ALL ROADS LEAD TO HARD LANDING

"There is no means of avoiding the final collapse of a boom brought about by credit expansion"

 - Ludwig Von Mises

If the Fed accelerates rate hikes they bring forward recession and asset meltdown. If they ease off rate hikes, they won't have dry powder for a recession and asset meltdown. Either way, investors are trapped at the END OF THE CYCLE...

Today's pundits who still believe in this "market", no longer believe in any element of TRUE financial analysis. They ignore eroding profit margins, they ignore collapsing P/E multiples due to high interest rates. They ignore cycle risk and recession indicators. They ignore consumer sentiment. They ignore Fed tightening policy. They ignore global risk factors. And of course they ignore ALL concept of over-valuation. All they believe in is the efficient Bailout Hypothesis, despite the fact that the Fed itself has repeatedly warned them that it's not happening this time. 

Mostly what pundits ignore is the risk of being wrong when the Fed is tightening liquidity at the fastest pace in history NEAR the zero bound. There is no monetary safety net beneath this lethal gambit. This is the monetary equivalent of Russian Roulette. 

The real policy error started 14 years ago when the Fed began conditioning investors to expect a bailout at the first sign of trouble. Prior to 2008, the Fed's mandate was price stability and full employment. The post-2008 mandate is full employment, price stability, and Dow making all time highs in perpetuity. Unfortunately, this untimely combination of end of cycle/supply chain bottlenecks now makes it impossible for the Fed to fight inflation AND save markets. 

"Federal Reserve Bank of Kansas City President Esther George said the “rough week in the equity markets” was not surprising, and doesn’t alter her support for half-point interest-rate hikes to cool inflation"

Going into this year, financial advisors told their retail clients that stocks usually perform well during the first year of a new rate hiking cycle. Fast forward five months and the Nasdaq is deep in bear market territory and the S&P 500 is now just points off of a bear market. 

What went wrong? Several widely unquestioned assumptions were invalid this time around. For one thing, the Nasdaq asset bubble started imploding a year ago. Secondly, the Fed tapered their balance sheet expansion in record time leading to further weakness in Tech. Thirdly, as I showed in my prior post, bond yields and mortgage rates sky-rocketed as the Fed continued to escalate their ever-more hawkish tone ahead of each FOMC meeting. In June, the Fed is planning to double tighten rates AND double tighten the balance sheet. Which would be the most extreme tightening measures in HISTORY.

All of this rising risk hasn't stopped today's pundits from continuing to propagate belief in the Fed put. This idea that the Fed is always ready to step in to save markets. Which is why investors are now counting on the Fed to bail them out of a nascent bear market.  

"Bolstering his opinion is a conviction that US inflation has probably peaked, or is about to do so, paving the way for a pullback in price pressures that will eventually allow the Federal Reserve to moderate the pace of monetary tightening"

This is the Goldilocks and NO BEARS economic fairy tale - not too hot and not too cold. And they lived happily ever after. The fact that this outcome WON'T allow the Fed to normalize policy is of no concern. Nor is it explained how we go from 8% inflation down to 2% in a few months, which has never happened before EXCEPT in the 2008 market meltdown. The fact remains that the ONLY way to get inflation from 8% down to 2% quickly is via market crash. Anything less, and the Fed will continue tightening long after inflation has "peaked". They won't be satisfied with a 5% inflation rate. 

Getting back to the topic of policy error, the Fed has systematically conditioned investors to misallocate capital throughout ALL points in the cycle. To actively embrace risk rather than protect capital. Which ironically is why the Fed sees no major market risk on the horizon. The Fed's own proprietary financial stress index is a mirror image of the stock market VIX - both are stuck at a relatively low level. No surprise, the VIX is one of the constituent data elements of the Fed's index. 

Both the VIX and FSI are confirming MASS COMPLACENCY in financial markets. And therefore the Fed feels free to continue tightening. 

