Out of the Cash Bunker

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 and 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.  

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:  

1. Geopolitical risk in the Middle East ahead of the Israel ground invasion into Gaza

2. Bad price action after tech earnings 

3. Technical breakdown below 4200

4. Upcoming QRA where Treasury were expected to announce a huge increase in coupon issuance (Yellen chickened out)

5. Fed meeting where most were expecting a hawkish pause

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. 

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.

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.  

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.

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.  

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.  

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.  

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.  

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. 

Catching the Falling Knife

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. 

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.

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.  

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%.  

The bond market continues to cry for help, 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.  

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.  

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.  

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. 

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. 

Expect the weakness to continue into Monday/Tuesday of next week, where I will be looking to buy the dip. 

More Bond Pain Ahead

Bonds are the focus of attention in financial markets.  You have the geopolitical monkeys 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. 

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:

1.  Huge move higher in yields in 2022 and a hawkish Fed

2.  Bullwhip effect leading to too much inventory, leading to a big slowdown in the manufacturing and goods economy

3.  Drawdown of Covid era excess savings leading to reduced consumption

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.  

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.

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.   

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. 

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.  

 

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. 

 

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. 

 

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.  

 

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 comfort of cash so there is a lot of dry powder waiting to be deployed in stocks out there.  So that will keep downside contained.

Avoiding the Roller Coaster in Cash

The 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.  

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.  

 

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. 

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.  

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.  

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.  

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 monkey inside us 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.  

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 U bottom that I mentioned several days ago.  

Geopolitical Monkey Brain

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.  

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. 

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. 

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. 

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.  

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%. 

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.  

So what did we learn since the nonfarm payrolls report on Friday and the start of the war on Saturday?  

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 rate cuts in 2024.  

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.  

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. 

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.

Low Rider

 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. 

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.  

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.  

 

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. 

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.  

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.  

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.

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. 

Bonds Crying for Help

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.  

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.  

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.  

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.  

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.  

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. 

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. 

 

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. 

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. 

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. 

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.  

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.  

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.  

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.  

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.

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. 

Fear and Loathing in the Bond Market

99% of investors have never seen such a long bear market in bonds.  The selling seems relentless, coming in waves, with only brief and shallow bounces.  It has been a wholesale repricing of future interest rate expectations, with more people getting skeptical about the Fed's ability to get down to their 2% inflation target.  Most investors now believe that any recession, if it happens, will be brief and mild, with the Fed not going down to 0% like the last 2 times there was a recession.  Those outcomes are certainly possible, and probably the higher probability outcome vs. a long, deep deflationary recession.  But at a certain point (may need another 30-40 bps selloff), the market will underprice a low inflation outcome, and overprice a high inflation one, making bonds too cheap, especially short term bonds.  

In the short term, I am less bearish on the US economy than the economists that I hear on CNBC and Bloomberg.  The tailwind from the big fiscal deficit is still carrying the economy in a high interest rate environment.  Another tailwind that is rarely mentioned is the surge in immigration in 2022:  

The number of people born somewhere else climbed by nearly a million last year, reaching a record high of just over 46 million, according to new estimates from the U.S. Census Bureau.   "The foreign-born population zoomed up," said William Frey, a demographer at the Brookings Institution in Washington, D.C. "The gain in 2022 was as big as the previous four years put together."

More immigrants not only means more labor but it means more demand for goods and services.  So the supply of labor has gone up along with the demand for goods and services.  You combine the big budget deficits with a big influx of immigrants, and everyone focused on tight monetary policy, and that is a recipe for a stronger than expected economy.  In recent months, you are finally seeing some people recognize the absurb levels of fiscal spending and deficit/GDP, and are connecting 2 plus 2 to figure out that its difficult to get a recession under those circumstances with such a tight labor market.  

