in day after day to buy up TLT calls, as if its a generational buying opportunity in long bonds. And they keep getting creamed, with hardly any signs of life from the weakest major market in the world. Not only are they hoovering up "cheap" TLT calls, they are piling in to TLT itself, with huge flows in the past 2 days, with back to back $1+ billion inflows (Oct. 25 and 26). Also from what I hear from most of the financial experts, they are bearish on the economy and most seem to be calling for a recession in 2024. The weak price action in bonds along with the overall bearish view on the economy from the pundits tells me a lot of bond investors are offside here and feeling a lot of pain. I don't expect that pain to go away until you see a flush out capitulation with 10 years breaking above 5%, and getting much closer to the Fed funds rate of 5.33%. </p><p>The bond market continues to <a href="https://marketowl.blogspot.com/2023/09/bonds-crying-for-help.html">cry for help</a>, and its only been answered by limited ammo call punters and knife catchers in TLT who are quickly losing their fingers. Politicians in Washington DC have totally ignored the message that the bond vigilantes are sending. That message is simple: cut your reckless spending and raise taxes. Instead, you see Biden ask for another $100B to spend on wars, touting it as a good for the economy and providing more jobs! And the Republicans are more concerned about being anti-woke and keeping immigrants out of America than they are about the huge budget deficit from Bidenomics and ballooning national debt. And most of the voting public can't put two and two together, and think the plunging bond market is because of Fed rate hikes, not the reckless spending in Washington DC. </p><p>The cavalry is not coming to save the bond market. Powell isn't coming to the rescue until you see blood in the labor market. And if he does, that's going to help the short end much more than the long end, as I don't think he's going to do QE when the Fed funds rate is so high. Bottom line, if you are going to make long term bets on the bond market, being leveraged long in the short to intermediate part of the curve will be much more profitable than being long in the long end of the curve when the economy slows. The steepening will continue for a while. </p><p>And I don't see the economy slowing fast enough to rescue the TLT buyers. There are way too many doom and gloomers hoping to profit off of TLT calls expecting a credit event like 2008. The excesses just aren't there in the private sector. Only from an unwind of a private sector credit boom can you get a credit event. The balance sheets of most households is rock solid, as the US government and the Fed re-liquified everyone with massive debt fueled spending mostly financed by QE over the past few years. </p><p>The only way you get a recession is if corporations decide to get much leaner, reduce debt by not reissuing at higher rates, and cut labor as a result. The next recession will have to come from CEOs and small business owners who choose not to issue bonds/take out loans at high rates, and instead choose to match the lower capital with less labor. You are not going to get a recession from a financial crisis, there is just way too much liquidity out there, with the Fed's balance sheet still bloated and with the US government pumping out multitrillion dollar deficits during expansions. And you definitely will not get the US government to cut spending or raise taxes, so they won't be the cause of any future demand weakness. All in all, its just a terrible fundamental situation for long term Treasuries. <br /></p><p>While I don't like the price action in stocks recently, and the complacency in the options market lately, I still think we are close to an intermediate term bottom due to oversold conditions and a seasonally favorable time with lots of stock buybacks coming in the next 2 months. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwz_yk6KhWVUW85qgxZ6eD9xnQ2NZrf-eQnXamUma6ufIvc9DevYJVmVHl0AFVhAVj92b_artSppgcgbOdaLGfQ9FL_Y4EZt9Rlr2WQVxj_Ja3sxWJwrUPa8CoVOjLv4mRVSm6S6vYuMVd18jxP1pCwfx5Z9ktRSQFpLIG1e7EtcOz5u6a0KT8mA6CxeY/s600/buybackseasonal.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="450" data-original-width="600" height="480" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwz_yk6KhWVUW85qgxZ6eD9xnQ2NZrf-eQnXamUma6ufIvc9DevYJVmVHl0AFVhAVj92b_artSppgcgbOdaLGfQ9FL_Y4EZt9Rlr2WQVxj_Ja3sxWJwrUPa8CoVOjLv4mRVSm6S6vYuMVd18jxP1pCwfx5Z9ktRSQFpLIG1e7EtcOz5u6a0KT8mA6CxeY/w640-h480/buybackseasonal.jpg" width="640" /></a></div><p>Expect the weakness to continue into Monday/Tuesday of next week, where I will be looking to buy the dip. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com4tag:blogger.com,1999:blog-1715439530278924605.post-40724121405627289002023-10-25T08:16:00.006-04:002023-10-27T03:58:53.994-04:00More Bond Pain AheadBonds are the focus of attention in financial markets. You have the <a href="http://marketowl.blogspot.com/2023/10/geopolitical-monkey-brain.html">geopolitical monkeys</a> who get excited whenever the media goes overboard reporting on fighting overseas, but they can only move markets for a couple of days before prices mean revert. So geopolitics doesn’t matter. Bonds are where the action is. <div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYPxG46D85fy-AdvdRXTJhUQ2d4uymM_PCG1Cy5R9JXaoqw4-Vc4ygaE752sukEscsXOiotUELt9JZmgkAWMbrLnSMuKPuNfVAzUNwxfej8tXribVFJOzArculdxamY5mrGDgN6OJC68RKrT6SuezfcwwUv05d92tmZxkBGWHj5YHcZCMBHUMok69TzzU/s1244/1FDD374D-EAC1-4317-98C0-33CBF9D3220A.gif" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="544" data-original-width="1244" height="140" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYPxG46D85fy-AdvdRXTJhUQ2d4uymM_PCG1Cy5R9JXaoqw4-Vc4ygaE752sukEscsXOiotUELt9JZmgkAWMbrLnSMuKPuNfVAzUNwxfej8tXribVFJOzArculdxamY5mrGDgN6OJC68RKrT6SuezfcwwUv05d92tmZxkBGWHj5YHcZCMBHUMok69TzzU/s320/1FDD374D-EAC1-4317-98C0-33CBF9D3220A.gif" width="320" /></a></div><br /><div>Here’s my theory on why bonds are getting crushed. At the start of the year, the vast majority was expecting a recession sometime in 2023 due to:</div><div>1. Huge move higher in yields in 2022 and a hawkish Fed</div><div>2. Bullwhip effect leading to too much inventory, leading to a big slowdown in the manufacturing and goods economy</div><div>3. Drawdown of Covid era excess savings leading to reduced consumption</div><div><div><br /></div><div>But the US economy in 2023 has been well sheltered by low fixed rate mortgages refinanced in 2020 and 2021, low term rate bonds and loans issued in 2020 and 2021, and implementation of Bidenomics fiscal pork bills like CHIPs, IRA, and infrastructure. Add in the COLA adjustments higher for Social Security checks to the elderly and you had a huge blowout in the budget