In summary, the S&P 500 is at the precipice of a bear market, and yet complacency reigns supreme. End of cycle risk is coalescing in the background while the Fed is systematically taking liquidity out of the market. Investors are no longer hedging because it's too expensive and they assume the Fed will bail them out sooner than later. 

Unfortunately, this time they can't afford to be wrong. Because a crash coming AFTER a -20% decline is WORST CASE SCENARIO and will stress test these Disney markets far beyond their breaking point.   

So the only question now is "What could go wrong?"

And the answer is ANYTHING. 

 

THE BAILOUT CYCLE IS OVER

Retail investor bagholders have a long tradition of going ALL IN at the top. Why stop now?

Today's pundits are largely of the groupthink mind that the Fed can thread the needle between normalizing monetary policy and recession. 

Every oil shock in the past 50 years has preceded recession. Every inflation shock for the past 50 years has preceded recession. Every housing bubble in 75 years has preceded recession. 8 out of 10 rate hiking cycles has preceded recession, and the DotCom bubble in Y2K preceded recession.

This time we have ALL of those risk factors and a negative GDP print in Q1, but pundits are STILL not certain there will be a recession.

Here we see the University of Michigan index of current economic conditions is the lowest in 50 years, yet this time the housing bubble is STILL growing. What are we to believe will happen when it collapses?

Retail sales came in today near expectations, which has led pundits to believe "the consumer is strong". However, headline retail sales are NOT adjusted for inflation. On a quantity basis, we can see that retail sales are imploding:

Real consumption expenditures, QUANTITY:

Walmart warned today that they are no longer able to pass along all costs to the consumer hence profit margins are imploding:

Walmart stock peaked only three weeks ago, which is several months AFTER the overall market. The same pattern that took place in 2008. 

What today's retail gamblers don't understand that institutions DO understand is that the Fed bailout cycle is OVER. The Fed is now intent on normalizing monetary policy as quickly as possible, because they know recession is coming. Which means they need as much dry powder as possible. So ironically, they are now in the process of accelerating recession in order to get rates to a level that will allow them to cut in the future. Investors are now trapped by this policy conundrum. 

The rational strategy is to rebalance portfolios from stocks back to T-bonds and to raise CASH aka. t-bills, money markets. However, RETAIL investors have been led to believe that inflation is NOT transitory and therefore they must OWN the riskiest end of cycle assets. By this I mean commodities and commodity stocks. While holding minimal cash.

What is not priced into these markets is DEFAULT risk. The Fed's proprietary financial stress indicator has fallen since the stock market crash began. Why? Too much complacency in the stock market AND in the high yield bond market. 

There is no cycle risk priced into these markets:

We got news this week that China is already in a recession.

Their market has collapsed back down to where it was in late 2015 right before the wheels came off the global bus. In addition, the Yuan is collapsing at the fastest rate in history (not shown). 

The markets have ALREADY done the Fed's job for them. Consider that the Fed rate is currently at .75% but the 30 year mortgage is at the highest level since 2008. HIGHER than it was in 2018 when the Fed rate was at 2.5%!

That's insanity.  

Homebuilder sentiment is collapsing. AND home buyer sentiment is collapsing as well. 

Last week saw the highest number of Nasdaq weekly lows in HISTORY. And yet in four weeks time the Fed is intent on double tightening their balance sheet AND a double rate hike. The most EXTREME Fed tightening measures in HISTORY.

Which means that the Nasdaq is imploding AND the Fed is tightening both at record pace. 

BTFD: Buy The Fucking Depression...

In summary, this same market pattern played out in 1929. At first, individual investors bought the dip. But then the selloff accelerated and they ultimately panicked and the market crashed. 

This chart shows the 1929 Dow inset against my predicted path for the U.S. market. Until the Fed panics, this market WILL NOT see a tradable bottom. Which means the initial crash will not be enough to stop stocks from going lower. I predict a neutral Fed will lead to a dead cat bounce followed by another leg lower. Which is what happened in 1929. The percentages are ESTIMATES. There is nothing magical about these price levels. If anything, they could be lower.   

