NO PAIN. NO GAIN

Some developments have taken place since my last blog post, so here is an update...

In my last blog post (early Thursday), lawmakers were going home for the long weekend with a presumed default date of June 1st. Under those conditions, it appeared unlikely that a default could be avoided. Since that time, Yellen moved the default date back to Monday June 5th. And of course Biden/McCarthy just reached a debt deal "in principle". All of which puts the 2011 scenario back on the table, meaning a passed debt deal arriving just ahead of the default date.

Here is how that would look overlaid on today's chart:

The deal would lead to a sell the news selloff early this coming week. Then, a short-covering rally ahead of the House/Senate vote. Followed by a sell the news crash. Of course if the deal doesn't pass, then markets would explode. 

A couple of other things happened since Thursday, both of which are related. The Tech trade went parabolic due to the Nvidia AI blowout. The numbers were very impressive but somehow those Nvidia-specific numbers managed to levitate stocks that have been seeing declining earnings in the most recent quarter. As I showed on Twitter, semiconductor stocks are now four sigma overbought against the 50 day moving average which is a record. And Tech stocks overall are 3 sigma overbought, which is the most since Y2K.

2023 has been the year of the Fed pause rally which has benefited the Tech sector more than any other:

Which is interesting because just as the debt deal came into focus over the last two trading days, rate hike odds for June sky-rocketed. Now currently 65%. Friday's PCE inflation report showed that inflation is NOT coming down as quickly as expected.

"The Personal Consumption Expenditures price index rose 4.4% for the 12 months ended in April, up from a 4.2% increase seen in March"

The Fed is going to view a debt deal as market positive therefore they will be emboldened to raise rates again in June. Which means the Tech rally is OVER. 

 

IF a debt deal is passed then there will be a tsunami of new debt issuance hitting the market at the same time the Fed is raising rates:

"This glut could cause problems at an already dicey juncture for markets"

Liquidity stresses for regional banks linger on, as suggested by their continued reliance on the Bank Term Lending Facility (BTFP)"

This was the level of t-bill rates that exploded banks back in March. But then rates backed down ahead of the debt ceiling deal, but are rising again:

What happens this coming week will depend a lot upon what happens in the rest of the world. Monday/Tuesday in Asia and Europe will set the tone for Tuesday's open in the U.S. Best case for bulls, an early week selloff leads to short-covering later in the week. Which as we see above, would be their last chance to get out.

Worst case, this is already over and bulls went ALL IN Tech stocks into an incipient global meltdown. 

Yes again. 

FLIRTING WITH DISASTER

We are standing at the cusp of global meltdown and investors have convinced each other that the most crowded trade - Mega Cap Tech - which is going late stage parabolic, is the safe haven.

Full credit to artificial intelligence.

Today's bullish pundits have gone full Tom Lee of Fundstrat. They will say anything possible to keep the sheeple from bolting. The latest Zerohedge hypothesis is that hedge funds have capitulated to "buy in" the melt-up but retail is bailing so that means the bull market is just getting started. Sadly, it means quite the opposite:

Bloomberg: Day Traders Lose $358,000 per day gambling on "0 dated" options. 

Retail investors are not "capitulating", they are getting wiped off the map by their newfound 0 date gambling addiction. Meanwhile, hedge funds ARE capitulating and otherwise covering all shorts ahead of an imminent debt default.

Is this a smart idea? Probably not. But they tried the same thing ahead of the pandemic as well:

Speaking of default, the House of Representatives just adjourned for the holiday with no prospect of a debt deal:

"House lawmakers are leaving Washington for the long holiday weekend Thursday afternoon — just one week before the Treasury Department says the U.S. is at risk of a debt default — without a deal to raise the debt ceiling"

“It’s just the weirdest thing to be going home in the middle of an impending disaster”

It's not weird it's totally normal by today's Idiocratic standards.

In 2022, the first two weeks of June were the two worst weeks of the year. Here we see the Global Dow and in the lower pane, we see NYSE breadth on this latest zero hedged "breakout to new highs", is the worst since last year.

FYI, crack has not been legalized. So it's not a legal defense.  

Yet. 

Zooming out on the weekly view we see that copper is leading the Global Dow lower into the abyss. Today we learned that Germany is now officially in recession.