which kept the economy buoyant in the face of higher rates. </div><div><br /></div><div>So we never got the recession and stocks surged higher, which was responsible for the 10 year yield move from 3.60% to 4.20%. How about the move from 4.20% to 5% since the start of September? We didn’t have any significant economic data and the Fed has actually become less hawkish, showing their reluctance to hike further. Many people point to supply, but the supply of coupon bonds has been large and steady throughout the year, so there's not much change there. It appears that the move comes down to simply having price sensitive buyers up to their eyeballs in bonds, so the marginal buyer could only be found at lower prices. The supply/demand mismatch has been present since the Fed started QT. There has been a continuous deluge of USTs being issued since 2020, due to the monster budget deficits. This was masked by a bazooka QE in 2020 and 2021. And then in 2022 and first half of 2023, by temporary duration demand from those thinking recession in 2023. But that marginal bid went away after it became apparent that the US economy was much stronger than forecast. What you are seeing now is a Treasury market normalizing to a non-recession US economy with rate cuts nowhere in sight. </div><div><br /></div><div>The yield curve was absurdly inverted as recently as August. You had Fed funds at 5.33%, 2 year at 5%, and the 10 year at 4%. The yield curve was pricing in an imminent rate cutting cycle, and if that rate cutting cycle doesn’t come soon, the yield curve has to steepen to reflect the lack of cuts. That’s what happened. During the bear steepening, you have seen a parade of investment managers and analysts talk about how cheap bonds are, how attractive they are, etc. There’s been no real fear on TV. The only fear you see is the fear of missing out on a "generational" buying opportunity in bonds. </div><div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsc4Ul2sJfjrtYodAMvOBBNuGcBzswVJWDg_A7SYyTV3_354QDnu8ONxGDUPGQBJ9sBecUyVNmwj0yvdBwJKJPSVsGa0mZnoCeAIngcRRZKru-JmyQhyphenhyphenF3nBaYa6oWg_8E26vydXBA_Xch4CscmkLqiFxQWhGNOEq6Pa8A8xB8HubfiaeTMTZGLOzoLf8/s690/JPMbondsurvey.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="384" data-original-width="690" height="356" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsc4Ul2sJfjrtYodAMvOBBNuGcBzswVJWDg_A7SYyTV3_354QDnu8ONxGDUPGQBJ9sBecUyVNmwj0yvdBwJKJPSVsGa0mZnoCeAIngcRRZKru-JmyQhyphenhyphenF3nBaYa6oWg_8E26vydXBA_Xch4CscmkLqiFxQWhGNOEq6Pa8A8xB8HubfiaeTMTZGLOzoLf8/w640-h356/JPMbondsurvey.jpg" width="640" /></a></div>Despite the huge selloff in bonds, active money in the JP Morgan US Treasuries survey was most bearish at the start of the year, and was the most bullish earlier this month. That's not what you normally see at bottoms for financial assets. And you have the options punters who rarely make money coming out and buying huge amounts of TLT calls, making leveraged bets on a quick recovery in long bonds. You see much less volume in TLT puts, even though the trend is firmly lower, and puts are the ones that have been paying. So from a positioning standpoint, it still looks like more blood needs to be shed before you can get a tradable bottom in bonds. <br /></div><div><br /></div><div>Fundamentally, in order to get a big move higher in bonds, you need an environment where the Fed is likely to start cutting. Its not going to be inflation sliding lower, because that's going to take too long. You need the unemployment rate to go up. The labor market holds the key to the future of Fed policy, as its much more likely that the labor market cracks before you get a CPI low enough to induce the Fed to cut quickly. Fed only cuts quickly when there are job losses, not when there are low CPI prints. I doubt you see a credit event come to rescue underwater bond holders, like some well known, but usually wrong market gurus are warning about. </div><div> </div><div>Higher rates work more like low kicks than high kicks to the side of the head. Credit events are high kicks to the side of the temple. Events that most people don't see coming. If you saw the head kick coming, you would duck and avoid it. But if it hits you, it means that you didn't see it coming until it was too late. Lagged effects of monetary tightening are like low kicks to the calf. Big difference. The low kicks take time to accrue damage and the result isn’t devastating like being knocked out. What’s most likely to happen in this cycle is corporations will slowly reduce labor to match the reduced capital rather than borrow at high rates that don’t provide a positive return on investment. Only when the labor market weakens enough will you grab Powell’s attention. I don't see that as being imminent, as the US is quite well buffered against rate hikes, and the budget deficit, will remain large, although most likely to decline somewhat. <br /></div><div> </div><div>Bottom line, we all underestimated the power of fiscal stimulus in 2023 and still underestimate it now. But without a doubt, 2024 will have less fiscal support for the economy than this year due to higher capital gains (more tax revenues from higher SPX, NDX), resumption of student loan payments, less COLA boost for Social Security due to lower CPI, and lower spending at the state and local level due to drawdown of excess Covid funds. Below are projections for 2024 state spending in a few states. This will work to reduce demand at the margin. <br /></div><div> <br /></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEij0QWS2a84S7Ee2mQZOsP9CEc2TayUJqFG9XdQmFv6KLSf2-_GFCVrJeQ_H301X5k1e7PpSz7k53xtW-nn4BA4JkLgrNSAdAn70kgOe3SY8X0r-a2bZSKVBAHNRpzVxzbeV6eHs86z6s2XKIcFiEUxBUCpthmYYb3Iajlet2RZoSk7PkQjywLrwhRxQ30/s1777/D161313F-0DDF-4EA0-A0FC-9CEC20292692.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="842" data-original-width="1777" height="304" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEij0QWS2a84S7Ee2mQZOsP9CEc2TayUJqFG9XdQmFv6KLSf2-_GFCVrJeQ_H301X5k1e7PpSz7k53xtW-nn4BA4JkLgrNSAdAn70kgOe3SY8X0r-a2bZSKVBAHNRpzVxzbeV6eHs86z6s2XKIcFiEUxBUCpthmYYb3Iajlet2RZoSk7PkQjywLrwhRxQ30/w640-h304/D161313F-0DDF-4EA0-A0FC-9CEC20292692.png" width="640" /></a></div><br /><div>While bonds have sold off a lot, I don't view them as a bargain, like some some eager speculators. I am hesitant to buy this dip (more like a trench) in bonds. The supply/demand equation is unfavorable, and expectations are quite low for the economy in 2024, so its not going to be easy to surprise to the downside. This is why I am not bearish on SPX, because of those low expectations. Its not everyone on recession alert like end of 2022, but you don't see much optimism about the economy in first half of 2024 from those on CNBC or Bloomberg. The most likely scenario for the next few months is the US economy