THIS IS CRASH

Bulls, F.Y.I...

At the beginning of the month, I reminded everyone that October is the notorious month of crash. Ominously, by mid-month, we were told via Ned Davis Research, that the current set-up is eerily similar to 1987, but that is no cause for concern:

"Circuit breakers were installed after the October 1987 crash, making a 20% decline "almost impossible"

There are three regular session stock market circuit breakers which are triggered at declines of -7%, -13%, -20%. On March 12th 2020, at the onset of the pandemic, the first circuit breaker was triggered at the open which paused all trading for :15 minutes. The -13% circuit breaker was almost triggered near the end of that same day, but the rules for circuit breakers prevent them from triggering in the last half hour. Which is why the market was down -13.5% at the close. Which happened to be the biggest one day percentage decline since 1987. So to believe that a -20% decline could not occur again, is wishful thinking. Investors are far more complacent now than they were going into March 2020. And this market keeps on dropping.

This week, Wall Street earnings "beats" are getting monkey hammered, especially in mega cap Tech. Which means that the charade is over. This negative price reaction proves that fundamental analysis is not a reliable predictor of stock direction. Going into this earnings season, Google, Microsoft, Amazon, Netflix, Nvidia, and Apple all had charts that were predicting impending weakness. I posted several of them on Twitter. Every one so far has reversed to the downside after earnings. In addition, the same price reaction already occurred at the July top - across the board earnings beats for mega cap Tech stocks were met with heavy selling. Which of course is something that Wall Street would never predict, and therefore most gamblers were trapped in bad trades. In other words, technical chart analysis was far more useful as a predictor of impending direction than Wall Street earnings predictions which have the veracity of a Magic 8 Ball.

The Nasdaq is now through all levels of support. 

All of which means that as the month has worn on, bulls have become more and more trapped. As a result, BofA (Hartnett) came out this past weekend and said that they were becoming tactically bullish due to the market's oversold condition. They said that extreme bearishness could either lead to a bounce or a crash. Which of course sparked a big rally on Monday:

“Investors are sufficiently bearish” for the S&P 500 to hold above 4,200 points for the next three-to-four weeks...if the index can’t hold at 4,200 with this level of bearishness, then there may be imminent risks of a credit event or hard landing”

Clearly, bulls and bears are on the exact same page now - stocks have ~5% upside, and -50% downside. Which makes this a tradable opportunity for someone with an IQ of a dead gopher. Or hedge fund managers desperate not to underperform the market into year end.

In summary, position accordingly. 

HARD LANDING

What we are witnessing is the fourth and last phase of Fed policy error...

The first phase policy error took place when the Fed foolishly doubled their balance sheet during the pandemic from $4.5 trillion to $9 trillion. The equivalent of 200 years of monetary largesse unleashed in one year. That unprecedented amount of monetary dopium found its way into every asset market on the planet from the housing market to junk IPOs/SPACs, Ark ETFs, Crypto Ponzi schemes, Reddit pump and dumps and most recently mega cap Tech stocks - What today's pundits are calling the "Magnificent Seven". Seven massively overvalued Tech stocks that account for all year-to-date market gains. Up until very recently, the Fed has been way behind the curve soaking up this excess liquidity. But now they are making up for lost time. 

The second order policy error was keeping interest rates at 0% for far too long even as inflation was already soaring. During 2022, the Fed made up for lost time by increasing the Fed rate 3x what it was prior to the pandemic. From 1.5% to 5%. That was policy error number three - panic rate hiking after being asleep at the wheel.  

By over-raising rates, the Fed committed a massive policy error, due to the policy mismatch of over-tightening on rates while under-tightening on the balance sheet. Meaning it was easy to issue junk bonds, but increasingly difficult for consumers to get access to credit. That Fed policy divergence is now collapsing the middle class. Below we see that homebuilders held up well during the rate hiking cycle. However, the 30 year long bond yield which is in the lower pane, has sky-rocketed since the Fed paused. This has caused homebuilders to collapse. The market is signaling that the Fed should pause quantitative tightening - balance sheet rolloff. However, the Fed plans to continue "normalizing" their balance sheet for several years.    

Which means that we are now in the fourth and final Fed policy error. During Powell's interview today he said that the long bond collapse (yield spike) is now doing the Fed's job for them. Indeed, and then some. As I remarked above, the Fed had been far too slow reducing their balance sheet. However, at this late juncture, the bond market is now bidless. While I was watching Bloomberg Asia on Tuesday night, Rishaad Salamat was asking his guest market analyst if "we are all just waiting for something to break". She agreed - The Fed, Wall Street, investors, Zerohedge, are all desperately waiting for markets to break because then as the story goes the Fed can come to their rescue. It's the exploding market bailout hypothesis. Needless to say it has a dubious set of believers and an even more dubious chance of working.  

The problem lies in what I said above - policy error #2 - the Fed has over-tightened on the middle class. It's far too late to seamlessly pivot to a bailout stance to avoid recession. This chart shows that in all three most recent instances, bank tightening of this current magnitude preceded recession. And, all three times, the Fed was already easing. But not this time.

This time, will be the "soft landing".

In summary, last October investors made a big bet on a Fed pause, which took almost an entire year to become reality.

Now, they are betting on a Fed bailout. Which will come far too late to save anyone who believes in it.

Unless, they're just a slack jawed pundit with no skin in the game. 

 

CONDITIONED TO EXPLODE

Fifteen straight years of bailout has conditioned gamblers to explode. All because they believe that printed money is the secret to effortless wealth...

