YEAR-END BONUS

In my last blog post I demolished the fundamental hypothesis. Now I will tackle the technical hypothesis. In a nutshell, the entire bullish thesis is predicated upon the ongoing misallocation of capital to the stock market, just as it is with every other Ponzi asset class...

First off, many pundits are now questioning why the Fed is over-tightening. The reason the Fed is over-tightening is because the jobs market remains inordinately strong due to the fact that low paid service workers are extremely scarce and in high demand. However, at the same time we are witnessing the beginning of a white collar recession centered in the Tech sector, which is what Michael Burry has been predicting for the past year.

Which means there is a severe mismatch in the jobs market: High demand/low supply for service workers. Low demand/high supply for Tech workers. These two labour markets are totally separate and yet they lead the Fed to the same conclusion - keep tightening. It's not as if Tech workers are going to take jobs at Chipotle. At least not yet. And if they do, the collapse in total consumption will be highly deflationary. Similar to what happened when laid off manufacturing workers took jobs at Home Depot. What we are witnessing is the last stage of the decimation of the middle class.

Now on to the casino...

Stories abound as to what caused the collapse of the FTX Ponzi scheme. Because what could go wrong? What these exchanges all have in common is that they issue their own proprietary Crypto currency which they use as the medium of exchange for all trades. The FTX coin (FTT) was one of the best performing cryptos of the past two years because FTX was laundering all client cash through their own currency in order to keep it artificially inflated. The other thing they were doing is what's called "burning Crypto", meaning destroying large amounts of their own currency float in order to keep it artificially scarce. Making it easier for speculators to manipulate it higher. Then they were taking this artificial wealth and they were squandering it on everything from penthouses and drugs to political bribes to ensure their scam stayed unregulated. 

And it worked great.  

But it was all doomed to collapse because the entire business model was not built upon creating value, it was predicated upon the greater fool theory. And so it was DOOMED to collapse. 

What's more interesting is that the wave pattern for FTX coin has been 90% correlated to the Nasdaq for most of 2022. Which proves that social mood is driving ALL markets now. 

For those who are not familiar with Elliot Wave Theory, it merely posits that wave patterns are the manifestation of investor emotion in markets - greed and fear. Much of the time wave patterns are not clear, particularly when markets are not trending. Other times, they are crystal clear. 

What is the most clear is when a market is declining and rallying in a three wave correction. This pattern is highly reliable because it indicates a waning level of speculative appetite and waning momentum.

Here we see FTX coin overlaid on top of the Nasdaq. FTX peaked ahead of the Nasdaq, but since then, every correction has been synchronized, with each correction weaker than the last. 

Until implosion.

Asking why FTX imploded, is like asking why Bernie Madoff imploded.

"The man who had to clean up the mess at Enron says the situation at FTX is even worse, describing what he calls a “complete failure” of corporate control"

Which gets us to the end of year bonus meltdown. This is normally the time of year when Wall Street does everything possible to keep markets levitated into early January. For obvious reasons. There are only a few weeks left in the year which can make or break their annual bonus. Historically betting on a market crash at this time of the year is a very bad bet. The seasonal rally tendency is strong. 

Be that as it may, December rate hikes are ALSO extremely rare in history. Only five in the past fifty years. Two of those rate hikes came in the past seven years, and they were BOTH disasters. In 2015, the global markets had been monkey hammered by the August China devaluation. So when Yellen raised rates .25% in December, the market crashed at the start of January. In 2018, global markets had been monkey hammered by Fed rate hikes, QT, and Trump's trade war with China. The rest of the world was much weaker than the U.S. UNTIL October when U.S. markets imploded as well. The U.S. market bounced weakly in November and then imploded in December. When Powell delivered a rate hike in December the wheels came off the bus. 

So it is that we find the Nasdaq has the same coiled spring pattern that failed late in 2021. Back then, Thanksgiving was the beginning of the pattern, whereas this year Thanksgiving appears to be the end of the pattern. 