This realization of a resilient economy that is less rate sensitive has re-priced the yield curve, with a bear steepening move that has put 10 year yields back towards the panic highs of October 2022.  The bond market is now in a 3 1/2 year downtrend, coming off of a 40 year secular bull market.  Gradually, fixed income managers are realizing that the previous bond market isn't coming back, and that supply and demand fundamentals are now much worse than they were in the previous 40 years.  The main reason is the US government.  When the government is addicted to deficit spending / tax cuts, without caring about debt or deficit levels, you have an unfavorable environment for bonds.  The enormous deficit spending and lack of tax revenue has brought huge amounts of Treasury supply into the market, which can only be digested at lower prices/higher yields.  Not only that, all of that Treasury issuance has goosed the economy by adding trillions of dollars into the economy that would otherwise not be circulating so freely, even with QT.  That keeps the Fed from cutting, which then puts pressure on the rest of the yield curve as the negative carry from borrowing short to buy lower yielding long term bonds reduces demand for long bonds, causing a bear steepening.  

Remember, the Fed did so much QE in 2020 and 2021, there is still a huge amount of money in the reverse repo facility which can be sucked out by QT without affecting the ample reserves in the system.  So QT is not tightening financial conditions.  Plus, once you get the reverse repo funds drained (will take about 18 more months at this rate), you still have a lot of excess reserves held by the banks that can be reduced without affecting interbank transactions or repo rates.  QT is not doing anything to the stock market because there is still so much excess liquidity in the system that is out there just parked at the Fed collecting 5+%.  

Of course, the origins of this comes from the outrageous fiscal and monetary policy in 2020, which laid the groundwork for this bond bear market.  For the bond market, it was short term gain, long term pain.   Despite the huge interest expenses racked up by all the national debt, politicians could care less.  They are all populists now.  On both the left and right, they pay scant lip service to the debt and deficits, and focus on ways to placate their core constituents by spending on clean energy, border control, defense, or just outright handouts like child tax credits or payroll tax holidays or pure tax cuts.  That's in addition to the natural increase in the deficits coming from the baby boomers entering retirement and collecting Social Security and Medicare.  Its just an explosion of deficit spending that will keep the long term trend of inflation higher and nominal GDP growth higher than in the past.  Real GDP growth down, inflation up.   

I remember when people actually cared about the size of the national debt, which kept politicians from going overboard on spending/tax cuts.  There was the famous national debt clock which gets no air time these days, but was a source of concern by many back in the 1980s and 1990s.  No one cares anymore.  

Eventually, you will get to a point where the economy slows down and can't handle the higher interest rates and the Fed will have to cut.  But probably longer than most people expect because a lot of businesses were bearish on 2023 and held back spending and investment until things improved.  So there is definitely some pent up demand that will be slowly unleashed in the next 6 months.  My best guess for when the economy slows enough to get the Fed to cut will be sometime in the summer/fall of 2024.   Next year, you have less spending at the state and local level, and the spending in the IRA and infrastructure bills will flatten out.  Capital gains tax receipts will be much higher in 2024 as stocks have gone up quite a bit since the start of the year. 

 Overall, the fiscal deficit as % of GDP should drop 2-3%.  That should be enough to slow down the economy and increase unemployment, which will put pressure on the Fed to start cutting ahead of 2024 elections.  Powell got re-nominated by Biden, and has no shot at getting re-nominated by Trump if he wins.  Don't forget that Trump hates Powell because he wasn't as dovish as advertised, and didn't yield to pressure from Trump to keep rates even lower.  So Powell will be incentivized to get political and help Biden win by cutting rates even before inflation goes down to 2% if he sees unemployment rising.  That should help the bond market in 2024, but that's a few months away so until then, there could be some more pain ahead as I don't expect the economy to get weak enough to support the bond market with all that supply coming down the pipe.  The 2-10s yield curve inversion is too steep for there to be much of a drop in longer term yields if the Fed stays steady.  The only reprieve will come with actual economic damage, and nothing else. 