Everything is playing out just as it did in 2011, except far worse. Market mass complacency has now backed up into the U.S. Congress where used car salesmen are now going on holiday believing that they can implode this house of cards economy with impunity.

Which gets us to my prediction for what comes next. I don't see a debt deal until markets fully explode. Then, comes what I call the "Super Clusterfuck" which will exceed all expectations. Followed by a too-late-now bailout from Congress and the Fed. 

Followed by mass rioting.

In other words, exactly what this ass clown Circus deserves.

NEVER GO FULL CIRCLE JERK

Sadly, in an Idiocracy there is no strength in numbers...

As I have pointed out several times on Twitter, the NYSE Composite is tracing out the same head and shoulders top as it did in 2011. Nevertheless, bulls and their amnesiac pundits seem to forget that the market imploded when the deal was actually made AND then the Fed was forced to ease WEEKS later. Given the state of this current impasse, the 2011 redux is now the best case scenario. However, the Super Clusterfuck is the most likely scenario. Sadly, only happily ever after is priced into the market. 

It's extremely ironic that the long-awaited Fed pause is now set to occur during the same month as the fiscal cliff diving gong show. Which explains why bulls are loathe to go risk off. Because clearly once the debt ceiling is raised it's off to the races. Sadly, they forget the experience of 2011 in which stocks crashed 20% AFTER the debt ceiling was raised. They also happen to forget the experience of March 2020 because as the chart above shows, stonks were in melt-up mode leading to the pandemic. Then as now, bulls were solely focused on the Fed. Because it's so much easier to reduce all of investing down to a single variable and then ignore that single variable when it doesn't suit your asset allocation. Merely waiting until the Fed is forced through economic dislocation to return to the bailout position. What I call buy and explode. 

Where was I...

Last Thursday, Biden and McCarthy said they were optimistic about reaching a deal. Then late on Friday, the GOP delegation walked out of the negotiations saying they were going "backwards". On Saturday, Biden said that the direction of the talks was "unacceptable".

So tonight, we have now come back to FULL circle jerk mode:

"There's nothing agreed to but everything's being talked about"

"Let me be clear. No, we're never putting a clean debt ceiling on the floor," McCarthy told reporters

Janet Yellen has spent the last two days reaffirming that June 1st is a hard deadline. That likely doesn't mean a Treasury debt default, but it could very well mean a pay suspension for Federal employees which would likely be met with a debt downgrade deja vu of 2011. We don't have long to find out. 

Trump has been pounding the table for the GOP to force cuts and otherwise force default:

“Republicans should not make a deal on the debt ceiling unless they get everything they want (Including the ‘kitchen sink’)”

"The former president is still influential in parts of the House Republican conference in particular, and his plea for the GOP to avoid making a deal that is good for both sides could throw a wrench into talks"

Clearly, any deal - if one were to occur - would be recessionary. In addition to large spending cuts, there is the issue of the liquidity implosion caused by massive Treasury issuance when the deal gets made:

 “My bigger concern is that when the debt-limit gets resolved — and I think it will — you are going to have a very, very deep and sudden drain of liquidity” 

What bulls ALSO forget is that in 2011, the Fed was forced to implement a variant of QE called "Operation Twist". Whereas currently they are still engaged in 2x QT mode. These are facts that the financial punditry are happily ignoring. 

All that is the good news. 

If the Treasury does default on one or more of their various commitments then bond yields would likely sky-rocket. Which is why I don't see an all clear yet to go ALL IN the long-term bond trade. In the case of a deal, then T-bonds likely take off as they did in 2011 (yields fall). However, if there's a default, things could get very ugly across the board. At which point not only would there be a fiscal clusterfuck, but a monetary clusterfuck at the same time. Which is why I recommend keeping some powder dry.

Either way, the upside for bonds far exceeds that for stocks in 2023 as the yield differential between the 1 year Treasury and stocks is now at the 2007 level:

In summary, never go FULL circle jerk.

Because in an Idiocracy there is no strength in numbers.

ARTIFICIAL INTELLIGENCE IS A CROWDED TRADE

This level of buffoonery has ZERO chance of survival...

The debt ceiling is not priced in, it's priced out.