Bank of America asserts that this rally is now running on glue fumes. To paraphrase this article, global stock inflows are the highest in eight months, marking a likely end to this latest bear market bounce:

 

As we see also, the oscillator is back in overbought territory and rolling over deja vu of prior rallies this year:

On the other end of the spectrum is the reflation trade, featuring financials, industrials, transports and other economic cyclicals. Financials do not like inverted yield curves, because it makes it impossible for banks to make money since they borrow short and lend long. Which doesn't make money when short-term rates are higher than long-term rates. 

Here we see another clear example of Elliot Wave correction, which happens to be distinctly reminiscent of the pandemic. 

 

In summary, risks have increased massively year over year. 

However, complacency has attended this entire decline, now featuring eight month high stock inflows. Here we see VIX 2nd derivative volatility at pre-pandemic lows. What's coming is an FTX style meltdown that will include ALL global risk assets imploding at the same time.

The Nasdaq now has the exact same wave pattern as an Enron-eclipsing Crypto Ponzi scheme. The bull thesis is that the exact same wave pattern that imploded FTX, is precursor to a new bull stock market. 

Anyone who believes that, deserves their fate. 

 

THE LIGHT AT THE END OF THE TUNNEL

Wall Street has weaponized denial against the stoned masses, and they wouldn't have it any other way. Everyone gets to invent their own ending.

For now...

Once again, the end of year lull is a con man's paradise. Ahead of the New Year reality check, Wall Street is free to futurecast whatever science fiction they want, unquestioned by CNBC, which is now competing with Disney+ for viewers. 

It's that time of the year when Wall Street issues their annual forecast for the coming year. Unfortunately, it's also that point in the cycle, when Wall Street's annually extrapolated forward earnings estimates have the veracity of a Magic 8 Ball. No surprise, Wall Street consensus calls for an INCREASE in profits during the coming year of roughly 5%. Yes, you read that right. Ed Yardeni is hitting the crack pipe even harder this year with a +9% forecast.

Here's what Wall Street consensus estimates "forgot" to include:

1) Fed over-tightening

2) Housing collapse

3) De-leveraging

4) Recession

In other words, there is no cycle risk embedded in these predictions. 

As a proposed antidote to this level of impending criminality, Zerohedge this week posited what they believe to be "The Most Bearish" prediction for 2023. I leave to the reader the pleasure of parsing Wall Street bull shit inter-laced with Zerohedge bull shit to obtain your own conclusion. Suffice to say, the "most bearish" prediction also omits all of the risks I mentioned above.  At worst it predicts 15% additional downside for stocks from this year's low and 11% downside for earnings from this year's earnings. 

Here is how that looks graphically for stocks:

What it all comes down to is that Wall Street predictions are ALWAYS linear extrapolated from one year to the next. They use spreadsheet models with assumption parameters and then they plug in whatever numbers they want, in order to reach their conclusion. What passes for serious investing based upon "fundamentals" are blind guesses at the unknown future. Because what else could they be, Nostradamus? And for most of the cycle those guesses are in the ballpark simply because during economic expansion, growth is linear.

Until we reach the end of the cycle. 

Below is what Wall Street's "worst case" scenario for earnings looks like from an historical point of view. It's barely even visible relative to the big jump in earnings post-pandemic. Meanwhile, a repeat of 2008 is not even slightly an option based upon current forecasts and positioning. And yet, we are contending with a CPI at 40 year high and the Fed is still tightening into a Tech wreck/housing collapse. During those two prior debacles, they were ALREADY easing at this point in decline. 

Which gets us to the topic of over-tightening. This week, Fed officials have been taking turns pounding markets lower after last week's "dovish" CPI print of 7.7%. Today it was James Bullard's turn to put the kibosh on the pivot/pause fantasy, going above and beyond the call of implosion:

"Bullard suggested that the rate may have to rise to a level between 5% and 7% in order to quash inflation, which is near a four-decade high"

Not even ONE dunce in the media has pointed out that debt levels have sky-rocketed over the past two years and interest rates have DOUBLED year over year, meanwhile, the Fed balance sheet hasn't changed year over year. Which means they are crushing the middle class to protect the Casino class.

It's history's biggest policy error without any question, taking place in broad daylight. 

Which gets us to recession risk which is currently obscured by the high CPI readings. In the 1970s recessions it took several months of recession BEFORE unemployment began to rise. That is typical inflationary labor hoarding behavior, when real wages are negative and the economy is running at maximum  end of cycle capacity. However, today's pundits always point to the strong jobs market as THE sign that the economy is doing well. This week's retail earnings are another widely ignored warning. 

