FOMC: FEAR OF MISSING CRASH

In 2023, bulls are trapped between the Scylla and Charybdis of Monetary and Fiscal dumb and dumber. It's a good thing they have artificial intelligence on their side...

The so-called "x-date" for U.S. default is now somewhere in June or July. No one knows for certain. Suffice to say, it's close enough to start garnering the attention of *some* markets. As of last week, the bond market had priced in a six sigma premium on the 3 month t-bill. However, that premium dropped when the House passed their smoke and mirrors spending bill:

WSJ: Democrats Reject House Spending Bill 

As we see below, the bond market is far more worried than it was in 2011.

The problem is that this debt ceiling fight has now become all about the 2024 election. Biden this past week said he is running for re-election. Therefore House Republicans see this as their best chance to implode his presidency. Neither side is willing to compromise because both sides are convinced they MUST "win" this battle or admit failure to their own base of morons. This is all politics now. 

Which means there will be no winners. Bulls are now hostage to the extant Idiocracy. This house of cards won't withstand a repeat of 2011 when stocks imploded -20% upon a deal being reached.

Here we see the gap between the Treasury VIX (Move index) and the S&P 500 VIX is the largest since 2008:

Also this week, bank explosion re-started after a six week hiatus. The issue for banks is that the pandemic flooded them with unprecedented deposits and they invested those deposits into long-term bonds, creating history's largest duration mismatch. Next, the Fed panic raised interest rates at the fastest pace in history, causing unprecedented bond losses. 

Now, deposits are leaving banks for higher yields, because money market funds are yielding 10x higher than typical deposit accounts. 

It's looking more and more likely that First Republic will be the next shoe to drop and very likely the first bank NOT to receive a FULL bailout. Meaning that the standard FDIC depositor limit of $250k per account would apply. 

Should that happen, we would very likely see mass panic across the ~$7 trillion of uninsured deposits still sitting in banks.

That's when that middle pane black line would meet the blue dotted line and keep on truckin'.

You DON'T have to be a genius to figure this all out. But you DO have to be able to fog a mirror.

All of which gets us back to the much-loved 1930s monetary "pause" rally. 

Since bank stocks imploded in early March, Tech domination has reached three decade breadth extremes.

"The S&P 500 at a forward price-to-earnings ratio of 19x would be a high hurdle even at lower rates let alone one where the growth outlook is diminishing, monetary policy is tight with risk-free yielding about 5 per cent, and event risks are increasingly disconnected from VIX"

Overvaluation, profit recession, monetary tightening, unprecedented event risk. 

Sound familiar? It's the bull case in a nutshell.

Tech over-weight has been further stretched this week by Tech earnings which have come in "better than feared". Which is the new Wall Street mantra for sucking dumb money into the casino.

Because, let's face it, that's where it belongs.

DENIAL IS DEFLATIONARY

Right around Earth Day each year my rage peaks. It's times like now when I have to remind myself that living in a denialistic Idiocracy has environmental advantages...

Case in point, the pandemic caused the largest carbon collapse in modern history. Oil demand dropped to a 25 year low overnight. Next, the pandemic deleveraging phase will re-collapse oil demand back down to the pandemic lows. In other words, we've achieved peak oil and we didn't even know it. It all happened while our leaders were flying around to climate conferences making promises they had no intention of keeping. 

All of this happened because the consumption Borg panicked over what turned out to be a relatively innocuous virus. There was no point during the pandemic when COVID was the leading cause of death. In 2020 and 2021, McDonald's killed more people than COVID. You know what I mean, shit lifestyle:

CDC:

 

Meanwhile, the FULL cost of the pandemic is still spiraling inexorably larger like a sky-rocketing medical bill for an uninsured geezer on course to supernova bankruptcy.

As we see above, oil demand never recovered after the pandemic, because the economy was virtualized by Cloud Technology. Cloud technology, AI - it's all very deflationary because it allows knowledge workers to be replaced by technology. In other words, the pandemic completed the last stage of the full scale commodification of humanity. 

During the pandemic, major corporations allowed office workers to work from home. Many companies such as Facebook encouraged workers to move out of state. Two years later and they are now instituting mass layoffs on an industrial scale. Companies are now giving employees ultimatums to return to the office or face layoff. What used to be an employee benefit is now an employee liability. And it's so much easier to lay off people when they are not in the office. Just send them an email informing them that they are terminated.

Enter earnings recession - meaning two quarters in a row of earning decline. Today's S&P companies are "beating" the quarter by having an aggregate -6% year over year decline in earnings. Wall Street will demand fresh layoffs in the new quarter or the stocks will get punished.

Here we see Challenger layoffs on a five month moving average. The highest since 2008. Note that I suppressed March 2020 due to the unprecedented pandemic mass layoff.