gradually slowing down, but not more than the low expectations people have. That should keep stocks in a range, around SPX 4200 to 4500. During that time, I expect bonds to settle down, but I don't expect a big move lower in yields, probably lingering somewhere between 10yr 4.6%-5.2%. Unless the labor market gets much weaker, you will not get that big rally in USTs. That's going to take a few months, because the labor market is always lagging, and the US economy is just not weak enough yet for mass job cuts. </div><div> </div><div>Missed the graceful exit on my SPX and NDX longs last week. Sold a bit on Friday to reduce risk, and reduced a bit more on Tuesday, as the price action is quite weak, and I want to have some dry powder just in case we get a bond panic as 10 year yields decisively break above 5% and SPX decisively breaks 4200. If that happens, I will buy that dip. This stock market is trading much weaker than expected, so my confidence level on a strong rally has gone down. Its very much possible we just get a underwhelming dead cat bounce towards 4300, but that's not the base case. Base case is a move towards 4400-4450 by mid November. Looking like you won't see any strong uptrends or strong downtrends in stocks for the time being. Looking more and more like a range bound market for the next several months as the earnings momentum will not be strong enough to get stocks meaningfully higher, but at the same time, expectations seem too low and I don't think the economy in 1st half of 2024 will be as weak as many are forecasting. Plus many are hiding out in the <a href="http://marketowl.blogspot.com/2023/10/avoiding-roller-coaster-in-cash.html">comfort of cash</a> so there is a lot of dry powder waiting to be deployed in stocks out there. So that will keep downside contained.</div></div>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com4tag:blogger.com,1999:blog-1715439530278924605.post-27257251234604772572023-10-17T06:17:00.002-04:002023-10-17T11:42:30.901-04:00Avoiding the Roller Coaster in CashThe most popular asset right now are cash equivalents, i.e. money market funds, T bills, and CDs. There is informational value in that. When the US government has national debt of over $33 trillion, over 120% of GDP, a ton of interest income is being spewed out to the private sector. The US budget deficit is nearly $2 trillion, with a big chunk of that going out as interest income. When investors are losing money in bonds, that reduces their percent allocation to bonds, at the same time, the influx of cash from interest income increases their allocation to cash, and reduces their allocation to equities. Slowly, investors are getting overweight cash as bonds are going down and stocks are range bound. <div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLOAG4uK_28na_CWVnCThnEc5XAWy4iSXyEfYQXRpfR-Do_cEh3RoeFmKURCh49-epllEgNo4hBOVRJqRnnaGuwQLvyrGQ_ERMAZbCfJQ2iKft6y3Vd44e9NdO3Lh8cFqQfycXGG8CTI_pJPpr4c7DVBcH2-Uk4SCgDnItQWAEaPF0d-69w8J7iidX-Fk/s450/No-Penalty-Certifacate-of-Deposit.jpg" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="450" data-original-width="450" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLOAG4uK_28na_CWVnCThnEc5XAWy4iSXyEfYQXRpfR-Do_cEh3RoeFmKURCh49-epllEgNo4hBOVRJqRnnaGuwQLvyrGQ_ERMAZbCfJQ2iKft6y3Vd44e9NdO3Lh8cFqQfycXGG8CTI_pJPpr4c7DVBcH2-Uk4SCgDnItQWAEaPF0d-69w8J7iidX-Fk/s320/No-Penalty-Certifacate-of-Deposit.jpg" width="320" /></a></div><br /><div>You also have to look at flows of supply into cash, bonds, and stocks. The huge US budget deficit is increasing the supply of cash, in the form of interest income, as well as the supply of bonds, in the form of Treasury issuance and QT, which combined is running at well over $2 trillion this year. Meanwhile, the supply of equities is not going up due to the approximately $1 trillion annual run rate of stock buybacks. So while I see many argue that the value fundamentals are favorable for cash and bonds over stocks at current yield levels, the supply demand fundamentals favor stocks. I hear very little about this favorable supply demand situation when people discuss stocks. Its always the overvaluation relative to bonds, the talk about a low equity risk premium, and how equities are a poor value. </div><div> </div><div>I cannot disagree, those are legitimate long term concerns, but in the short to intermediate term, supply demand plays a bigger role than long term valuations. And as long as corporations can maintain big stock buybacks, and earnings are sustained, its difficult to get a bear market under those conditions. You need earnings to go down 20% to get a bear market. With huge budget deficits from past pork bills and massive Treasury interest expense set to continue for the next few years, that fiscal expansion will make it tough to get nominal growth negative. And you need nominal growth to go negative to get a meaningful drop in earnings. Even the much feared stagflation would mean that corporate earnings aren't dropping much due to the benefits of inflation for revenue growth. You need to see deflationary impulses in the economy to get a big drop in earnings, and politicians will zealously fight a weak economy and deflation with stimmies and pork at the drop of a hat. <br /></div><div><br /></div><div>Right now, the surge in long bond yields is the excuse for selling off the equity indices, but the big cap tech stocks and other mega caps which drive the SPX are not feeling much pain from the higher yields, as they are cash rich and have loaded up on long term debt. On the other hand, small caps are more rate sensitive due to having higher debt/equity ratios and with more shorter duration maturities on their balance sheet. The maturity wall won't really hit for them until 2025, but its close enough that investors will sell off these stocks anytime yields surge higher. That's why you continue to see the big divergence between SPX and Russell 2000. It is similar to what you saw in 1999 when the Fed was raising rates and yields were rising. </div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6w_bgtT1xSh5A3-RsrMAL3s8_Ze2Ue97BUWXpjYdxwIsMJ9tRXDoss-JSzSo0_N1WOKD3SeKRt4a0vajvYhyZOguRhw-ONtOzphLxXWJ-QD3e9qzs58BBm0g_zPxH6rgUJPMBmhcDJeOXMtUQtolPr-pcpcaS5SU72flm745S9wZWct5UxqnYvNUbS-k/s964/SPXRUT.