Further rate hikes are not priced in, they are priced out.

Recession is not priced in, it's priced out. 

How do we know? Because the most overvalued sector is now deemed a "safe haven" from risk. You can't make this shit up:

"Investors are loading up on mega-cap tech stocks as they turn more bearish, according to Bank of America"

"Mega-cap tech behemoths like Apple, Microsoft, Alphabet, and Amazon are returning to their safe haven status"

First off, how could bearishness be at the highest levels of the year if Tech is the most crowded trade. To read this one would think that Tech stocks are safer than cash. In what world is the most crowded trade a safe haven?

The world of artificial intelligence.

Here's another factoid from the article: 

"Investors most long growth vs value stocks since July 2020"

July 2020 is an interesting timeframe because back during the pandemic recession - as short as it was - investors were rotating to mega cap Tech stocks which were perceived safe havens. When that rotation ended, there was a very sharp selloff and mass rotation out of mega caps. This past week, Apple once again has eclipsed the entire small cap stock sector in market cap. This impending selloff in mega cap Tech will be taking place in a bear market unlike 2020 which was a Tech bull market.  

 

The S&P Tech ratio now exceeds the pandemic and Y2K.

Which gets us to the temporarily suspended bank run. We also learn via the article above that another consensus crowded hedge fund trade is short banks. Which means that this week hedge funds are getting squeezed on their short trades while become massively longer their Tech trades.

A recipe for mass deleveraging.

Meanwhile banks are now three wave corrective at all degrees of trend, so once hedge fund short-covering ends, they will explode lower.

This week, Home Depot reported the worst quarterly revenue miss since the Y2K recession and the biggest drop in quarterly revenue since the 2009 recession. Confirming that the consumer is imploding.

Today, Walmart "beat" on earnings because their biggest sales category is groceries which are the last consumption item people stop buying. They also said that sales eroded continuously throughout the quarter.

Which gets us to the impending debt ceiling debacle. The article above states that more than 70% of investors believe the debt ceiling is no big deal:

"Investors appear to have little concern about the ongoing debt ceiling showdown in Washington, D.C. According to the survey, 71% of surveyed investors expect a US debt ceiling resolution before the X-date, which the Treasury Department estimates is June 1"

In summary, Tech is over-crowded, bank shorts are unwinding and there is little concern over the debt ceiling. Whereas institutional investors believe that all risk is priced in, it turns out that NO risk is priced in because they all believe that everyone else is bearish. Therefore they can own the riskiest stocks in the market while the economy implodes in real-time. 

We have achieved peak artificial intelligence. 

 

NO WAY OUT

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

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

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

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

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

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

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

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

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

Sadly, that is wishful thinking. 

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

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

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

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

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

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

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

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

Those who believe that were not around in 2008.

THE SUPER CLUSTERFUCK

You knew this was coming...

I am officially calling this event "The Super Clusterfuck". It consists of unprecedented fiscal and monetary tightening and massive misallocation of capital to a Tech bubble into a  financial meltdown that is obviously well underway...

On Tuesday, Biden met with Congressional leaders to discuss the debt ceiling. They met for one hour. In the first ten minutes they laid out their polar opposite positions and during the last :50 minutes they waited for the hour to end. It was pure charade. Both sides are hardening their position ahead of the impending "x" date. 

On Wednesday Trump said that the GOP should force a U.S. default if Biden doesn't accept major spending cuts:

“I say to the Republicans out there — congressmen, senators — if they don’t give you massive cuts, you’re going to have to do a default” 

The fact that Trump - who has been wiped out financially several times - is giving debt advice is merely a sign of the times. We've reached level '11' idiocy and we're now in sudden death overtime. 

Sadly, for markets there is no sign that Biden & Co. are going to cave on spending cuts, certainly not of the scale envisioned by the Freedom Caucus. Which means that markets will now decide the fate of the debt ceiling.

Which gets us to monetary policy because the CPI came down a mere .1% annualized (4.9% v.s. 5%) from March to April. However, markets were bid on the belief that this CPI print will ensure the Fed pause. If the Fed pauses here then it's very likely that inflation will re-accelerate because that's what happened in 2008. However markets went into meltdown mode which caused inflation to collapse. It's also what happened to Volcker in 1980 and he was forced to raise rates even faster later in the year.