Another related impact of the pandemic was the downsizing of office space caused by all of this virtual working. Companies are finding that their post-pandemic office space requirements are a fraction of what they were pre-pandemic. Enter another cost cutting opportunity.

 

Which gets us to the fiscal clusterfuck, which is also deflationary.

Remember this guy Kevin McCarthy, the House Speaker who got voted down by his own party multiple times back in January? Well it turns out HE has to get Republicans and Democrats on board with a debt deal to avoid U.S. default within the next month.

What could go wrong?

"The clown car that has been Rep. Kevin McCarthy’s speakership spluttered to a halting start over 15 long ballots in January and hasn’t had a second of a smooth ride since"

Goldman Sachs economists echoed earlier warnings from Treasury Secretary Janet Yellen that default could occur as soon as the first half of June, due to “weak tax collections.”

Tick tock.

Put it all together and in the coming weeks, we have a clown car of incompetence heading over a fiscal cliff.

We have an earnings recession in which the most-overowned and over-valued sector (Tech) is facing the worst earnings decline of any sector.

And another Fed rate hike. 

All signs point to a well deserved hard landing.

RALLY INTO RECESSION

The entire bull case now hinges on recession and just-in-time bailout...

We have now officially entered the age of Artificial Intelligence. Why that's good is not for me to say. 

Strange days indeed. Normally it's bears who are waiting for recession, however this time around it's bulls. This lethal turn of events became inevitable when Fed stimulus became the ONLY factor that matters to stock prices.

If you don't believe me, here we see that the entire rally since the October low took place amid falling bond yields. We also see what happened in March when yields flared up again. Bank run.

So it is that stocks are happily rallying into a latent depression deja vu of 1930.

 

On the monetary policy side, things get even more dire near-term given the ~85% probability of another rate hike in two weeks time. 

Here we can compare what happened in late 2018 when the Fed blew up banks versus now. Back then, they paused and bank stocks rallied back above where they were pre-rate hike. Whereas now, six weeks later, regional banks have gone nowhere.

Another rate hike seems like a bad idea given that 2018 is the ONLY example when the Fed pulled off a soft landing. And now they have thrown out that playbook. 

Then there is the looming fiscal fiasco. So far, this year is turning out to be similar to 2011. Back then, the incoming GOP House majority was hellbent on imploding the Obama budget. Funding ran out in May. This time, funding already ran out in January. The Treasury is already resorting to "extraordinary measures" to keep the budget from imploding. 

As we see below, in 2011 the U.S. never actually defaulted on the debt, but GOP politicians dicked around until markets went RISK OFF. After that, the deal was ignored. Similar to October 2008 when the TARP bailout passed after it failed the first time. The market imploded. Similar to March 2020 when the Fed cut rates and restarted QE during the incipient meltdown. The S&P futures went limit down. 

You get the idea. These fucking morons are wasting time while bulls get more optimistic by the moment. 

 

In summary, party on Garth.

BTFP

The pause rally which began last October just passed six months. Which is the same length of time the Dow rallied in 1930 from the October 1929 crash low. Then the wheels came off the bus for good...

This has been the pause rally. Never mind that there was no rate pause - it's imaginary. Like everything else in Disney World.

An unnamed bull claimed recently that more money was lost trying to avoid bear markets than from the bear market itself. Tell that to those who hung on after 1929. It took 25 years to get back to breakeven. Not everyone has that kind of time. 

Bulls continually make the most optimistic assumptions to arrive at their fairy tale conclusions. Wall Street is currently predicting a -4% earnings recession in 2023. 

Below we see that in 11 out of 11 recessions since 1950, corporate profits as a share of GDP fell back below 6%. The pandemic was the twelfth recession, the shortest recession in history, and the only time profits grew during the recession. Bulls are now betting it will happen twice in a row.

If they are wrong, they have -40% downside. Minimum. 

Corporate profit / GDP (blue horizontal line is 6%):

We are in a demographic super bubble. The pandemic arrived at the worst time possible for Boomer retirement. Twenty million mass layoffs in March 2020 - aka. a decade worth of jobs - forced two million Boomers to retire early. Subsequently, the economy has been beset with inflation especially in the low paying service sector. The Fed has made almost ZERO progress in bringing down service-side inflation. Which means they will continue raising rates until something else breaks. 

Fed policy throughout this debacle has been highly regressive. Which means that it has been good for the wealthy and very bad for everyone else. They have kept their balance sheet at double the pre-pandemic level while raising rates TRIPLE the pre-pandemic level. The middle class is about to implode, but the wealthy are totally clueless. In 2023, both fiscal and monetary policy will be highly restrictive. Fiscal policy will be constrained by the impending debt ceiling crisis which hits no later than July.

Which gets us back to the casino.

The pause rally is now six months old. During this time, markets have fully discounted a rate pause. What they haven't discounted is a recession. 