As is the inversion of the yield curve, now at a 40 year high:

Same article from above, further down:

"On Wednesday, Esther George, president of the Kansas City Fed, said in an interview with the Wall Street Journal that a recession was likely given how rapidly the Fed has tightened credit.

“I have not in my 40 years with the Fed seen a time of this kind of tightening that you didn’t get some painful outcomes” she said.

In summary, who do you believe?

WORSE THAN EXPECTED

Climate inaction is merely another widely ignored warning for a society in latent death spiral. What they need to learn the hard way is that talk is cheap, until all of the hot air explodes with extreme dislocation...

This week is COP 27, which happens to mark the 30th year of UN climate conferences leading to absolutely nowhere. Which is more cynical, to not believe in man made environmental disaster, or to believe that pretending to care will fix the problem? This climate charade is just another warning for a society in latent death spiral, with not even the slightest will or ability to change its ways. The pandemic was the best test for climate activism we will ever get - because it caused the largest carbon collapse in world history. No flights to anywhere. No commuting. A virtual economy. The price of crude oil went NEGATIVE for the first time in history. Green energy/EV investment sky-rocketed. Fossil fuels were divested. At the apex of the bubble, Tesla had a larger market cap than the S&P Energy sector. 

However, upon exiting the pandemic we now learn that all of the predictions for climate apocalypse have been moved up in time from 50 years to next week. More drought, more wildfires, more mega hurricanes, and more empty lakes and rivers. 

In other words, it's far too late to pretend to rearrange the deck chairs on the Titanic. What we don't know, is whether or not global economic collapse will "fix" climate change after the fact. 

But fortunately we are about to find out...

Who says I'm not an optimist?

Now back to the Casino where all manner of economic risks are likewise being ignored:

As we approach the end of the year, investor cries for a pivot keep growing louder. Zerohedge has been predicting imminent pivot for months. Now Cramer is on the pivot bandwagon as well. Recall, it was only a few months ago that ALL pundits were pounding the table that inflation is NOT transitory and the Fed was far behind the curve. It turns out the Fed actually believed them and they are now in full Volcker mode, meaning "keeping at it", as Volcker did for two years straight.

“Pausing (Pivot) is off the table right now. It’s not even part of the discussion”

What it comes down to is the fact that today's pundits are following the POST-2008 playbook, whereas the Fed is following the PRE-2008 playbook. Meaning the Fed won't pivot UNTIL investors panic. And ironically, Team Pivot is preventing them from doing so. All of which is a tale of extreme moral hazard. Gamblers were bailed out for fourteen years straight during economic expansion and bull market. Now, when the economy is imploding, there is no bailout forthcoming.

Which is why bulls are doomed to explode. 

The primary assumption bullish pundits are making is that Tech stocks will resume their bull market when the deflation trade returns. However, below the Y2K experience shows the Fed pivot effect was very short-lived. 

Nevertheless, today's investors are eagerly waiting for the melt-up to begin. 

The other major assumption that today's bullish forecasters are making is that there will be NO deleveraging caused by Fed tightening. And yet we also see above that in 2007 the Fed pivot  preceded the housing bubble implosion. 

Which makes yesterday's headline very timely. The largest jump in household debt since 2008:

 

In other words, despite massive interest rate increases, household debt is STILL increasing. Which means that as the various bubbles collapse, households will be stuck with massively inflated liabilities. Which, will be highly deflationary.

In summary, the recent collapse of the FTX Crypto Ponzi scheme was merely a warning for what is coming. The CEO claims he had no idea how much leverage had accumulated in customer accounts. So far, there have been NO arrests. Why? Because what used to be considered corruption is now merely accepted as fraud-as-usual. Over the course of the past several decades, this society has systematically de-regulated criminality.  

The same can be said for the global economy - central banks have no clue how much leverage exists in all of its derivative forms. However, they are going to tighten until we find out who has been misallocating free capital. Or as Warren Buffett says:

"When the tide goes out, we discover who has been swimming naked".  

And when that happens, trapped bulls who ignored a decade of warnings are going to need a time machine.