So if bonds are weak for the rest of 2023, does that mean the stock market won't go up anymore?  No, not necessarily.  Stocks have rallied huge even as the 10 year yields have risen over 100 bps from the lows in April at 3.25%.  Bond yields are secondary to the stock market.  Earnings are the primary driver.  If a stronger economy keeps earnings expectations higher in the future, that helps stocks, regardless of higher bond yields.  So I could definitely picture a scenario where bond yields grind even higher and stocks going higher alongside it.  That's what happened for the past 5 months.  It has happened numerous times in the past.  Notably 2013.  2017.  2021.  And this year.  

The SPX is trapped in the middle of a range here, and volatility is dying.  VIX at 14 and realized vol even less.  The FOMC meeting on Wednesday has low expectations, and knowing Powell, he's not going to be giving away much here, being as mealy mouth and data dependent as possible, especially as he'll be on hold.  As we approach quarter end, you could see some rebalancing out of equities into bonds, so that could put some pressure on stocks in the next several days.  Had a big inflow into equity funds according to BofA in the week ending Sept 6, so investors are a bit sanguine here.  Also, JP Morgan fund hedge flows from the short call and long put spread being rolled over into December should require several billion of SPX selling by dealers to accommodate the rollover.  Don't like playing in the middle of the range, so not shorting this.  Overall, the flows look bearish for stocks here. 

Calm Waters, Europe vs US

It has been a calm, sleepy market in SPX for the past 2 weeks.  The VIX is getting pummeled, as the realized vol is just too low to allow the VIX to stay above 15.  There is a bit of a sticker shock effect for market participants when they see the VIX in the 13s even though the SPX is not in a bull trend, but options traders aren't stupid.  They will not keep paying a fat premium for IV when realized vol is so low. The much hyped September seasonal weakness has occurred, but not in the way that many expected.  Its been a very controlled drip lower, since the start of the month.  Its mostly sideways, yet from watching CNBC and Bloomberg, I sense that the fast money crowd is looking for a down move in the coming weeks.  We got an oddly high put/call ratio yesterday even though the market didn't go anywhere.  Perhaps they are loading up on puts before the big Sep. opex on Friday.  They are definitely not bullish here. 

One thing that has been noticeable is European weakness. European indices have  been underperforming the US indices for awhile now.  There is a very simple reason that separates the US and Europe.  Its not demographics or the economic system.  They aren't that different.  Its fiscal policy.  Europe is governed under rules and stipulations determined by the EU in Brussels.  They have a big say in what kind of fiscal policy that the member states can run.  In particular, there is a limit to the budget deficits as a percent of GDP that are allowed.  Before 2020, their rules were strictly followed and this kept a lid on fiscal policy for most of Europe.  After 2020, the rules were relaxed because of extraordinary circumstances but that wasn't meant to be a permanent relaxation of rules, just a temporary one.  In particular, Italy took full advantage and ran up huge fiscal budget deficits to stimulate its economy, making it much stronger than most of the other member states.   And Italy has horrible demographics and a huge debt to GDP ratio, making them spend way more than other EU countries on interest expense rather than actual government spending.  That shows you the power of fiscal.  But rules are rules. EU budget rules hang like a dark cloud over the European economy, and has kept the member states from going full bore on fiscal stimulus. 

In the financial markets, fiscal policy is very underrated, and monetary policy is very overrated.  That is a result of decades of fiscal policy which didn't stray too far from normal, with low single digit budget deficits as a percent of GDP.  Fiscal policy used to be a near constant, with only small stimulus packages during a recession, and with no  bold spending plans over the past few decades.  That's changed since 2020.  With more populism, and politicians as well as most voters no longer caring about deficits and the national debt, sovereign governments are much more willing to spend without taxing more.  In fact, they are spending more and taxing less.  More spending + tax cuts/subsidies = bigger deficits = stronger economies.  But there is no free lunch when the government spends more money.  

The more money that the government spends, even when its not financed with the money printer (QE), the more demand that is pumped into the economy that would otherwise not be there.  Sure, that money now has to come from investors instead of from the central banks, but those investors can use those government bonds that they purchased as repo collateral to invest in stocks and other bonds like its cash.  So net net, the government spends more money and economy gets stronger, and investors can continue to buy riskier financial assets, even though they have to buy more government debt as its issued.  

