Monday, June 6, 2022


Over the past 14 years of continuous monetary bailouts, "Don’t fight the Fed" has been changed to "Don’t fear the Fed". Now, bad news is good news. So it is that gamblers are doubling down on depression…

In this post I was planning on assessing the bull case vs. the bear case. However, there is no real bull case to consider on a long-term basis. Since the lows of 2008, we've been told that "extreme valuations don't matter" because interest rates were at generational lows. That argument is no longer true. Over the course of this summer, investors will face the most extreme Fed tightening in history. Which means that now, record valuations DO matter. In addition of course, most of today's pundits happily ignore the ongoing Tech implosion and RECORD housing bubble. The only two bearish pundits who capture the magnitude of today's risks are Michael Burry and Jeremy Grantham. Burry made his claim to fame not only predicting the 2008 subprime meltdown, but successfully betting against it. Of course there was a book and a movie, "The Big Short" about the entire debacle. And yet, today's investors seem intent on ignoring his latest stark warnings: 

"Burry's view seems to be that consumers are raiding their savings accounts to weather inflation in food, energy and housing costs, and a r
ecession is likely once those cash reserves are exhausted"

last summer, Burry warned buyers of meme stocks and cryptocurrencies that they were facing the "mother of all crashes."

Here is the personal savings rate with U. Michigan consumer sentiment:

In the past year the Fed has crashed Emerging Markets, Ark ETFs, Cloud internets, IPOs, SPACs, Crypto currencies, and the global bond market. And yet, investors have ZERO fear of the Fed right now. Complacency is rampant. Today's pundits only tell investors what they want to hear. They never mention the EPIC downside risk if this experiment fails. They never tell people that this time there is NO Fed safety net.

Investors have been conditioned over the past decade to believe that bad news is good news. They are now FULLY addicted to Fed bailouts. As risks increase, they are trained to increase risk allocations. Ironically, the Fed sees this mass complacency as a signal to continue tightening. Therefore, they have now commenced tightening their balance sheet for the first time since before the pandemic. In addition to double rate hikes the Fed is  now reducing their balance sheet at $45b/month, which will increase in $15b increments to $90b by September. Back in 2017, the Fed STARTED tightening at $15b/month. So they are starting QT at 3x the level of last time. Adding together rate hikes AND QT, the progression of tightening will look like this, below: 3x this month, 4x in July, and 6x by September (2 rate hikes and $90b in QT). As I said on Twitter, there have been no times since 2008 when the market rallied from this level of breadth disintegration WITHOUT Fed bailout.  

The only bull case right now is for a tactical oversold bounce. The bullish belief is that institutions have become too bearish and therefore a bounce is inevitable. Perhaps. However, it's not true that the market is heavily oversold. And therefore, there will be very little fuel behind any tactical rally. Which means the downside is far greater than the upside at this juncture. Let's take a look at the "bull case", so I can demolish it. 

We hear a lot about a "breadth thrust" meaning a high degree of participation in stocks, which took place last week.

Here we see the S&P 500 with the S&P oscillator (middle pane) the highest since March 2020 AND January 2019. Both were the beginning of large rallies. However, what we also notice is that those times, the oscillator FIRST became heavily oversold attended by a large spike in the put/call ratio. NOT this time. We also see that the last time the oscillator became this overbought was THIS YEAR in April and that was the END of the bounce, not the beginning.

MINOR details that can end up costing A LOT of money. 

The Dow, same idea. Three times the Dow has been this overbought this year and each time the market rolled over. 

Why? No capitulation compared to last times:

The S&P volume oscillator confirms what breadth is saying - this market is NOT oversold. 

I will become bullish when this indicator becomes oversold indicating capitulation AND when the Fed has capitulated and stops raising rates.

That combined scenario is limit down away.

The next bullish argument: "Institutions are bearish". Yes, major institutions have been selling all through 2022 which is what they do at every stock market top. Is that a warning sign or opportunity?

Here we see Active Manager positioning is bearish, but it's not as bearish as 2008. ALSO, prior bounces from this level of bearishness ALL had Fed participation. So make the popular 2015/2016 comparison at your own risk. 

In summary, bulls are playing based upon the rules for a BULL market. Which means they see a market becoming moderately oversold and they buy the dip. In a bear market we can expect sentiment surveys to become more and more bearish but less and less useful IF they are not attended by commensurate positioning. Investors are sliding down the slope of hope and  today's pundits are merely greasing the slide for them.

There is a wall of put options below this market and SO FAR that is keeping the market bid. However, below the bear market level there is NO safety net for this market. Grantham predicts the market has 40% downside below this level. I predict that this Disneyfied market will cease to function normally below this level. And that is when ALL of today's bulls will realize that 14 years of continuous monetary bailouts are ending BADLY. As anyone with an IQ of 5 could predict.