Powell: Caveman Lawyer

There seems to be a dominant frame developing in the market, one of a sharp growth slowdown and a probable 2023 recession, with inflation peaking soon.  I agree about the sharp growth slowdown, but don't agree with the recession or inflation peaking (not the  manipulated CPI, but real actual inflation numbers) calls.  

When it comes to the economy, with a Fed that's not willing to take the pain necessary with big time rate hikes (up to 5% Fed funds) to kill inflation, only fiscal policy will be able to cause enough of a growth slowdown to result in a recession.  And the budget deficit will be over 6% of GDP for 2022, and only glide down to about 5% of GDP for 2023.  That's quite expansionary, so the methamphetamine kick will still be there, just not as high as 2021. 

Rising energy prices won't do it.  A slowdown in corporate profits won't do it.  Raising rates from 0 to 2.5% is not going to get the job done.  Its like trying to bail water out of a sinking boat with a shot glass.  There is still too much liquidity sinking the boat.  So a slowdown in capex spending, some corporate layoffs at the margin, and higher mortgage rates enough to cause a recession?  If the budget deficit was close to 0, I would agree about the recession calls.  But its not.  Nowhere even close to a balanced budget.  

We underestimate the stimulative effect of big budget deficits.  Its free money raining down on the economy.  Normally during an economic expansion, like you have in 2021 and 2022, budget deficits are low, as tax receipts go up.  But the spending and handouts was so enormous, and the spending is still heavy, for the foreseeable future.  Projections of a budget deficit of 5% to 7% for the next 5 years.  In the EU, they get all worked about going over 2% deficit to GDP, so the fiscal juice in the US is on a whole another level compared to other developed nations.

American exceptionalism is not high tech, its lots of government pork masking a structually low growth economy with little productivity increases and slowing population growth due to lower immigration levels.  

To really kill inflation, the US needs to either raise taxes, reduce government spending, or a combination of both.  Social Security and Medicare need to be massively reduced.  Same for defense spending.  That's just not happening.  The US is well on the MMT road and the US dollar will start losing its reserve currency status as the deficits continue to get out of control, and Fed eventually has to monetize all of it in order to save the financial markets.  

Mini me monetary tightening by Mr. Caveman Lawyer Powell will not get the results they want.  They need to meaningfully curtail demand by decreasing the number of dollars in circulation.  Talking tough is just a CYA (cover your ass) exercise to save face.  They will continue to make minimal moves that are more bark than bite.  Powell is not that guy to put the inflation genie back in the bottle.  He will cave under pressure, like he did in early 2019, even as his colleagues talk a hawkish game.  Caving is in his DNA.  Its in his survival instinct.  High inflation or low inflation, when his back is against the wall and financial markets are having a temper tantrum, he will go back to his familiar role of being the market's sugar daddy.  He can't take the criticism.  Inflation could be totally out of control and he will still cut rates if the stock market crashes.  Guaranteed.  

I am noticing a sea change in the psychology of market participants over the past few days.  The bullishness is going up on a short term time frame, as its become consensus that the market is oversold and due for a bear market rally, and more people are coming around to my view that we are in indeed in a bear market.  Based on the huge amount of inflows into stocks in 2020 and 2021, and the high % of household net worth invested in stocks, I only see corporations providing a bid to the market with buybacks, while retail and institutions will be reluctant to add to their holdings in stocks, since they are already at a historically high level.  More likely than not, we'll see retail outflows as they pass the denial stage and lurch towards acceptance. 

I continue to feel the post dotcom bubble 2000 vibes in this market, so its a dangerous market for buying dips, and even more dangerous for chasing rallies.  Bitcoin and crypto currencies are the poster boy for excessive speculation in previously unthinkable investments, which became extremely popular in 2020 and 2021.  Expecting a painful slide lower for bitcoin for the next 2 years.  

For the overall market, best case scenario, I see a bounce up to SPX 4200 and a resumption of the downtrend after that bounce.  Worse case scenario, we top out this week and continue to grind lower towards 3600 for the rest of the summer.  This market is tailor made for short sellers, and selling rallies will be profitable until Powell cries uncle and gives up on 50 bp rate hikes, signaling a slowdown in the tightening cycle, probably coming at the September FOMC meeting.  So until then, rallies will be brief, IMO.  

We have a big gap up today, I have a small "legacy" position in SPX which I will be looking to clear out this week, so may sell it today or tomorrow.  Still holding energy, as I am a long term believer in the inflation trade.