There is a reason why the bond market is so weak.  The current fiscal policy, in the US anyway, is being run as if the economy was in a deep recession, with budget deficits of 8% of GDP with near full employment and fairly strong GDP growth.  Its hard to have a recession under those conditions, even after 525 bps of rate hikes.  US fiscal policy is ridiculously inflationary.  The bond market hates it.  The stock market likes it, because it boosts corporate profits, even with much higher borrowing costs.  

When big corporations and homeowners are already well financed with long term debt, their net interest expense will remain low even with yields exploding higher, because they locked in low rates in 2020 and 2021.  It makes them less sensitive to bond yields, and Fed policy.  It seems like the macro pundits are more worried about higher rates than the borrowers who actually are involved.  

So the country (US) that has the most long term fixed interest rate debt and is the least sensitive to monetary policy is running the most expansive fiscal policy.  While the ECB is trying to follow the Fed because of short term inflation pressures which are much more likely to subside than in the US because their governments aren't going hog wild with spending, and because their homeowners are on more variable interest rate debt, which is much more tied to current monetary policy.  

While the CPI in the US is much lower than in Europe, that's not going to last.  The CPI in the US is already bottoming, and going back up, while in Europe, they will continue to go lower as the EU inflation leading indicators are all pointing down.  Add on top of that the trend of European industrial production moving offshore, and you are looking at a big divergence between European and US inflation in 2024.  The Eurostoxx is sniffing out the weakness in Europe, as Europe, which was leading for the first quarter of 2023, is badly lagging the US in Q2 and Q3.  It doesn't help the case that the ECB remains stubbornly hawkish, thinking they can copycat Fed policy, and get the same economic results.  Lagarde has outsourced EU monetary policy to Powell, who has much more room to be hawkish than Lagarde, but it seems like Lagarde is trying to outhawk him.  It should lead to a very weak European economy in 2024, which will seep a bit into the US, but not much.  The US government always figures out a way to prime the pump with more stimmies out of the blue, so the US should remain resilient for the next several months.  Bottom line, for the next 6 months, US stocks > European stocks, and European bonds > US bonds.  

There hasn't been much to do.  There is no reason to press any positions here.  If I had to choose a trade right now, it would be to buy bonds, just from a purely tactical view.  It would be for a short term trade, not a long term holding.  My preferred trade is to wait for a dip to buy SPX and NDX.  Perhaps after you get past September triple witching opex, you can start to see a bit of a downdraft to buy into.  There is a potential government shutdown at the end of September, and the restart of student loan payments on October 1 which could act as bear catalysts.  Take a look at the underperformance of the Eurostoxx and Russell 2000 vs. SPX over the past month.  The divergences are building for another move lower in the coming weeks, although I am not playing it. 

SPX vs Russell 2000

SPX vs Eurostoxx 50

Its not a time to force trades, wait for the market to come to your levels.  Less is more here.

Fiscal >> Monetary

Biden is running things as hot as he can.  Powell is trying to cool things down without going overboard.  Its not a fair fight.  Expansive fiscal policy (lots of spending and tax cuts) is popular.  And potent.  Politicians don't even pretend to care about the deficit anymore.  They know that the masses don't care.  People just want to keep their jobs and receive government handouts from time to time.  The US is a socialist country now.  The government has a huge influence on the economy, much more than it has versus anytime since World War 2.  The massive budget deficits prove it.  Powell can't win a fight against Biden because he has to pay more and more interest on an ever growing pile of debt with each rate hike, interest that is stimulative to the economy!  So his main tool of raising rates to slow down the economy just doesn't work like it used to. 

Most of the macro "experts" are still looking for that long awaited recession.  That is the general consensus from all the macro pundits that treat their opinions as if they are fact.  Still.  You would think that after wrongly forecasting a recession for 2023, they would rethink their views and see where they went wrong, but most are just blaming the long and variable lags of monetary policy for their missed macro calls.  Its like the investor that buys a stock that continues to sink after he buys, saying that he was just early, not wrong. 