Currently we are witnessing a suppression of volatility similar to what was seen in late 2017 prior to the famous Feb. 2018 "Volmageddon" event. The only reason this suppression of volatility is considered bullish is because most of the people putting on this short-term trade are playing with other people's money. Over the past 15 years of non-stop monetary bailout, investors have been systematically conditioned to ignore risk. Which means that this can only end one way: With systemic meltdown.

Oct. 10th, 2023:

“If you remember 2017, right before we got into Volmageddon in February 2018, the volatility environment smelled similar to right now”

Derivatives specialists have argued that options-selling funds are acting as a market tranquilizer, day in day out - all of which essentially serve as indirect wagers on stock calm"

“It works until it doesn’t”

Wall Street's favourite business model - something that mints coin until it explodes at public expense. 

Below is what this looks like visually via the short VIX ETF. The big drop was Feb. 2018. Keen observers will note that this rally in complacency is almost 2x longer than the previous two vacations from reality.

The risks are so obvious today, that everyone merely assumes they must be "priced in" to this Disney market. In the same way that the most obvious subprime was NOT priced in last cycle. 

Recently even Nassim Taleb - author of the "Black Swan" event, called today's risks a "White Swan" event i.e. common and obvious. 

“Systems don’t correct themselves without some kind of pain.”

“A white swan! It’s a white swan event,” Taleb said during the interview.

"He believes the economic risks we currently face are obvious. After years of ultra-low interest rates in the U.S., Americans have piled on unsustainable levels of debt"

I've said this exact same thing for many years - but I'm not famous enough to first invent a fictitious financial term and then reject my own theory publicly. Because in the world of finance there is no such thing as a true "Black Swan" event. Per Minsky theory, money managers steadily increase risk over the course of the cycle until something explodes, then they tell their investors it was a "Black Swan" event, in order to exonerate themselves. In this elongated post-2008 cycle, conflict of interest has been put on steroids. Fifteen years of continuous monetary bailouts has conditioned investors to ignore even the most obvious of risks. 

The Fed has many times attempted to re-calibrate their financial risk index in order to more accurately predict financial crises. However, each time they do so, investors onboard even more risk. Which means that this latest financial meltdown will come as a total surprise to unprepared central banksters and volatility selling gamblers alike. 

Which gets us to this war in Israel. The current war started 50 years (+1 day) from the Yom Kippur War of 1973. Back in that war, Israel was caught off guard by a simultaneous Arab attack via the Golan Heights and the Sinai Peninsula. It was almost a total disaster for the Israeli side, but in the end the attack was repelled. After the war, Golda Meir resigned in shame. 

In similar fashion this latest incursion came as total surprise. All because an interlude of stealth war preparation was widely conflated as Middle East peace, delivered by The Punisher Netanyahu. 

That's where the comparison between these two events largely ends. The 1973 war triggered the OPEC oil embargo because the Arab nations wanted to punish the U.S. for siding with Israel. That embargo coincided with the closing of the Nixon gold window, both of which fueled the infamous 1970s stagflation. To believe the same massive commodity shock could be absorbed now is a fool's errand. As Taleb asserts above, current levels of debt are totally unsustainable. At best this Middle East conflagaration will serve to accelerate the Lehman Moment.

Something like this:

 

GLOBAL MARGIN CALL

The month of crash has officially begun. 

Since the Fed "pause" last week, global bond yields have sky-rocketed. Under this new paradigm, the Fed won't have to tighten again because the bond market is tightening for them. 

No one seems to have any answers for why this is happening. Bulls are at a total loss to explain how a Fed pause caused long rates to explode. The most obvious explanation is that the global bond market is now going bidless due to relentless central bank tightening. Real yields are rising which is a sign of central bank policy error. However, central banks are now trapped between the threat of further inflation and the need to support asset markets during an incipient meltdown. Consider the stark difference below between March 2020 and this current situation.

Central bank policies are currently at the opposite end of the bailout spectrum relative to 2008 and 2020. But to hear bulls tell the story, CBs can just flip a switch and instantly bail out everyone. As I said on Twitter, this time there will be a long line for bailout. A long soup line.

Because by the time central banks get the bond market back under control, the stock market will be a smoking crater. 

Over the past weekend, the government shutdown was temporarily avoided for six weeks, but it came at the expense of Speaker McCarthy's job. I had predicted a market meltdown if this happened, but instead of course the market rallied.

One more obvious risk to ignore. 

It appears that gamblers have yet to consider the implications of a market meltdown with a non-functioning Congress. They seem to forget that in 2008 and 2020, Congress backstopped both the FDIC AND the corporate bond market. So it's only fitting that corporate bonds are currently breaking the lows of last year and soon banks will be at new lows as well. 

Which begs the multi-trillion dollar unasked question - at what breaking point does inflation risk morph straight into default risk? And the answer is when the deflationary impulse returns which should be any minute now. Because the deflation paradigm will cause a massive re-allocation of capital from stocks back to T-bonds when everyone realizes that today's earnings estimates are off by a minus sign.

Consider that rotation scenario in the context of Utility stocks that are ALREADY imploding the fastest since 2008.

THESE are the stock market safe havens. Where will investors hide when the rout accelerates.

Netflix?

In summary, in the first week of crash month, it's only fitting that the average U.S. stock has now given back all 2023 gains and is now sitting at a loss for the year. Meanwhile, gamblers remain totally complacent. 

Because in a groupthink Idiocracy, the realization that they own an epic clusterfuck will dawn on them at the exact same moment.

aka. Too late.