In either scenario markets will implode. Sooner or later.

However, what is never discussed in the lamestream media is that rate hikes of 5% STILL have not brought inflation under control. Why? Because the Fed balance sheet is 95% correlated to the CPI and lately it's been rising again to counter the incipient banking meltdown.

THIS balance sheet is the epicenter of the Fed's policy error dating from 2020 to now. It increased 100% during the pandemic and it has only come down 5% since the Fed started tightening. It is the SOLE source of monetary inflation. Only a dunce assumes that a 1.5% reduction in interest rates in March 2020 caused 40 year high inflation. Especially now that rates are 3x higher than they were pre-pandemic.

Hence, that is the fatal consensus and it's totally unquestioned. 

Which gets us to Tech domination in stock markets. Bulls have already forgotten that Tech stocks were at the epicenter of the pandemic bubble. They've forgotten about the record 1,000 IPOs/SPACs of mostly junk Tech stocks in 2021. They've forgotten about the pull forward of investment in Cloud technology so everyone could work from home. Therefore they're seeking shelter in a sector that has an earnings decline of -10% year over year. Yes you read that right.  

Tech domination was inevitable at this stage of the cycle, due to the imploding economy and the attendant end of rate hikes. However, Tech is only a good bet in a recession IF it's not the last and largest market bubble. 

BULL TRAP

 "There is no political solution to our troubled evolution"

Bulls are trapped in a latent Idiocracy with no way out and no way of knowing the risk they are taking. Each side of the political aisle is cheering on their own stooge leaders. Waiting for the big  political "win" when they push the economy off the fiscal cliff.

The pandemic was the largest combined fiscal and monetary stimulus in world history. Followed by the largest fiscal and monetary reduction in history.

Meaning, we are right now enduring the largest boom and bust in history. 

The largest asset bubbles in the past 100 years were 1929, 2000, 2008 and 2020 when measured statistically relative to historical baseline.

January 2022 Jeremy Grantham:

"All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected all the way back to trend with much greater and longer pain than average.Today in the U.S. we are in the fourth superbubble of the last hundred years"

Does anything strike you as odd about these years: 1929, 2000, 2008, and 2020? It should. 

Fully 70 years lapsed between the Great Depression and Y2K, then in a span of 20 years there were THREE 3-sigma superbubbles in the U.S. That is statistically impossible assuming a normal distribution. Therefore we live in an era of unprecedented Black Swan tail risk. Meaning this is the riskiest market period in world history without comparison. 

This is why I had to start writing my own blog. Because we live in an era of statistically impossible boom and bust, and yet today's bullish pundits all assume that the next 100 years will be just like the last. They ignore the fact that in this era it is totally impossible to extrapolate a bullish market future from the recent past.   

 

Take a look at the chart above and in particular 1980 aka. "Morning in America". That was the Reagan revolution and it was kicked off by the Volcker gambit. Meaning Fed chairman Paul Volcker used high interest rates to kill the 1970s inflation and then markets took off, unleashing a two decade stock rally that culminated with the Y2K superbubble. Volcker's gambit worked, because that was demand side inflation driven by the strongest middle class in U.S. history. Today's inflation is driven by rampant corporate profiteering which is relentlessly imploding the weakest middle class in history when measured by labor share of GDP, benefits, job security etc. Meanwhile, Volcker had an 19% Fed rate to cushion the inevitable massive recession. He used 10% of that on the way down. This Fed has a 5% Fed rate to cushion the downside of this impending recession that is imploding what is left of the middle class after three successive boom and busts in two decades. 

What we are witnessing in real-time is the END of Globalization which has been the dominant economic force for the past 100 years. Which is what makes Warren Buffett so ridiculously out of touch with reality. He is extrapolating his own 93 years since 1930 into the indefinite future.

As if there will be ANOTHER middle class to implode. 

Therefore it's fitting to watch our political leaders push this Titanic off the cliff with their fiscal gong show. As we see below, the debt always rises in recession. It exploded after 2008 and again during the pandemic. And yet here they are actively pushing the U.S. into recession out of their fake concern for the national debt. 

In summary:

"What the wise man does at the beginning, the fool does at the end" - Warren Buffett