Monday, May 15, 2023


The longer this market denial persists, the worse will be the final outcome...

I posted this chart of the 1930 Dow v.s. the S&P 500 today on my Twitter feed about a week ago. The duration of the initial decline is different, but the rebound rally and bank run is eerily similar, as is the mass complacency taking place right now. Back in 1930, pundits generally believed that the worst was over even though under the surface the economy was imploding. The Dow decline in 1930 was not as steep as the 1929 crash however it ultimately took the Dow down -90% by 1933. 

I predict this impending decline will be much steeper than the one in 1930, but the total downside will likely be less once the Fed finally panics. After all, they didn't have QE back in those days. Nevertheless, downside in the range of -60% to -70% in a short period of time will evoke massive turmoil. And shatter confidence in "markets".  

The key bull argument for the past six months is that the Fed will pause and then a new bull market will begin. Many believe a new bull market already began at the October lows. However, this entire pause rally assumes the Fed is done raising rates. Which is far from certain. In other words, bulls are hoping for a recession so the Fed can be done raising rates. 

The problem with the pause theory - aside from all of the black swan events that are taking place - is the fact that the Fed is still tightening their balance sheet at TWICE the pace they tightened in 2018. Back then, the pause rally was stalling by mid-year so the Fed cut rates three times (1/4 pt) and ended QT. That kept the market bid until the end of the year.

This time, the stimulus crash is taking place without Fed bailout. 

The other problem with hoping for a recession as part of the bull market case is that it will very likely lead to deleveraging:

"It has been a long time since we had a proper credit cycle," Oleg Melentyev wrote to clients on Friday, pointing to the credit cycles beginning in 1981, 2000, and 2007. Those cycles were upended by a dramatic tightening of credit conditions, leading the three-year default rate on US corporate default debt to soar to around 15%"

"We think it is reasonable to argue that that the default cycle, whenever it starts, should add up to a lower peak around 8%"

Sadly, that is wishful thinking. 

What the Fed is doing now is tightening credit conditions by imploding banks, which I regard to be questionable policy.

First off, they are raising money market rates which is incentivizing deposit outflow. Secondly they are flattening the yield curve which makes banks less profitable. As we see below, in 2008 the Fed steepened the yield curve so that banks could "run off" their bad assets. Using their quarterly profits to cover up their balance sheet losses. This time around, the Fed is doing the opposite, making it impossible for banks to make money. That in turn leaves banks with less money to lend to insolvent companies and consumers. Thereby tightening credit conditions into a recession. 

What we are witnessing is the end of an almost fifteen year debt binge at 0% interest rates, which was capped off by the pandemic stimulus consumption orgy. Attended by the belief that we successfully borrowed our way out of the 2008 debt crisis. 

Now, banks are very quickly returning to the 2009 origin amid the widespread belief THIS will be the easy way out. 

In this chart we see that consumer delinquencies in dollar terms are already as high as they were in 2020 and the unemployment rate is still at the all time low. Now that is frightening. 

Today's bullish pundits also believe that this will be the first recession in U.S. history without a rise in unemployment.

The last bullish fantasy is that there is too much bearishness among money managers for the market to go down. 

This theory assumes that active managers could be bullish throughout a bull market but then remain steadfastly bullish during the bear market.

Those who believe that were not around in 2008.