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="777" data-original-width="964" height="516" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6w_bgtT1xSh5A3-RsrMAL3s8_Ze2Ue97BUWXpjYdxwIsMJ9tRXDoss-JSzSo0_N1WOKD3SeKRt4a0vajvYhyZOguRhw-ONtOzphLxXWJ-QD3e9qzs58BBm0g_zPxH6rgUJPMBmhcDJeOXMtUQtolPr-pcpcaS5SU72flm745S9wZWct5UxqnYvNUbS-k/w640-h516/SPXRUT.PNG" width="640" /></a></div><div><br /></div><div>Since I remain somewhat bearish on the US bond market, I expect the SPX and NDX outperformance over Russell 2000 to continue for the rest of the year. The US economy has continued to be underestimated by the investment community and I still hear too much talk about a US recession in the first half of 2024 due to higher bond yields and the lag effect. I am skeptical of those prognostications as the very fact that investors are worried about an economic downturn in 2024 means that pentup demand is building for investment. The Covid bullwhip effect is over, and the inventory build cycle is favorable for goods for 2024 and 2025. There is no shortage of liquidity out there. The Fed balance sheet is still egregiously huge relative to US GDP. People forget how much QE the Fed did in 2020 and 2021. It dwarfs the mini-me QT that is ongoing now. </div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8XBzRqRM8NrBcVQqqlXbDBK7Wb1dJeU6SQhKbFEkiZFw_TgAUEbqMOgrjd44PZTdcZNVmjidpHsGiOka9WZiXjzF0_9JU08arfNkyafHLU9NPc5c5Da4khe18sQhs3bM42tAZT4ZGZTqrvJdsODY6inYJ44g733EmiDhU8NyUYEuoX5rmtjIcSLqKyyY/s1136/Fedbalancesheet.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="531" data-original-width="1136" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8XBzRqRM8NrBcVQqqlXbDBK7Wb1dJeU6SQhKbFEkiZFw_TgAUEbqMOgrjd44PZTdcZNVmjidpHsGiOka9WZiXjzF0_9JU08arfNkyafHLU9NPc5c5Da4khe18sQhs3bM42tAZT4ZGZTqrvJdsODY6inYJ44g733EmiDhU8NyUYEuoX5rmtjIcSLqKyyY/w640-h300/Fedbalancesheet.PNG" width="640" /></a></div><p></p><p>Its easy to sit in cash and collect 5% when stocks AND bonds are both going down. But that was also the case when I heard the "experts" on CNBC and Bloomberg tout cash in March, April, and May of this year. The SPX rocketed higher soon afterwards. Stocks and bonds tend to not continue to go lower when investors are hunkered down in the safest asset around: cash. FOMO is always around the corner, waiting to get unleashed as soon as cash starts to underperform either stocks or bonds, or both. </p><p>On to the markets. The VIX had a mini spike on Friday out of the blue, much more than the move in SPX would warrant. And on a Friday, when VIX usually declines due to the weekend effect. That caught my eye, as the indices haven't really moved that much and the IV is much lower than the historical vol on a 1 month basis. It can only be summed up as one thing: investors have some fear. You don't pay up for VIX or puts if you aren't concerned. The news media has done its job of getting people worried about war. The <a href="http://marketowl.blogspot.com/2023/10/geopolitical-monkey-brain.html">monkey inside us</a> can't resist the temptation to buy into the hype and get scared. That was the reason for the Friday selloff and the VIX spike. The big move higher in crude oil, gold, and even a small short squeeze in the weakest of them all, the long bond was able to catch a safe haven bid. That's how nervous the market was heading into the weekend. Monday quickly reversed that move, when nothing happened, but the reluctance to embrace this rally remains. Price moves before emotions. Emotions catch up later. That's why traders who trade on emotion are always late to buy on the way up. </p><p>A lot of puts were bought over the past few weeks, meaning that if the market grinds higher into this Friday's monthly opex, dealers will have to buy futures in size to delta hedge as puts melt lower from both a rise in price and a drop in vol. The VIX at over 17 with this kind of volatility is overpriced. Remain long as SPX trades very well considering the renewed weakness in bonds and the elevated VIX. But will not stay long for much longer, as I expect more two way trade and chop after this week, as there are worries about the technical setup and the <a href="http://marketowl.blogspot.com/2023/10/low-rider.html">U bottom</a> that I mentioned several days ago. </p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com10tag:blogger.com,1999:blog-1715439530278924605.post-62551849418225622612023-10-10T06:14:00.001-04:002023-10-10T10:09:42.026-04:00Geopolitical Monkey Brain<p>War bad. Peace good. War starts ---> Sell. War ends ---> Buy. That's the monkey brains behind the knee jerk reaction that you saw Sunday/Monday in the overnight futures. About the only move that made some logical sense was the move higher in crude oil, but even that is a bit of a stretch, only because it could maybe make it harder for Iran to sell some of its black market oil barrels. Maybe. But probably not. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhsnhd6Y1xDvSMDSlQH17VArfO5WAFRAzRbj1F2OMpcNDLBx3B9ZLLr9mRmqXgwBjVNY1URXn77u-sPkoSxBTitCwHFmmIRVL1e-CkKpz8fXrcy4ZRSAsOm1-1eoQUTNk6D56AytUeRTits53be5l7d2YCUz7LLaK1yvmJ14Kd4jyNG4l6ewegbn3-TC0/s591/monkeysfighting.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="351" data-original-width="591" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhsnhd6Y1xDvSMDSlQH17VArfO5WAFRAzRbj1F2OMpcNDLBx3B9ZLLr9mRmqXgwBjVNY1URXn77u-sPkoSxBTitCwHFmmIRVL1e-CkKpz8fXrcy4ZRSAsOm1-1eoQUTNk6D56AytUeRTits53be5l7d2YCUz7LLaK1yvmJ14Kd4jyNG4l6ewegbn3-TC0/s320/monkeysfighting.PNG" width="320" /></a></div><p></p><p>The primal urges tell the average investor to sell and ask questions later. I bet you if this happened in the middle of Africa, let's say in Nigeria (where crude oil is actually produced), people could care less. Some lives are more equal than others. Black lives (especially African) and Muslim lives are definitely less equal than Jewish lives. People were getting massacred in Syria (on a much bigger scale), and most people could care less. The markets sure didn't care. But its happening in Israel, and there are a lot of people in finance who manage a lot of money who are Jews. And they have intense interest in this event. That amplifies the kneejerk reaction to the news. Nothing against the Jews, but they have a lot of power. They are a minority group that control a lot of money. <br /></p><p>This is nothing like Russia invading Ukraine. Russia is a huge country. Israel is not. Russia produces a ton of commodities, including 10% of the world's oil, and a huge amount of natural gas. Israel does not. That was a legitimate market mover, because of the great uncertainty, but even that turned out to be a relative non-event for the crude oil market in the long term. War in Israel matters to Israel. It doesn't matter to the rest of the world. But you'll see the 5 minute Middle East geopolitics experts come out of the woodwork using mental gymnastics on how this war in Israel has a huge effect on the world, espousing their expertise on Twitter as if its a public service! I'm just a simpleton who believes that wars are local, and have local effects. World Wars happened 2 times in the last millennia. They are the exception, not the rule. <br /></p><p>Its painful to listen to CNBC, but its part of the job. Trading alone, the quickest way to get exposure to the zeitgeist of the market is through Twitter, CNBC, and