To go back to when they still had a chance to change their ways. 

Before it was way too late. 

PIVOT IS JUST A CRASH AWAY

Today's bulls have FOMC: Fear of Missing Crash...

For the purposes of this discussion I will be referring to the chart below. Best case scenario, bulls stage a short-covering rally each time they implode closer to full bailout. Worst case scenario, they panic and implode straight down to the bottom. 

Either way, until they panic, there will be no Fed bailout. 

What bulls call the impending bailout, I call the impending clusterfuck. 

What we got this week was not a pivot on rates, it was an impending taper on rates. The current Fed funds rate is 3.75% and it's expected to increase .5% in December and another .5% by March which is when the Fed would pivot to neutral. Which means that bulls are front-running the Fed by a full four months on the pivot, which makes this rally a taper rally.

This week, Wharton Professor Jeremy Siegel was saying that if the Fed pivots in December then this rally is for real. 

Siegel:

Inflation Is Over. It's Rally Time

"There's still a chance we can avoid a hard landing if the Fed pivots in December"

Today (Sunday), the Fed came out and said they are not planning to pivot in December. Why? Because every time risk assets rally, they are forced to move back their pivot in terms of timing and magnitude of rate hikes:

"The U.S. Federal Reserve may consider slowing the pace of rate increases at its next meeting but that should not be seen as a "softening" in its commitment to lower inflation, Federal Reserve Gov. Christopher Waller said on Sunday"

Markets should now pay attention to the "endpoint" of rate increases, not the pace of each move, and that endpoint is likely still "a ways off"

What no bullish pundit is considering right now is what will happen when in fact the Fed does pivot from hiking to neutral which will only come amid MASSIVE market turmoil. They are all using the 2018 playbook of massive face ripping rally. However, what they ignore is that the inflation trade has been the dominant theme of 2022. These are the most successful trades of the year. I am of course referring to value stocks, commodity trades, dollar carry trades, and long stock short bond trades. Picture what will happen when all of those trades implode. There will be no leadership in the market. UNLESS one believes that Tech will exit its bear market and lead the market higher once again. 

What today's pundits don't seem to know is that overvalued Tech stocks are now dead money, and will be dead money for years to come. There hasn't been a single bubble in history that popped and then immediately resumed its ascent. After Y2K, it took 17 years for the Nasdaq to make a new high.

Still, investors are in no way giving up on the Tech trade, as recent unprecedented VXN flash crashes have proven:

 

 

In addition, when U.S. bond yields fall then the carry trades will unwind and the vaunted "TINA" trade will implode. A process that has already started as we see below, the $USDJPY having it's biggest collapse since the START of the pandemic. This means that the hot money that flooded the U.S. due to hawkish Fed policy, is already leaving the U.S. ahead of the pivot. Meanwhile, bullish gamblers are piling into the casino ahead of the pivot. 

Next, we talk about the value trades which are led by the Energy sector. This sector already imploded back in June and has enjoyed a three wave rally. Including Exxon and Chevron, the XLE is at new all time highs. However, on an equal weight basis the Energy sector is three wave corrective. What this chart shows us is that the 'b' wave retraced all of the 'a' wave gains, which means it's a weak rally. Confirmed by the fact that NYSE lows spiked each time Energy came down to the origin of the rally. 

To confirm this theory, we look at Warren Buffett's Berkshire Hathaway conglomerate which is considered the best deep value fund in the market. It's heavily weighted with bank stocks and other cyclicals, and of course a heavy allocation to Apple. 

Look up to the chart above, and look below. They are the same wave pattern on the same timeline only Berkshire is an even weaker version of the Energy trade, the stock has gone nowhere for six months.

All of which means that social mood peaked earlier in the year and is now making a new lower high in speculative appetite.  

In summary, for fourteen years straight, central banks bailed out stock market bulls. Now they are saying you are on your own. Which leaves bulls praying for a crash and a recession, so they get their long awaited pivot. However, the ongoing delay in capitulation means that by the time it arrives it will be far too late for "soft landing". And what will the Wharton Professor say?

Oh well, I was wrong. It wasn't the beginning of a new bull market, it was the end of the cycle, and at the end of the cycle, low rates come with a caveat: careful what you wish for.