BTFD: Buy The Fucking Depression

This article from the Wall Street Journal confirms that retail investors are buying stocks with both hands while institutions are selling in massive quantities. Which is what happens at EVERY stock market top. Once again, retail investors waited until the end of the cycle to plow record amounts of money into stocks at record over-valuations this time with NO Fed safety net. It's financial suicide:

"This year’s stock market volatility has turbocharged a favorite strategy among individual investors: buying the dip"

Many individual investors who bought the stock-market dip are sitting on losses...This year, the S&P 500 has fallen 16%, its worst start to a year in nearly a century"

Vanda estimates the average individual investor portfolio peaked late last year and has since tumbled, giving the average individual a paper loss of about 28%"

In other words, individual investor losses roughly equal Nasdaq losses. So far. The lack of panic is highly evident in the subdued Nasdaq VIX:

Investors have been systematically conditioned by central banks to buy the dip despite ever-increasing risk. They no longer look at valuations or economic information, they just blindly buy stocks whenever they fall. On the assumption that this strategy will ALWAYS pay off. The last time this strategy REALLY failed of course was in the 1930s. After the market peaked and crashed in 1929, it eventually lost 90% of its value by the lows of 1932. The high of 1929 was only regained 25 years later. 

Ironically, Warren Buffett was born in 1930 so he began his investing career AFTER the worst bear market in history. Therefore he believes that stocks always go up as well. Of course Japan and China give us much more recent examples of what happens when monetary policy fails. In both those cases, stocks remain far off their all time highs. 

You don't have to be a genius to predict how this all ends:

The Fed pushes global markets over the cliff until the global asset bubble explodes - a process which is already well underway. Retail gamblers will be trapped with MASSIVE losses. The Fed is slow to react at first, but eventually reverses.  In the meantime markets continue to implode. Consumer confidence collapses. Global depression ensues. 

Here we see that consumer confidence has already collapsed to where it was at the bottom of the last housing bubble. This time, it has collapsed at the top of the housing bubble. Meanwhile, the Fed is tightening monetary policy at the fastest pace in history. 

A disaster in the making. 

Ultimately, investors will lose confidence in the Fed and in markets and they will bail at the bottom. I don't predict a 90% loss however because this time the Fed is going to Japanify the bond market which will ultimately put a bid under stocks. Something that was not attempted in the 1930s. Nevertheless, the degree of dislocation will ensure that investor confidence is fully shattered.

This is by far the most likely scenario given the information we already know. And yet, not even ONE mainstream pundit sees it coming. They all see Fed interest rate hikes for the rest of 2022 and into 2023. Zerohedge always has the bipolar "depressionary hyperinflation" angle covered. Which is an asinine theory of course. There will either be recession or inflation, not both. 2008 is the closest analog. Back then, inflation expectations collapsed along with the commodity markets. This week we learned that China is likely going to cut interest rates as soon as next week. And they may soon lockdown Beijing over COVID. In addition, Europe has backed off the idea of a Russian oil ban. So the argument keeping oil bid no longer exists.

We can see there is now a massive divergence between crude oil and the Canadian dollar, which is a proxy for global growth:

The markets are going to do the Fed's job for them, only FAR FASTER. They are going to take away the punch bowl and collapse inflation expectations. Which means that most of today's pundits will be catastrophically wrong as to how this all plays out. And most investors in risk assets will get wiped out.  

 

 

The dislocations we've already seen this week in Crypto currencies should have been a warning as to what is coming to other markets. Crypto is currently 95% correlated to the Nasdaq. The Crypto losses to date are $1.7 trillion which is more than subprime losses in 2007 ($1.3 trillion).

The next big shoe to drop will be in Emerging Markets which have been getting monkey hammered by the rising dollar.

And are now BIDLESS.

