THE LAST PUMP AND DUMP

Bullish pundits have been saying for weeks that this rally can continue until everyone is bullish.

Check. 

In my last post I explained that bull markets are measured from the bottom whereas bear markets are measured from the top. Therefore it's very easy to be in a new "bull market" while languishing far below the all time high. As is the case now. That said, all bull markets must start from a bear market low so the lack of a new high does not itself consign this bull market to implode.  For that confirmation we turn to other indicators. 

Among the indicators is CNN's proprietary "greed/fear" index. This indicator is particularly useful because it combines seven separate technical indicators into one composite index, making comparison between time periods easy: Momentum (1), Breadth (2), Positioning (1), Volatility (1), Equity premium (1), Credit spreads (1). 

As of this writing this index is at 78, deep in the "Extreme Greed" territory. The highest level since February of this year. Recall, February is when banks left this rally and when the mega cap "AI" melt-up began. Note the divergence from the average stock since February:

Here we see AAII (retail) net bullish is at the highest level since the Nasdaq's all time high. Which serves as a very good confirmation for my NDX wave count. Exactly what one would expect to see at a wave '2' high. For those who are not familiar with Elliott Wave Theory, it merely posits that investor emotions are manifested in the market through repeating "fractals" or patterns. Is it perfect? Of course not. However this chart is about as clear as it gets, both in time and price and now sentiment. 

As another indication of extreme complacency, we see that the VIX has now round-tripped back to the pre-pandemic level, as of this week:

Bullish pundits are now claiming that the recent weak breadth is a plus for this market because it means that the rest of the market is going to "catch up" to Tech. They arrived at this new consensus because this week, the Russell 2000 small cap index outperformed all of the other indices. It's important to note that they fell for the exact same b.s. at the all time high. 

This was a lame rally by any standard, especially given the amount of call option firepower:

Which brings us to the FOMC meeting next week. Back at the October lows no one would have predicted continued Fed hawkishness this far into 2023. Just as no pundits predicted extreme Fed hawkishness throughout 2022. Fed Funds futures have fallen back to a 70% probability of a pause next week. However, the Bank of Canada surprised markets this week with an unexpected rate hike. So, it could happen. 

In summary, this pattern of investors becoming bearish at capitulation bottoms and bullish at rally tops is something we will see over and over again during the coming years. Each time, pundits will make up new and less credible reasons for why this is going to be "the" big move. Each time, they will only succeed in herding investors into another dead-end Ponzi rally, at which point more investors will explode. Over time, bullish pundits will lose all credibility and they will be called "perma bulls". A derisive term indicating someone who is always wrong. Starting 18 months ago.  

THE GREAT 1930 RALLY

The great secular bull market is over. Bulls just can't bring themselves to admit it, because they can no longer afford reality...

During the 1930s there were 10 cyclical "bull markets", meaning rallies >= 20%. Each one imploded. The first bear market rally took place from the October 1929 low through May 1930. When that ended, the market collapsed to the 1932 nadir -90%. The goal now is to not repeat the mistake of buying that first bear market rally on the belief that the worst is over, when the worst hasn't even started yet.  

The Dow's biggest gain in history was in 1933 when it gained over 100% intra-year. However, the market was still down -80% from the all time high. What most investors don't realize is that massive losses require far larger gains, because the losses are calculated from the top and the gains are calculated from the bottom. 

It would require a 1000% gain to offset a -90% decline.

The high wire act that all of today's bullish pundits follow is to ignore all of the obvious risks that have coalesced at the end of the cycle and instead fall back on long term average stock market returns. Because they all believe that investors are owed a recurring rate of return. For example:

"Whenever there’s a period of extreme market volatility, new investors might wonder if it’s really worth keeping their money in the stock market at all"

Investors who keep their money at work in the S&P 500 have been able to enjoy an annualized stock market return of around 10% over the long haul"

When valuations are extreme as they are now, historical averages have no meaning. Whether in stocks or real estate, or any other market. During the pandemic, home prices rose 40% in two years. There is no historical precedent for that magnitude of gain. John Hussman has consistently explained that current stock market valuations portend a -2% average return for the next decade. However, long-term averages do not provide an accurate depiction either. As we see above, what's more likely to happen is that the major decline is front-loaded, followed by positive returns from that point forward. 