If the Fed eases it will because of recession. As we see below, when rates came down, stocks imploded. 

  

 

Many bulls are saying that October was the low because sentiment reached an extreme. However, what they are ignoring is the fact that stocks remained historically overvalued relative to Treasury bonds. 

Below is the equity risk premium which measures the S&P yield relative to the 10 year bond yield. In 2008 and 2020, the ERP soared. In October 2022 the ERP hit a cycle low. 

Entering earnings season, bulls are counting on RECORD corporate stock buybacks to paper over the incipient collapse in corporate earnings. We are on MAXIMUM smoke and mirrors. 

One must ask the obvious question, if corporate buybacks are  so high then why are the stocks with the largest buybacks imploding?

In summary, volatility has collapsed back to where it was at the all time high. 

Which means, BTFP.

A BUBBLE IN COMPLACENCY

What we are witnessing in real-time is monetary policy failure. The full cost of which will be revealed during the deflationary phase...

There has never been a rate hiking cycle without a recession and there has never been a recession without a significant rise in unemployment. Therefore, today's bullish pundits are of the mind that  for the first time history, we will have both - no recession and no significant unemployment.

Unemployment rate (red)

Fed funds rate (green)

The two most recent cycle downturns were the Tech bubble in Y2K and the housing bubble in 2008. This pandemic hangover bubble features both six sigma Tech overvaluation and RECORD housing overvaluation yet pundits don't predict a meaningful correction in either market. What we are witnessing is 15 years of central bank moral hazard unwinding the hard way. Amid abject denial.

Here we see homebuilder stocks inversely correlated to homes sold, for the first time in history. Which is why the ratio of homebuilder stocks to homes sold is at a record high (bottom pane).

In Tech-land, delusion is likewise rampant. The best performing sector so far in 2023 is about to see the largest earnings decline of any sector:

"This year’s rally in the shares of the biggest technology companies is the best thing going for bulls. It’s about to run into an earnings season that’s expected to deliver the biggest profit drop for the tech sector in more than a decade."

The (15%) projected drop for tech earnings in the first quarter would be the biggest since 2009. The consensus has been consistently weakening: Six months ago, analysts in aggregate were expecting that tech-sector earnings would edge up by 1%"

Q4 2022 saw the biggest decline in Tech spending in U.S. history:

At the beginning of a Tech bubble, the stocks hiring the fastest perform the best. When the bubble collapses, the stocks laying off the fastest perform the best. 

"Tech already has cut 5% more than for all of 2022, according to the report, and is on pace to eclipse 2001, the worst year ever amid the dot-com bust"

We saw all this before of course in Y2K. Back then it took 17 years for the Tech sector to overcome the bubble high. This time, gamblers are expecting new highs any day now.

We just got "better than expected" CPI, but the core CPI re-accelerated. There has never been a time when the Fed paused rate hikes with the core CPI above the Fed rate. So another rate hike is a lock for May.

The Fed has raised rates 4.75% but the core CPI has only come down 1%. Which means we are witnessing monetary policy failure for the first time in history:

Warren Buffett says more bank failures are inevitable, but ALL deposits are safe. Which is totally delusional. 

Article 1:

"Investing legend Warren Buffett believes there could be more bank failures down the road, but depositors should not ever be worried"

Article 2:

"Buffett said the government would likely step in to backstop all depositors in all U.S. banks if that was ever necessary, though he did note that would require Congressional approval"

Buffett, 92, said he so confident that U.S. depositors are safe that he would put a million dollars of his own money in a bank"

A multi-billionaire doesn't even have $1 million of his own money in a bank, but he says it's 100% safe.

Because if it's not, HE is not getting bailed out this time. 

SYSTEMIC RISK EXPLOSION

Markets are priced for 100% bailout. Anything less than that and they will spontaneously explode...

Allow me to recap the past month:

Four weeks ago, Powell announced that the Fed was re-accelerating their rate hikes. By the end of that same week, the U.S. had suffered the second (Silicon Valley Bank) and third (Signature Bank) largest bank failures in U.S. history. 

Subsequently, the Fed implemented their "BTFP" asset repurchase program whereby banks temporarily trade their unrealized loss encumbered assets in exchange for fresh Fed loans at 4.75%. Unfortunately, the average long bond exchanged in these programs is bearing 1.75% so the BTFP program allows banks to go out of business slowly, instead of instantaneously if they marked to market. 

Meanwhile, Congress held a hearing into the collapse of these banks and thoroughly castigated the FDIC for bailing out wealthy depositors using the "Systemic Risk Exception" (SRE). Which is moronic because the entire catalyst for the bank run was wealthy depositors assuming that they can't rely upon the SRE for future bailout. Congress has now conveniently confirmed that assumption. 