In summary, the losses are racking up in IPO junk, ARK ETFs, Emerging Markets, Cryptos, and Mega Cap Tech. However, complacency is rampant. 

Retail investors are just buying the dip lower and lower into the economic abyss. And sadly, there is no one who will tell them it's a bad idea. The amount of economic hardship this will cause is totally unthinkable. 

The age of easy money is OVER and now the age of democratized fraud is ending far worse than the majority expect.

Who knows if it was meant to be this way.

"In the broadening top formation five minor reversals are followed by a substantial decline."

In its formation, most of the selling is completed in the early stage by big players and the participation is from general public in the later stage"

Indeed.

SLOWLY AT FIRST, THEN EXPLOSION

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.

TD Ameritrade Investor Movement Index for April:

"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. 

THE MINSKY MELTDOWN

This week the Fed pulled the trigger on the first .5% rate hike in twenty-two years. In the process they very likely initiated global financial meltdown. The general consensus is that it was not enough. You can't make this shit up...

The Financial Instability Hypothesis

https://www.levyinstitute.org/pubs/wp74.pdf

"Over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. If an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. This is likely to lead to a collapse of asset values"

Why is it that every time this society gets to the end of the cycle, they conveniently decide there is no cycle anymore? This society goes from youthful naivete to aged cynicism without stopping at reality in between.  

This week Larry Kudlow deemed the .5% rate hike as "dovish":

"The basic inflation rate is running around 8%. That would require a 9% or 10% Fed funds rate, or even higher in the days of Volcker shock and awe. Volcker also reined in money supply growth and here, Powell completely struck out"

The 30 year mortgage is currently at 5.25%, can you imagine a 30 year mortgage at 18% which was the 1980 level?

We are constantly reminded this is the highest level of "inflation" in 40 years (despite nominal oil prices still below 2008 levels). However, the rate of change in interest rates is the highest level EVER in the biggest housing bubble in HISTORY. 

To cap off FOMC week, Stanford University held a conference to discuss how far monetary policy is behind the curve. 

Two Fed members were on the hot seat, Waller and Bullard:

"It's going in the right direction ... hopefully we'll be able to get away from this behind-the-curve characterization soon," Bullard said.

Indeed. Much sooner than anyone can possibly imagine. 

All of the above means that the Fed's mandate is to cool the economy and bring down inflation. NOT to save asset markets from collapse.

This change in policy taking place after FOURTEEN straight years of bailing out markets, is NOT priced in to any asset market right now. Investors are still under the delusion that the Fed can slam on the brakes as hard as possible for price inflation AND yet keep asset markets inflated. It's the delusion of the CENTURY, and it has been assiduously cultivated by Wall Street and their media acolytes. 

Not everyone took the bait:

"Wall Street titan Jeremy Grantham has been warning of a “superbubble” in the U.S. since last year, arguing the S&P 500 is set to be cut in half as an era marked by exceedingly risky investor behavior begins to fade."

Now, with interest rates for a 30-year fixed-rate mortgage rising to 5.27% this week, their highest levels since 2009, he sees that point coming ever closer"

Of course, not everyone is convinced that the housing market is set for a dramatic drop"

Got that? We can't even agree on what is a "bubble" anymore. In my neighborhood prices went up 30% in the past year. Apparently that's NOT a bubble, but eggs going up 30 cents, that's existential inflation.

What a bunch of fucking morons. 

Clearly these people can't spot an asset bubble over and over again in their lifetimes, so how do they know what is inflation? In other words, what if all of these asset prices are temporary? That would mean they could all come crashing back down and leave the Fed "dick in hand", just like last time. Then you will see rampant morons rioting in mass protest. Wondering how they are going to pay for cheap eggs when they don't even have a job. Buried by another housing bubble. 

What economists never noticed is that consumer sentiment NEVER recovered after the pandemic. Corporate profits sky-rocketed and consumer sentiment went in the other direction.