DOUBLED DOWN ON COLLAPSE

The one thing this market has going for it in spades is mandatory delusion. The current level of delusion is indicative of imminent financial and mental breakdown...

The mid-term elections came and went as expected. Impending gridlock is widely considered to be bullish for stocks, which is the theory I debunked in my last blog post. Bulls are now citing the exact same historical market statistics they data mined back in 2018 to rationalize a year-end rally. The latest CPI shows that inflation is beginning to roll over, albeit very slowly. Back in 2018, the CPI was 1.7%, today it's 7.7%. Fed futures predict there will be another full 1% of rate hikes between now and March. All of which makes this set-up far more lethal than the one that imploded markets back in 2018. Nevertheless, gamblers are wasting no time going ALL IN on expectations of a big year-end rally. Today is the biggest rally since December 2018 which took place AFTER the Fed pivoted. In other words, bulls are doubling down on collapse.

The operating theory behind a pivot rally is that once the Fed stops raising rates, gamblers have a period of time to enjoy one last melt-up rally before the wheels come off the bus due to rate hikes. It never enters their minds that the melt-up already occurred and now they are sitting in a bull trap.

The year-end melt-up was a bust in both 2007 and 2008 but never mind those inconvenient facts. 

Another risk factor that raised its head this week is the renewed collapse of the Crypto Ponzi sector. Recall that Bitcoin had been seeing the lowest volatility of the year recently, then it headfake rallied last week, prior to imploding lower this week. Something called an "FTX" had been buying up all of the other collapsed Crypto Ponzi schemes earlier this year when it too caught the collapse contagion. It turns out that combining multiple Ponzi schemes into one big one does not diversify risk. Echoes of the  lesson NOT learned during the subprime disaster circa 2007, when Goldman Sachs would package up toxic subprime mortgages from all corners of the country and package them as AAA rated securities. No one on Wall Street thought it was a bad idea. Bear in mind, today's Crypto-loving Wall Street analysts were all playing Halo in the 8th grade back in 2007.

So how could they know that all of this is 100% idiotic? 

All of which merely leaves another technical stock rally now running on glue fumes. Make no mistake that hedge funds are no longer hedged and therefore the put wall that has held up this market up until this point in the year is now substantially non-existent.

A necessary and sufficient condition for final collapse. 

Option skew is the lowest since 2008:

In summary, this is either a year-end Wall Street bonus rally, or the biggest bull trap in history. In technical terms, the quality of this rally is dog shit - my own proprietary definition. This is merely the latest short-covering rally now running on glue fumes. Led of course by the Nasdaq which is on the way to becoming totally bidless. This latest overbought notion of an impending Fed pivot being once again pure fantasy.

One year ago the Fed warned investors that risky assets were set to implode. They specifically mentioned Crypto Ponzi schemes. So trapped gamblers have ignored their warnings for a full year now.

Nov. 8th, 2021:

“Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate"

"The central bank also said stablecoins pose an emerging threat, that fragility in China’s commercial real-estate sector could spread to the U.S. if it deteriorated dramatically, and that “difficult-to-predict” volatility similar to this year’s meme-stock frenzy could become more frequent as social media increasingly influences trading"

THE END OF THE INFLATION TRADE

Impending government gridlock will very likely attend deflationary ice age...

First off, the Wall Street view per Zerohedge is that a "Red Wave" would lead to fiscal reduction which would be deflationary. However, they also believe this would be good for stocks. Sadly, this fact-challenged view ignores all recent history. In the most recent years, the market has performed best when both monetary AND fiscal stimulus were the strongest i.e. 2020 and 2021. Zerohedge admits that deflationary gridlock would lead to a Treasury rally i.e. yield collapse. However, they don't acknowledge that the Tech/deflation trade is already imploding deja vu of Y2K. Which is precisely the impending rotation failure I discussed in my last blog post.