Therefore, imagine if you will that next some smaller banks implode and the FDIC decides NOT to implement the SRE and instead allows wealthy depositors to get wiped out. When that happens, we will witness mass bank failure as ~$8 trillion of uninsured deposits flees small banks and heads for money market and t-bill funds. 

It's the same set of events that  led up to Lehman. There had been multiple failures and multiple bailouts followed by a bailout-weary Fed finally deciding that Lehman was NOT too big to fail. So markets exploded. Because they were priced for  100% bailout.

All of which explains why after four weeks of BFTP, the small banks are at new lows. We are one non-bailout away from wholesale meltdown. So what to do?

Load up on risk.

"March recorded the worst U.S. bank failures since the 2008 crisis, but that did not stop some investors from snapping up battered financial stocks"

The other development over the past four weeks since Silicon Valley Bank exploded, is that the economy has fallen off a cliff.

Why? Because banks have tightened lending standards due to the new tighter regulatory and funding environment. Which means that the IPO equity market AND the bank lending market are both shutdown at the end of the cycle.

All of which means that the end of cycle stock to bond rotation has now begun. The exact same pundits who didn't predict the bank run, also did not predict the resulting slowdown in the economy. Which is why t-bond shorts are now getting duly monkey hammered. 

Recession is a lock for 2023. And now even the majority of pundits who've been saying it wouldn't happen are finally realizing they were wrong. All because they thought that Fed tightening at the fastest rate in 40 years wouldn't lead to a tightening of credit:

“We have argued for some time that the economy would avoid recession this year," said Ian Shepherdson, chief economist and Kiernan Clancy, senior U.S. economist at Pantheon Macroeconomics. "But that view now looks untenable, given our expectation of a sharp tightening of credit"

The last market narrative that is now imploding is that Tech stocks are safe havens from deflation. During regular slow-growth part of the cycle that is certainly true. However, during the end of the cycle deep recession phase, that is false. 

Below, fittingly we see that semiconductors are imploding on the right shoulder amid the highest volume since March 2021 aka. the left shoulder. Consider that volume is already the highest in two years and it's only Wednesday in a holiday shortened week. 

In summary, the systemic risk explosion has been slowly coalescing for two years. However, this society has an extreme case of survivor bias and is highly adept at ignoring those who are already under the bus. 

Third World myopia. 

APRIL'S FOOLS

"What a fool believes he sees, no wise man has the power to reason away. What seems to be, is always better than nothing"

In my last blog post I discussed the epic divergence that has opened up between mega cap Tech stocks and the rest of the market. In the meantime, that divergence has only grown larger. 

As we close out the first quarter we learn that a mere eight mega cap Tech stocks account for all of the S&P's year-to-date gains:

What's even crazier is that the equal weight Nasdaq 100 peaked back in February. Of the eight stocks listed above (AAPL, MSFT, GOOGL, META, AMZN, NFLX, TSLA, NVDA), only three have exceeded their February highs: Apple, Microsoft, and Nvidia.

Here we see the equal weight Nasdaq 100 has yet to exceed the February high. In addition, new Nasdaq highs peaked two years ago and had a major divergence at the all time high in November 2021. Now we are seeing another major divergence on this right shoulder:

 

Zooming out to the weekly view. We see that this is merely a VERY weak correction in a bear market. Compare the rally off the low in March 2020 to this one. That was a straight shot higher. This has been a sideways to down choppy rally to nowhere.

Do you remember the high last August ('a')? We were told that the Nasdaq is in a new bull market. That was the end of the rally.

Now, we hear the exact same thing all over again, at a lower high: 

The Nasdaq Just Entered A Bull Market  

 

That's the good news.

Unlike Tech stocks, banks have been unable to manage any sort of meaningful rally. Compare 2008's short-covering rally to this one. In addition, we see via the VIX there is no sign of fear in this market.

Belief in "just-in-time" bailout is total. Bulls now believe that the Fed can implode markets and rescue markets before they implode. This is the belief of the day. 

 

As I have said many times, bulls are the reason the Fed must keep tightening. On this rally, once again the high yield spread has declined signaling an EASING of financial conditions in financial markets. The real economy is a whole other story.

History informs us that the Fed will reverse when the S&P is -20% lower from this level. And by that time, it will be far too late for just-in-time bailout. 

This week, the most famous bear in modern history, Mr. Big Short Michael Burry inexplicably capitulated. He claims that he was wrong to say "Sell" back in February at the market's rebound high.

Bulls were ebullient. 

But, it's pretty clear that he too has been suckered by this latest bear market rally. 

Mark this date. 

 

In summary, fittingly in a denialistic Idiocracy, the bullish hypothesis and the bearish hypothesis are the exact same now. Financial dislocation will force the Fed to reduce rates sooner than expected. However, what bulls seem to forget is that back in 2008, when the Fed cut rates, markets collapsed.

All of which makes this, the Big Long:

Any questions?

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