We've never seen this much disconnect between consumer sentiment and corporate profits. One is inflated, and one is deflated. 

The Tech bubble is DOOMED. It's collapsing for the same reason it collapsed in Y2K - slowing growth AND a Fed eager to make up for lost time. Back in 2000, the Fed purposely held off on rate hikes until after the millennium date change, because they were worried computer systems would fail. When that didn't happen, the melt-up accelerated into March 2000. By May 2000 the Fed was doing everything possible to contain inflation. Sound familiar?

The Tech sector just got rejected at the 200 dma for the first time since 2008:

In summary, the Fed and its inflation acolytes have triggered global Minsky Meltdown. Which in today's Idiocracy means they didn't do ENOUGH.

Why? Because SO FAR, most of the pain has been in non-U.S. markets.

This time, the Fed is constrained from initiating a monetary bailout. Which ensures MAXIMUM dislocation at the zero bound. 

2008 sans bailout aka. 

MONETARY POLICY FAILURE. 

THE BIG LONG 2022

The mainstream financial media deserve the majority of credit for the masses NOT seeing this coming. Zerohedge deserves credit for excellence in generating mass confusion. No one does it better. In summary, end of cycle GREEDTHINK is driving the most expensive circle jerk in human history:

"Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms or supports one's own views"

Reading the news THIS week one would never know that in April the Nasdaq had its worst month since 2008.

How soon they forget:

Two things are killing Tech right now, one is DECLINING growth as described in the article above, which is the death knell for momentum trades. The second factor is higher interest rates which are the death knell for high valuations. This week, the Fed raised interest rates .5% which is the most since May 2000 when the DotCom bubble imploded. The Nasdaq finished that year down -60%. This current Tech wreck started over a year ago and now it's spreading to the mega cap names as well. 

After Y2K, the Nasdaq didn't make a new high for 18 years. The 2008 crash required a maximum Fed bailout, but still the Nasdaq fell another -40% before hitting bottom AFTER October 2008:

In addition to the Nasdaq being down the most since October 2008, the S&P 500 was down in April the most since March 2020. This time of course, the Fed is tightening at the fastest rate in history whereas back then it was easing at a record pace.

Which means that this set-up is March 2020 deja vu EXCEPT this time sans bailout. Anyone can see that breadth during this period of time in no way resembles 2018 and 2020. 

Right now investors are piled into LATE cycle inflation trades because the stagflation hypothesis is unanimous. Here we see that commodities are the most overbought in four decades.

In addition, the stock/bond ratio is at the highest level in history, and yet today's pundits claim that investors are "too bearish" for a continued stock market decline.

Stagflation is a "RISK ON" trade. 

What today's pundits never admit is that "stagflation" is temporarily evident in EVERY late cycle just prior to recession. It just means slowing growth and high prices. Only in the late 1970s was stagflation NOT transitory. So therefore this must be the late 1970s. 

It couldn't be for example 2008 deja vu:

What these stagflation pundits forget is that Powell is doing his best imitation of Paul Volcker who KILLED stagflation in 1980.

What makes THIS situation uniquely lethal is the fact that the housing market has yet to implode. Whereas during the prior two housing bubbles (1980/2008) the housing bubble had already imploded BEFORE consumer sentiment collapsed. 

Which means THIS Fed is raising rates into an impending housing collapse at the ZERO bound which will make this recession far worse than 2008 and 1980.

When the Fed's first rate hike didn't collapse global markets (ALMOST), they decided to double down on collapse:

In summary: A Tech wreck in progress, record overbought inflation trades, collapsing Emerging Markets, and a housing  super bubble with a Fed hellbent on maximum tightening.

All of which means that the biggest policy error in market history is attended by the WORST positioning by investors at any end of cycle in history. Why? Because today's pundits are groupthink idiots and the masses wouldn't have it any other way. 

Which portends MAXIMUM DISLOCATION @ 

MINIMUM BAILOUT.