Bloomberg. The doom and gloom was palpable. The crowd was already leaning heavily bearish after that "blockbuster" NFP report, but this just put them over the edge. It didn't match the 0.6% gap down in the futures. If you had only heard the financial media and seen the tweets, you would have thought the SPX futures were down 80 points. They were down 30. Its going to take a big move higher from here to get rid of that gloom and doom. Gloom and doom is a not a long term stable psychological condition. Its temporary, and when it subsides, stocks are usually higher. <br /></p><p>Most of the last 3 weeks have been risk off days, with the focus squarely on the plunging bond market. Now that you have a war in Israel, which should be a nothingburger for the bond market, but with emotions high, and bond shorts nervous, its has provided a backdoor bailout for stuck longs in long end of the Treasury market. I don't expect this bond bounce to last long, but it probably keeps the shorts away for at least a few days to give the beaten up longs some breathing room before the shorts pounce again. That breathing room should be enough to provide some upside fuel for stocks in the coming days. We've had a slow motion capitulation over the past 2 weeks, it culminated with a panic gap down on the blowout NFP number, which cleared out the last remaining nervous longs, to allow for this bounce. With the war leading to Treasuries now showing some signs of life, you can't be negative on stocks, not until you get a healthy bounce into real resistance, which is around 4450-4500 SPX. There is a lot of air up above current levels, between SPX 4340 to 4450. That air pocket means that if investors decide to reallocate to stocks, you could see a quick move up to 4450, possibly by early next week. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5IXbZwZHzfQT7O9wqEHH_wkL-yvOb-qzGZvbfLJrv4zp9K_mlWRuQtp6abOEHxpM6Gx3HOpaHAhzd27InAXPYXU3IHk8-dBe-2kVHTRmKMRwvDXNy6hxdMp8lXiAdGxP9BvBVnsLHOpRGI7jBpcg9B5LA1XqvBcVAVM7RS3CiVkIDjE1PGfp2vm-WaO4/s1153/spxbarchart.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="623" data-original-width="1153" height="346" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5IXbZwZHzfQT7O9wqEHH_wkL-yvOb-qzGZvbfLJrv4zp9K_mlWRuQtp6abOEHxpM6Gx3HOpaHAhzd27InAXPYXU3IHk8-dBe-2kVHTRmKMRwvDXNy6hxdMp8lXiAdGxP9BvBVnsLHOpRGI7jBpcg9B5LA1XqvBcVAVM7RS3CiVkIDjE1PGfp2vm-WaO4/w640-h346/spxbarchart.jpg" width="640" /></a></div><p>Back to fundamentals. On Monday, you saw a parade of Fed speakers come out and voice their views, as they love to do. These Fed governors feel so self-important, and are always out there giving their two cents. It seems like the tide is slowly changing from hawkish to dovish. Yes, they are still on the hawkish side, but overall, they seem much closer to neutral than hawkish when you hear them. Lately, in response to the big move higher in long term yields, they seem to view that as doing the Fed's work for them by tightening financial conditions, making it less necessary to hike again. Its looking less likely that the Fed will hike in November, and Fed funds futures are pricing in only a 14% chance of a hike at the next meeting. A month ago, the hike probability was at 44%. <br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYFbjcP5PqTM29JfBJNqhdhVasyQtiAIwjRR76bfWLbHY4tvuFaSy1EHcXd676aVAznfxsosD1rbMT5rugcJiBopgkiaopJE0EkWhZIj_Xh-K-6aNcKOG2oQ_K82SkwmGcNotQIovxI6pQAzLKSyRYfJ8SsNFLvs_s3DuElxbbuHLPkTl_0w1N5yqF_fM/s1043/fedfundsprob.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="636" data-original-width="1043" height="390" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYFbjcP5PqTM29JfBJNqhdhVasyQtiAIwjRR76bfWLbHY4tvuFaSy1EHcXd676aVAznfxsosD1rbMT5rugcJiBopgkiaopJE0EkWhZIj_Xh-K-6aNcKOG2oQ_K82SkwmGcNotQIovxI6pQAzLKSyRYfJ8SsNFLvs_s3DuElxbbuHLPkTl_0w1N5yqF_fM/w640-h390/fedfundsprob.PNG" width="640" /></a></div><p></p><p>With the Fed quiet period less than 2 weeks away, Powell or Nicky Leaks of the WSJ will have to signal a rate hike soon if they want to get a hike done at the next meeting. But I don't sense any urgency on the part of Powell to do that. He seems content to go for that soft landing, even as he tries to talk out of both sides of his mouth by saying there could be a hard landing. Actions speak louder than words. His actions appear as if he's intent on going for that soft landing to prevent Trump from getting elected in 2024, which would be a de facto termination of his tenure soon afterwards. </p><p>So what did we learn since the nonfarm payrolls report on Friday and the start of the war on Saturday? </p><p>1. The NFP and CPI are now nonevents as far as determining future Fed rate hikes. They will become important market events again when the Fed is getting closer to <i>rate cuts</i> in 2024. </p><p>2. Bond yields appear to have overshot the upside in a panic last week, and there are few sellers left at these levels, at least for the next several days. Even with that jobs number on Friday, and then the big move higher in crude oil, the flight to safety bid was actually able to overpower the higher crude move. Now with the flight to safety premium in play until market players calm down, you have a short window where bonds won't be a huge headache for those long stocks. This is the window of opportunity for the SPX to make its move higher. </p><p>3. Geopolitics is overrated. And overhyped. It usually pays to fade the geopolitical kneejerk reactions in the market, especially when they happen over the weekend. <br /></p><p>The price action in stocks and bonds with the news flow has given me more conviction in my short term bullish view on SPX. Staying long.<br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com8tag:blogger.com,1999:blog-1715439530278924605.post-69575848826937928562023-10-06T08:02:00.003-04:002023-10-06T11:34:03.614-04:00Low Rider<p> Not a good sign for the bulls. The SPX is staying under 4300 for several days in a row. Its lingering down there. Setting up camp in low territory. It doesn’t change the outlook for the next few days, but it does change the outlook for the next few weeks. Even if the SPX has bottomed, its been a U bottom, not a V bottom. Big difference between the 2. A U bottom is not necessarily a bottom shaped like a U. Its a bottom that spends a lot of time trading close to the lows. U bottoms give you a lot of time to buy cheap. U bottoms spawn rallies that are choppy, with less upward thrust, and less likely to rally to new highs. They also often happen in bear markets. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFFLi9LWJAyZVKZJb_n4KHMSVLnHJJ-BS7GiIhmOLOgJlLAcmEvYKq_iRUB9qSef8XVvIDP4GbhEzwM7tXDDqPmLF-OPWpkHYZBj8ecK5CBkidb7QYIOxXcWYDKGve-QARqfwX9shDbiZ-vTwLUvjzONZqx1EqQbo1oI74dq6eCLiBulagNUsgjEIbfdc/s980/2642C3BD-B5C5-4A27-8805-6218B2668B37.jpeg" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="612" data-original-width="980" height="200" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjFFLi9LWJAyZVKZJb_n4KHMSVLnHJJ-BS7GiIhmOLOgJlLAcmEvYKq_iRUB9qSef8XVvIDP4GbhEzwM7tXDDqPmLF-OPWpkHYZBj8ecK5CBkidb7QYIOxXcWYDKGve-QARqfwX9shDbiZ-vTwLUvjzONZqx1EqQbo1oI74dq6eCLiBulagNUsgjEIbfdc/s320/2642C3BD-B5C5-4A27-8805-6218B2668B37.jpeg" width="320" /></a></div><p></p><p>V bottoms are the opposite, the rallies are longer lasting and cleaner, with minimal pullbacks on the way back to previous highs or new highs. V bottoms don’t give you much time to buy near the lows. V bottoms have been more common than U bottoms because the SPX has mostly been in a strong bull market since 2010. </p><p>Examples of U bottoms since 2010 are June 2011, June 2012, April 2018, March 2022, June/July 2022, September/October 2022, and December 2022. It is no coincidence that more than half of the U bottoms happened in 2022, after one of the biggest stock market bubbles in financial market history. U bottoms generally happen in chronically weak markets. Not temporarily weak markets. </p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ1CbXNoRPRJjCnnips2pDijm26GkmJROiXm1LnsL9I6nnbWBCNaeLGu_aIMGy9jfSeHHxZu1dvnDbvHQL83K4BdQlm_JksmPyDKLah1ZmYSlwKaJJ_Imhyphenhyphen3trN1oRA1m3RdiZZxyQXvAAEpfPj4IJmlnPYIq2niSy76vFQGPd6f5uiaP6aLP6Cx4i2Ho/s1052/Ubottoms2011.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="526" data-original-width="1052" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ1CbXNoRPRJjCnnips2pDijm26GkmJROiXm1LnsL9I6nnbWBCNaeLGu_aIMGy9jfSeHHxZu1dvnDbvHQL83K4BdQlm_JksmPyDKLah1ZmYSlwKaJJ_Imhyphenhyphen3trN1oRA1m3RdiZZxyQXvAAEpfPj4IJmlnPYIq2niSy76vFQGPd6f5uiaP6aLP6Cx4i2Ho/w640-h320/Ubottoms2011.jpg" width="640" /></a></div><br /> <div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcC_q5526FqmeZWlSvIHewc1dfhkbFnXLi5D-LIUcI_726zQIKTiewYwARLEbRy5xQmjVHQHMD00b3RweFrbBt7NzR1STgjgPS88EfFF4Y3J9q4oOub2IBg2Sd68wepKJxEBVru-H2LrW708lf8cdqEXpRtXJt4wBfhQmRKSxf23DEs3Pyj_nww7k9Yk8/s1049/Ubottoms2018.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="519" data-original-width="1049" height="316" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcC_q5526FqmeZWlSvIHewc1dfhkbFnXLi5D-LIUcI_726zQIKTiewYwARLEbRy5xQmjVHQHMD00b3RweFrbBt7NzR1STgjgPS88EfFF4Y3J9q4oOub2IBg2Sd68wepKJxEBVru-H2LrW708lf8cdqEXpRtXJt4wBfhQmRKSxf23DEs3Pyj_nww7k9Yk8/w640-h316/Ubottoms2018.jpg" width="640" /></a></div><br /><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhanf-aFr1EVPcGI6FQwjR1UlMVLP9_LjQD534tYfe5Gp5VmiNEkPyN1jab8BnH4cM0lRGOksX9gRG4cYba7YYtfgVmoJEgnI1-BBJQkr-75cmZ1kwis6KFp-LqpWp87_R_zmRzG7H7ghOJUqDyAr493L2w3cliJTSKY8koHdHdy1IGKi-ALfjY9owi6TA/s1045/UBottoms2022.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="522" data-original-width="1045" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhanf-aFr1EVPcGI6FQwjR1UlMVLP9_LjQD534tYfe5Gp5VmiNEkPyN1jab8BnH4cM0lRGOksX9gRG4cYba7YYtfgVmoJEgnI1-BBJQkr-75cmZ1kwis6KFp-LqpWp87_R_zmRzG7H7ghOJUqDyAr493L2w3cliJTSKY8koHdHdy1IGKi-ALfjY9owi6TA/w640-h320/UBottoms2022.jpg" width="640" /></a></div><p></p><p>As you can see in the charts above, the messier and longer it takes to recover from the lows, the rallies coming out are usually shorter, choppier, and have less upside than V bottom rallies that were common place in 2013, 2014, 2017, 2019-2021. <br /></p><p>This kind of messy U bottom was not what I was expecting. After the strong rally in the summer, after a correction, I was looking for a V bottom, which obviously has not happened. While the hysteria over higher long bond yields is overblown here, its a much more valid reason to selloff than past vacuous reasons like Grexit, Brexit, upcoming elections, trade wars, etc. So you can’t totally brush it off as meaningless, like you could for so many of the news based corrections in the past. </p><p>There is some fundamentals behind this selloff, as higher yields definitely have negative consequences for earnings growth, as well as reducing both the supply and demand for credit. However, based on the trends in the commodity market (oil down over $10 in the past week), as well as apartment rents, the bond selloff is more a positioning story than a new fundamental weakness story. There are lots of bond holders who are deep underwater and feeling pressure to lighten exposure and cut losses. Politicians and the Fed basically ignoring the cries for help from the bond market are not helping the cause. So it appears that bond yields will have to stay elevated for the next several weeks, as I don't see the US economic data coming in weak enough to rescue the bond market on its own. Plus, I already see so many economists and investors bearish on the economy, its not going to be easy for economic data to really surprise to the downside. </p><p>Recent options market data is showing continued high levels of put volume relative to call volume. Even on the days that the market is flat to slightly higher (Wednesday and Thursday), you saw some very high put/call ratios. And with the VIX above 18 and realized vol at much lower levels, a few days bounce could really crush IV levels. That should in turn result in dealer hedging the IV drop by buying stocks and index futures.<br /></p><p>You can get a technical rebound soon in the bond market, just based on how much attention and how fast long bond yields have gone up, and with the big move lower in crude oil over the past few days, which is a huge relief for bond investors. Bond yields have tended to lag crude oil prices with a few days lag. At least you have inflation that is not getting worse, so once you get through the forced sellers and weak hands, you probably can get a consolidation of the big move and range bound trade for the next several weeks. Even a range bound bond market should be enough to provide a decent bounce from stocks at these levels, but it won't be a powerful bounce that you can just ride for months. Bounces from here are probably 1-2 weeks in length. And then a pullback, and then back up again. It should be a choppy rebound. Still long and hanging on, but definitely not adding more, and staying away from bonds. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com6tag:blogger.com,1999:blog-1715439530278924605.post-332658367367208312023-09-28T05:46:00.001-04:002023-09-28T14:24:25.965-04:00Bonds Crying for Help<p>The bond market is getting destroyed. The US Treasury market is screaming a cry for help. But politicians, Treasury, and the Fed are ignoring its cries. The bond market is begging for Yellen to come out to say they will be doing Treasury buybacks or will issue more T-bills and less duration. Or Powell to come out and say that QT would likely be stopped when the Fed cuts. Or for Congress and the White House agree to spending cuts to lower the budget deficit. Those are unlikely to happen. So the bond market is on its own. The US government brought this upon itself. You only get a selloff of this length and magnitude in the biggest, most liquid bond market in the world when there is a huge fundamental change. That change has come gradually and then suddenly, just like how people go bankrupt. