Tuesday, May 10, 2022


The Fed is raising interest rates heading into recession. Investors want to know when they should double down on stocks. It's the power of imagined reality...

"What a fool believes he sees
No wise man has the power to reason away
What seems to be
Is always better than nothing"

Way back in late 2014 hedge fund manager Hugh Hendry penned an open letter to his investors telling them that he was "taking the blue pill now" - the Matrix metaphor for drinking the Kool-Aid. He had reached the conclusion that central banks would continue manipulating markets ad infinitum, thereby creating an ever greater divergence between fantasy and reality. He called QE, the "virtual simulation of prosperity". This divergence he claimed would go on indefinitely, but then end extremely badly. However he believed that no one could predict when it would end because by the time it ended everyone would believe in the invincibility of central banks. He called this new investment approach the power of "imagined realities". Looking forward to 2015 he predicted that amid GDP growth at 25 year lows the PBOC would create a Chinese stock bubble and he was going to buy into it. He was right - for a time - because in 2015 the PBOC did create a vertical stock market rally, but then it all came crashing down and they lost control of the market. What I call "Shanghai Surprise" i.e. when you find out central banks are NOT invincible. In the event, Hendry lost his hedge fund as large investors left in droves. Here we see Chinese stocks peaked back in 2008:

What we are witnessing right now in the U.S. is the EXTREME version of imagined realities i.e. investors buying a disintegrating market with NO explicit OR implicit central bank support.

"Demand for equities was light to start the month, but as the major indices continued their strong pullback below key support levels, we saw demand accelerate"

This shows the IMX relative to collapsed Nasdaq breadth in the bottom pane. In all of the prior times % Nasdaq above 200 dma reached this current level, the Fed DID bailout the market. As we will see in the next chart below, they are nowhere near doing so now. 

Worse yet, China's COVID zero policy is creating an extreme divergence in monetary policy between China and the U.S. By locking down large parts of the country, China is exacerbating global supply chain shortages, forcing central banks such as the Fed to tighten more. At the same time, the lockdowns are imploding China's economy causing them to ease more and weaken the Yuan. Emerging markets are caught in the middle, forced to devalue their currencies in line with China while inflation is rising. It's a recipe for mass exodus of capital WORSE than what happened back in 2015 when China's stock market imploded. Back then the Fed was only planning to raise rates and then they stopped. China's lockdowns are only short-term "inflationary" from a supply chain standpoint. Their collapsing currency and the sky-rocketing U.S. dollar are long-term DEFLATIONARY.

All of which is why I don't predict these markets will have a conventional crash. I predict we will see global asset EXPLOSION across every risk asset class, that is totally uncontrollable by central banks.

This graph of the Nasdaq shows that the Fed has stepped in to rescue the market EVERY time it fell meaningfully below the 200 day moving average (red line). Currently, the Nasdaq is down -27% but the Fed Funds futures still predict a 100% probability of rate hike in June. With an 85% probability of ANOTHER .5% rate hike. 

Tech is not the only problem. During the pandemic, cyclicals got bid up to ludicrous valuations. And now as the economy turns from inflation to recession, the reflation trades are about to go BIDLESS.

Millennials have never been through a bear market. Their primary investment experience took place during the 2018 and 2020 Fed bailouts. So they believe that markets ALWAYS magically v-bottom and sky-rocket higher. Hence they keep buying more as the market collapses. The thought that they could keep plunging lower never even enters their mind.

They will keep buying lower until they get margined out of existence.  

"Nursing losses in 2022 that are worse than the rest of the market’s, amateur investors who jumped in when the lockdown began have now given back all of their once-prodigious gains"

“A lot of these guys started trading right around Covid so their only investing experience was the wacked-out, Fed-fueled market”

In summary, we have now reached the terminal juncture that Hugh Hendry predicted "no one" would see coming. The point at which central banks lose control. As we see via today's totally useless financial media, investors desperately want any excuse to embrace risk. Which is why their current preoccupation is finding the "bottom" in this bidless market. Which is what happens in EVERY bear market. Investors slide down the slope of hope.  

The market is technically broken now. We are seeing a Y2K level of financial decimation. In 2021, Wall Street dumped RECORD amounts of junk stocks into the market which are now imploding the Nasdaq. The Nasdaq will be dead money for years if not decades. History will say that the Millennials were protesting Wall Street at the beginning of the cycle and got bilked by Wall Street at the end of the cycle.

And then they exploded and brought down the entire Casino.

Because it was all one JUNK MARKET inflated by the unquestioned belief that printed money is the secret to effortless wealth.