After thinking about my missed call for a sharp weakening of the economy in 2023, it really comes down to focusing too much on monetary policy and not enough on fiscal policy.  And not thinking about the lack of monetary policy transmission with the low fixed rate mortgages that most homeowners locked in with refis in 2020 and 2021.  Same goes for corporations that issued tons of low interest rate, long duration debt in 2020 and 2021.  That immunizes a big swath of borrowers from higher rates.  That is not the case in Europe, which is why Europe is already experiencing a noticeable economic slowdown, while the US is cruising along with minimal economic damage despite 525 bps of rate hikes.  

In fact, it can even be argued that the rate hikes have been marginally stimulative, considering that a huge chunk of the higher interest payments that people are receiving are coming straight from the US government and its massive debt load.  There is a huge difference between governments paying interest and private individuals and corporations paying interest.  When governments pay interest, they are just issuing more debt to pay the interest, which effectively makes it like a stimulus payment more than a debt payment.  While those paying variable short term rates on loans are feeling some pain, they are counterbalanced by a bigger group of borrowers that are paying low fixed interest rates on loans that were made when rates were much lower.  And its the fat interest on cash and short term bonds that are tipping the scales in favor of the interest rates actually not having much of a restrictive effect on the economy.  

Most of what I hear out there is about the lags of monetary policy, how the higher rates will slow down housing and hurt credit formation, and eventually lead to a much slower economy and a recession.  That is the base case for most macro pundits.  The calls for recession haven't been canceled, they've just been pushed back to 2024.  Long and variable lags of monetary policy is sounding like a cliche that used to be true in the past when variable rate borrowings and shorter term debt was the norm.  Now corporations are issuing more long term debt than they have in the past, and most mortgages are now fixed rate, with most refinanced at historically low rates.  Monetary policy just doesn't have the bite that it used to because the US economy is less sensitive to interest rates than in the past.  

And I haven't even mentioned fiscal policy.  Take a look at federal spending as a percentage of GDP (excluding interest payments on the debt):  

 It is above 25%, which is higher than after 2008, when the US was in a deep recession and tax receipts were way down + high unemployment leading to more welfare/jobless payments.  The amount of pork flowing through the system, even without the jumbo sized interest payments on the debt cannot be ignored.  It is the elephant in the room that people are not talking enough about.  It is the single biggest reason that the recession didn't come, despite the warnings from most economists. Looking forward, fiscal spending will continue to run at high levels due to entitlement spending (Medicare and Social Security) that will naturally increase due to the retirement of the baby boomers, as well as the reckless attitude towards spending in Washington, as deficits don't matter anymore.  The masses love stimulus and prefer an economy that is running hot vs one that is running cold.  Bidenomics = run everything on overdrive and hope the engine doesn't blowup/inflation doesn't get out of control before 2024.  

There have been some moves over the past 3 months that I've completely missed out on, and/or have been on the wrong side of.  The move higher in stocks in June and July.  The move higher in crude oil in August.  The move higher in yields in August.  The one move that I did get right was the move lower in stocks for August, and it wasn't quite the magnitude of a move that I was looking for.  Predicting macro is hard.  I should probably give up on it, but its so enticing to try to be a macro guru and sound smart, when it doesn't really add any value for my trades and investments.  Really the only edge that I have in trading the big markets is looking at positioning and what people are saying/expecting in the coming weeks/months.  Anticipating the anticipators.  

Been wrong again this week.  Thankfully it was low conviction so I had no money on the thought.  Was looking for a continued grind higher and instead we've got a meaningful pullback.  Still think there will be some buying going into triple witch opex next Friday, perhaps to SPX 4520-4530.  But not a high conviction idea so I've yet to put money behind it.  I may put on a small long position today just for fun as I think its better than 50-50 odds that it bounces up next week.  Also getting more constructive on bonds at these levels, but wouldn't go big here.  Playing small ball until I see better opportunities.  Limiting risk until I have more conviction.