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgy1YDL7qmdCwrt-LctP2mQGUhCM-5NfFm-bRjFXtZjGXyZtLb7KSET5SHpDJ7A2qyA1nA6QOXO7p3We8UP77uVaU7ec8MaaMUKtwVFlNyK2WGdxLYS_TQH2sQzCO0QBexq8KiqNjUL9M0xBMwoVp5Wx9CIUTmzccWQP7RPPJkL3XrUNR8UBOqH9EcyJKw/s601/bondscrying.JPG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="376" data-original-width="601" height="200" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgy1YDL7qmdCwrt-LctP2mQGUhCM-5NfFm-bRjFXtZjGXyZtLb7KSET5SHpDJ7A2qyA1nA6QOXO7p3We8UP77uVaU7ec8MaaMUKtwVFlNyK2WGdxLYS_TQH2sQzCO0QBexq8KiqNjUL9M0xBMwoVp5Wx9CIUTmzccWQP7RPPJkL3XrUNR8UBOqH9EcyJKw/s320/bondscrying.JPG" width="320" /></a></div><p></p><p>First the gradually part. It didn't start with the 2008 recession. Contrary to what many believe, Obama was not a big spender while he was in office. In the first 2 years when he had both Houses of Congress under Democrat control, he didn't do a Biden style big fiscal stimulus, even though the economy was in a deep recession. He did small, piecemeal fiscal packages that hardly moved the needle. The big budget deficits from 2008 to 2010 were mainly due to tax revenues tanking because of huge losses in jobs and capital, not lots of spending or tax cuts. For the rest of Obama's tenure from 2011 to 2016, the Republicans controlled the House, and they pushed for spending freezes while the economy was in a low growth, low inflation environment. That was a huge boon for the bond market, as the Fed was stuck at zero because fiscal stimulus was not coming, and the organic growth rate was just too low. </p><p>Then Trump gets elected, and you get huge tax cuts as well as spending increases, increasing the budget deficit up to trillion dollar territory during expansionary times. That was the first sign of trouble for the bond market, and you did get the Fed to actually start raising rates again because inflation was creeping higher, and the economy was slowly heating up. This was the beginning of the end for the bond bull market, as the wave of populist fiscal policies gained traction in Washington D.C., and politicians realized that voters like tax cuts, they liked stimmies, and they didn't really care about the national debt or the budget deficit. You had MMTers urging on more fiscal spending, with inflation just a mere afterthought. </p><p>All of this created a huge tinderbox that was just waiting to ignite with a flick of a lighter. That was Covid in 2020. You don't get the huge fiscal response if you have politicians worried about the budget deficit and spending too much money. And politicians like to follow what is popular, and they realized that handing out cash for nothing was extremely popular. And because of the low inflation decade from 2011 to 2020, they felt like inflation wouldn't flare up even if they spent trillions of dollars! And even if they thought inflation would go up, it would happen a few years later, so it didn't really matter to them. So you had the perfect recipe for reckless fiscal policy in 2020. And because investors had been so used to a long bond bull market, and with rates getting so low, bond investors felt invincible. Ignoring the negative consequences of such outrageous spending. </p><p>So Trump and Mnunchin in 2020, with the firm approval of Pelosi, went to give out trillions in stimmies to individuals and corporations for doing nothing, or just keeping employees on payroll, for way longer than necessary. Powell got in on the action and printed gobs of money to monetize the debt so rates would be super low, especially mortgage rates, while all this happened. It was a huge transfer of money from the public sector to the private sector. The repercussions of all that stimulus still reverberate today. </p><p>Then Biden just pours gasoline on the bonfire while having great luck by having the House and Senate under Democrat control, by the skin of his teeth. Enabling him to pass trillions more in pork spending packages in the form of infrastructure, CHIPs, and IRA bills. Inflation was already starting to rage, this just added to it. Bidenomics = Inflationomics. He is the most inflationary president in US history. You can't totally blame him. He is a politician. He does what is popular. And spending money is popular in America. Because it reduces unemployment and gives people more cash. And the inflationary consequences come later. It embodies the American mindset. Buy now. Pay Later. <br /></p><p>These Biden spending bills are the main reason that the US economy is outperforming the European and Asian economies in 2023. American exceptionalism is massive, shameless pork spending and huge budget deficits, fully utilizing its reserve currency status to prime the pump. It is not sustainable in the long term. Reserve currency status is hard to obtain, but once obtained, it is easy to hold on to. People are stubborn and hold on to long held beliefs until the evidence becomes overwhelming to make them change their mind. The US government is doing everything in its power to abuse its reserve currency status by running multi trillion dollar budget deficits in expansionary times, having a huge Fed balance sheet that is excruciatingly slow to be reduced by a peashooter QT policy. Take a look at the fiscal deficits as % of GDP. It never was so low in an expansion as you are seeing in 2021-2023. Budget deficit of 8% of GDP with unemployment at 4% is ridiculously expansionary policy. That is why inflation isn't coming down faster and why the recession isn't coming. <br /></p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWePcNpO3c7j6n8daDfHK0sZGfH_Q6jRLizNDVunsubG9H92e3ia-MYvNE1py9tx0nuHQRmaYNxi3lHpgr7wwdWVD9YJy28nnF887EId0qLmgbmsxsANSoTCMc4ErCCRmnRFxdniijkmw6l92t-e9_NxnB2lLqiIflMeQzGKhCPBRqDEwAFaeGzvdWu5M/s1133/deficit2023.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="573" data-original-width="1133" height="324" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWePcNpO3c7j6n8daDfHK0sZGfH_Q6jRLizNDVunsubG9H92e3ia-MYvNE1py9tx0nuHQRmaYNxi3lHpgr7wwdWVD9YJy28nnF887EId0qLmgbmsxsANSoTCMc4ErCCRmnRFxdniijkmw6l92t-e9_NxnB2lLqiIflMeQzGKhCPBRqDEwAFaeGzvdWu5M/w640-h324/deficit2023.png" width="640" /></a></div> <p></p><p>The US Treasury market is now starting to convulse from all the mistakes that politicians made for the last several years. You can't blame Powell for this mess, although he was huge enabler in 2020 and 2021 with all that QE. Its Argentine fiscal policy that is causing the huge rout in the most important bond market in the world. There are only two ways this gets resolved: 1) Treasuries keep going lower until they find fair value for the current fiscal environment of reckless spending and tax cuts with no regard for budget deficits. 