Tops Take Time

We got the hawkish pause, and a selloff in both stocks and bonds.  Another weak response to an FOMC rate decision, making it several in a row that has shown weakness. A recent phenomena, the total opposite of what you saw for most of the past 20 years.   I remember there being a study done about how a big percentage of the S&P 500's annual gains were achieved on FOMC days back in 2011 or 2012.  The markets are getting more and more efficient, and these obvious patterns tend to get either front run or just no longer work as they get gamed out by investors/traders.  

It looks like Powell has not completely fallen into the trap that the market rally setup, which was to induce the Fed to hike again this month. Although it did influence him enough that his default stance now is a hike in July.  Which means that if you don't get a stock market swoon (SPX below 4100) from now until the next FOMC meeting, even with weaker economic data, he's going to do another 25 bps at the July meeting.  This is not great for my bond position, but it works well for my short equities position.  I was skeptical that the Fed would get egged on by the market to overtighten, but that's what's happening.  And with the animal spirits back with a vengeance in the stock market, its testing the Fed's credibility on fighting inflation, which Powell seems obsessed about maintaining at the moment. 

I will admit, I've been wrong about the US economy and stock market since the middle of 2022, when the big rate hikes were happening.  Like many, I was expecting recessionary conditions to show up around this time period, and they have not.  I definitely underestimated the staying power and potency of what a huge fiscal stimulus does to an economy.  Also, the obvious boost to the house owner's balance sheet from having a 3% mortgage, has also been a source of resilience in consumption, as less of the monthly budget needs to be allocated to making mortgage payments.  Lastly, with how quickly the Fed went from 0 to 500 bps, the gradual nature of bonds maturing mean that the net average of the interest payments that corporations and individuals pay is still not that high, but is gradually rising.  While floating rates reset quickly to reflect market rates, the fixed rate market is much bigger and most of it is still low coupon, meaning most borrowers are not feeling stress from debt on their balance sheet, yet.  It will come eventually as all are resets to much higher rates for those that do need to reissue debt.  

That being said, the equity market is very overvalued on a relative basis to fixed income, and assume that what happened in the last 30 years will repeat over the next 30 years.  That seems like a bold assumption to make.  With the rally this year, equities as a percentage of household assets is now greater than 38%, which is higher than all periods except during bubbles in 2000 and 2021.  On a long term time frame, equities as a percentage of household financial assets is a great indicator.  It is the single best predictor of future returns.  

Bears got spoiled in 2022 when all rallies faded quickly, with the market giving very little time for bulls to sell the rally highs, and plenty of time to sell the lows.  That's the exact opposite of what had happened from 2009 to 2021, when bulls had all the time in the world to sell the highs and very little time to sell the lows.  The kind of pointy, quick top that you saw in August 2022, the last time the SPX was above 4300, is not common.  Most tops are a process, not an event.  Most of the time, the index trades near the highs for a few weeks before having a correction.  

But with a 200 point SPX rally in 2 weeks, near 4400, you are getting a good entry level to put on a short for a quick trade.  These type of sharp moves towards 52 week highs usually end up retracing at least half of the rally within the next 1-2 weeks.  Not likely that it gets back down to 4200 this month, but 4280-4300 is very doable.  With the stock market entering triple witching expiry, you have a potential classic top on expiry week, followed by a selloff post opex, into the seasonally weak late June time period.  Also, the weakness in the bond market is another good sign for those looking for a short term top.  

Given the speculative nature of this market with traders aggressively buying up stocks like NVDA, TSLA, and even the mega cap tech names, you have a nice short setup.  I entered a short position in SPX and some of the speculative tech names yesterday with plans on adding more today and tomorrow if the market stays up.  Not looking for any home runs here, just a single or a double.  The time to set up to try to hit the home run will be in July, if the market chops around these levels for a few weeks.