Which is where this all gets interesting. Consider this factoid:

"In 19 midterm election years since 1946, stocks have advanced from late October through year-end every single time except 2018"

2018 happens to be the ONLY year in market history that featured rate hikes, quantitative tightening, and mid-terms - before this year. And leave aside collapsing Tech bubble, collapsing housing bubble, high inflation, and EM currency collapse because no year in history had ALL of today's risks. In other words, these two mid-terms have more in common than any of the past mid-terms. And yet according to Zerohedge, 2018 is the year to ignore. You see, the formula for bulls is to use historical statistics that are blindly ignorant of all correlated risks by assuming that all years are statistically independent. Because if risk variables are NOT independent, then data mining history would be totally useless. Dependent variables do not reduce risk, they compound risk. In other words this blind prediction strategy is a formula for  sounding smart while ignoring ALL risk.

Following Zerohedge logic, we are on the verge of a big Tech/growth rally:  

The other deflation trades of course are recession stocks. And those are played out as well. Something about a one year bond yielding 4.5% will do that. 

THESE are the safe havens:

 

That covers the market.  

But now more interestingly, consider the inflation trade in particular. When Trump was President the (fossil) energy sector lagged the market massively while the green energy sector sky-rocketed. But when Biden was president AND had Democratic control over House and Senate, the fossil fuel sector sky-rocketed and green energy collapsed. 

Why? Several reasons. First obviously the pandemic. Secondly however, Trump endured the fossil fuel divestment movement which saw massive pension funds and endowments dumping ALL fossil energy stocks to buy green energy stocks. When Biden got elected, the vaccine was rolled out, the economy re-opened, the green energy trade was massively overvalued, and therefore fossil fuel stocks led the market higher for the past two years. 

All of which can be clearly seen in the Energy sector chart below. This shows that Energy stocks massively underperformed the broader market long before the pandemic. And now they are the ONLY sector making new highs. 

Clean energy was bid way before the pandemic and imploded soon after Biden was elected. 

You don't have to be a genius to figure any of this out, but you DO have to be observant of history. In addition, markets are far more intelligent than the typical pundit and they usually react the opposite of what conventional logic would suggest. For example, consider all of the people crowding into Energy stocks AHEAD of a possible red sweep. 

The kiss of death:

The darker side of gridlock is not just impending deflation, it's the fact that gridlock will amplify whatever economic chaos arises from the impending monetary meltdown. Why? Because gridlock will prevent the type of safety net programs which avoided full scale economic depression during the pandemic. 

How long until Zerohedge figures out that after the mid-terms there will be no chance of a Wall Street bailout. Because without combined monetary and fiscal stimulus there will be no middle class bailout.

In other words, this election is the final step towards setting the stage for extreme market and societal acrimony on a scale that no one on Wall Street predicts. 

Because let's face it, no one predicts their own collapse. 

 

THE EFFICIENT MELTDOWN HYPOTHESIS

It's bulls versus the Fed. Get some popcorn and stand back...

On first glance this past week's FOMC statement appeared dovish, leading to a manic melt-up algo rally. However, at the press conference Powell threw cold water on the rally when he said there is more work to be done on rate hikes. That's all it took to implode the most recent "Pivot" rally. The remainder of the week was highly volatile due to options unwind and the jobs report which was hotter than expected but not as bad as feared.

It's clear these pivot rallies have been making the Fed's job of bringing down inflation, that much harder. As a result, these rallies keep pushing out rate hikes, so it's Powell's job to come in every FOMC meeting and pound markets back down. The Fed has finally realized that inflated asset prices are driving  economic inflation. While it's true that options algos have been pounding volatility down, at the same time the Fed keeps pounding stocks down.  Which means they are on a collision course, and I suggest the Fed will win.

The Fed is not going to stop raising rates when they can see that their Financial stress index keeps going down with every pivot rally:

In addition, we learned this quarter that Tech earnings are imploding. Which means that the entire growth/deflation trade is now going bidless, which happens to also be the pivot trade. Therefore if/when the Fed does pivot, there will be no leadership in the market. Putting it all together and the Fed will tighten until they break markets, and then everyone will be shocked at how quickly this house of cards explodes.

We are seeing very unusual action in the Nasdaq VIX market lately. There have been seven flash crashes in the Nasdaq VIX in the past twenty days. And only 18 total flash crashes in the past 27 years.

In summary, the Fed is going to break some shit, and bulls have conflated that meltdown moment with their long awaited bailout. 

The inevitable consequence of being told for 14 years straight that bad news is good news.