2) The US government starts to control its spending and causes a recession, which brings a bid back to USTs. </p><p>It is out of the Fed's hands now. They are not the bus driver, as many think. They are bus riders. The bus drivers are the President and Congress. They control the future of interest rates, not Powell. The long term future for US Treasuries and the US dollar look bleak. Yes, even the almighty dollar. The last time the US ran such big budget deficits during an expansion was in the early to mid 1980s under Reagan. The US dollar kept going up until it didn't. Here is what happened to the US dollar in the 1980s. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-JVEA4sZ2gQVgM3FvEGE7BPmTliDmdL_sdh9DahPke8vyJWCWoOygcIvlOTW41tmXo9pRP9mpeGV8fnZBDYU_x6WvQ2HbUATYq1ZQQtUVoMjxXx2824S2a12I_Q_6jtcZECFaq3HZ3L0upjsai9ISs2bYBUF5uk2Q6OkbWhgJsBL7-uvkZDMqAkoaOlo/s734/dollarindexchart.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="455" data-original-width="734" height="397" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-JVEA4sZ2gQVgM3FvEGE7BPmTliDmdL_sdh9DahPke8vyJWCWoOygcIvlOTW41tmXo9pRP9mpeGV8fnZBDYU_x6WvQ2HbUATYq1ZQQtUVoMjxXx2824S2a12I_Q_6jtcZECFaq3HZ3L0upjsai9ISs2bYBUF5uk2Q6OkbWhgJsBL7-uvkZDMqAkoaOlo/w640-h397/dollarindexchart.png" width="640" /></a></div><p></p><p>I expect a similar situation this time around, with the dollar remaining strong until the trend reverses violently in the other direction as a massive US budget deficit causes the supply of US dollars to overwhelm demand. Also, the US dollar is fundamentally overvalued based on PPP to Europe and Japan, the 2 biggest weightings in the US dollar index. <br /></p><p>The SPX is following the seasonal patterns to near perfection. You got the initial weakness in August, followed by strength at the end of that month. And then September follows through with its reputation of being the weakest month of the year, with the weakness back end loaded into the second half of the month. This is not voodoo. Seasonal patterns happen for a reason. Post quarterly options expirations are notorious for being weak in March, June, and especially September. A lot of options open interest is concentrated in those quarterly expirations, and the rolling over of options positions/being less hedged make the SPX more vulnerable to selloffs. Puts dominate the index options space, so when put open interest goes down, that means less put protection which means more fund managers are more likely to sell when markets are going lower, rather than staying still. That's happening since Sep 15 quarterly options expiration. Add into the bond market weakness and you have what you see on the screens. <br /></p><p>Don't believe those who are members of the Church of What's Happening Now about the bond market and its affect on stocks. The stock-bond relationship is overstated in times like this. Yes, all things equal, lower bond yields are better for stocks than higher bond yields. But stocks focus much more on future earnings, and with most SPX companies having locked in long term rates at much lower levels, their future profits are not so negatively affected by higher bond yields as they would be in the past. Also, one of main reasons the bond yields are higher is because the US economy is stronger than most expected, which means earnings expectations have gone up. And with so much fixed rate debt (mortgages, corporate) in the US locked in at low rates, higher bond yields have a smaller effect on the economy than people think. Probably the only thing I would worry about is the lack of bank credit that would result from these higher long term yields, as they pressure bank balance sheets and reduce the demand for credit. But that would be something I would be more worried about at a 10 year yield above 5%, not here. </p><p>On the intraday V bottom pattern: they are not reliable. In fact, they
often lead to gap downs the following day and breaking of the intraday
low in the following days. We did see a lot of put volume on Wednesday
which is necessary for the bottoming process. GS Prime broker data has shown that hedge funds have sharply increased their short selling over the past week. So the foundations for a tradable bottom are coming into place. We also got much closer
to the much talked about SPX 4200 support level, which is rock solid.
Based on the price action and the relatively low volatility (VIX is
still under 20), its likely the SPX bottoms above 4200, probably
somewhere between 4220-4240. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3zm5So2fc5wqQTECwBYZBLmjhXNDIvvD-ET3ttv4QzlZ8bIx1o5kPeqasBORmSbsIPGqmeRumufheygNVkRkd121w0jFG57xIVM8-AzNbp_CwGV_Mi47VWOPkDsAe9EDRYm-vS2Z_VyequVUgi2CwnzhKE3kUp51YXm4VV49xL6qMZDi_OGcfU-vYaVo/s695/GSprime09252023.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="433" data-original-width="695" height="398" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3zm5So2fc5wqQTECwBYZBLmjhXNDIvvD-ET3ttv4QzlZ8bIx1o5kPeqasBORmSbsIPGqmeRumufheygNVkRkd121w0jFG57xIVM8-AzNbp_CwGV_Mi47VWOPkDsAe9EDRYm-vS2Z_VyequVUgi2CwnzhKE3kUp51YXm4VV49xL6qMZDi_OGcfU-vYaVo/w640-h398/GSprime09252023.png" width="640" /></a></div><p>You had a huge rally in June and July from 4200 to 4600, coming off a long term base that was between SPX 3800-4200. August and September are consolidating those gains. The fundamentals for the US economy has not changed much over the past 2 months. Its still stronger than most expected at the beginning of the year, and you still have a lot of skeptics who think a recession is right around the corner. Yes, yields are higher, but as I mentioned above, currently the US economy is not that interest rate sensitive. </p><p>Its regrettable that I didn't put on a short position earlier in the
month, even though I felt like ingredients for another selloff were
there, including price action, seasonality, and the bond market weakness. That would have been immensely profitable, even if I covered
early around SPX 4300-4350. The clue to get short was the inability to V bottom towards previous highs around 4600 in September. Held on to my previous view and didn't adjust as the market was showing weakness when it should have been stronger. That opportunity is behind us, so on to the next one, which is to buy the dip.<br /></p><p>The technicals are oversold, the fundamentals haven't changed much, and we are entering a period where the market usually bottoms. I put on a starter long position in SPX/NDX on Tuesday, and am waiting to add more around SPX 4230-4250 in the coming trading days. <br /></p>Market Owlhttp://www.blogger.com/profile/18136766420445585120noreply@blogger.com16