Another risk bulls are ignoring is incipient recession. The current Federal deficit is -6% of GDP and the growth rate is at best 1%. As we see below, that is the largest non-recession deficit since WWII. If every other generation had been this profligate, there would have been NO recessions, but the U.S. would have been bankrupt a long time ago. 

The next question is how will a massive -6% deficit during "expansion" ever provide adequate stimulus during a major recession? Clearly the "Keynesian" multiplier is essentially zero. Meaning additional fiscal stimulus is having no effect on the economy. Corporate profit growth is entirely dependent upon expanding fiscal stimulus which only barely passed this latest debt ceiling vote. So how will fiscal stimulus offset imploding demand in a recession? Corporate profits are set to fall off a cliff amid sky-rocketing corporate defaults. You don't have to be a genius to figure this out. The Federal deficit is already worse than 6 out of 8 recessions, and it's getting worse with each recession.

Corporations are massively levered to the cycle both operationally and financially.

Another risk factor bulls are ignoring is the collapse in breadth. 

They did the same thing at the all time time high, they assumed breadth doesn't matter:

December 2021:

Narrowing Market Breadth May Signal A Market Top

In the meantime, breadth has become far worse. 

In this chart we see that the ratio of equal cap to market cap has collapsed at the fastest rate since March 2020 and October 2008. The key difference is that during those prior times, breadth collapsed during a market crash. This is the first time that breadth has collapsed in a "rally".

In summary, this is a cyclical "bull market" within a secular bear market. And now it's running on glue fumes.

Unfortunately, most bulls can no longer afford reality.

 

FEAR OF MISSING RECESSION

The debt deal is a done deal. Deja vu of 2011, it was a last minute agreement just one business day prior to default. Now we will find out if a fiscal gong show was worth going ALL IN artificial intelligence in a recession. Basic logic would suggest it is a bull trap of biblical proportions...

“Monopolistic tech” is winning through pricing power and the squeeze on smaller suppliers, Hartnett wrote in a note, highlighting the Nasdaq 100 Index is now at a record high relative to the Russell 2000 small-cap index"

Many pundits including the ones above show the NDX / Russell. Whereas I show the S&P Tech sector relative to the NYSE Composite, which is in a broadening top. Each touch of the upper trendline has brought a larger crash since 2021. Meanwhile, we also see this is the largest surge since March 2000 (lower pane).

Outside of Tech the entire stock market, commodity markets, and the bond market are screaming recession. Once again this week the yield curve soared, however the Friday (today) jobs report came in much stronger than expected. During the recessions of the 1970s-1980, jobs rolled over AFTER the economy was already in recession. Meanwhile looking at the chart below, we see that in 1980 the unemployment rate hit 10%. Currently it's at 3%.

The minimum jobless increase in any recession in 45 years is a double from this level (6% in Y2K).

For the past two weeks, retailers have been warning of impending recession. This includes Home Depot, Costco, Macy's, Advance Auto Parts and even Dollar General.

Consider what happens to consumer sentiment during recession. 

Today's bulls believe that it will improve.

Getting back to Tech, we see that FANG+ - the ten largest Tech stocks in the market - have returned to the left shoulder level. Look what happened to Nasdaq volume when they rolled over (lower pane). That's minor compared to what is coming.

This set-up is now very similar to what happened during the Trump Tax cut. There was a FOMO melt-up into the event, but as soon as it came into effect, the market exploded. 

It was a Monday after a hotter than expected jobs report. 

FYI.

 

SUPER CRASH

AI financial extinction is the most crowded trade...

On the same day that AI stocks went late stage parabolic, we got this perfect headline, below - Tech executives, who gratuitously used the term "AI" a record number of times on their most recent earnings calls are now warning that Silly Con Valley's latest hype cycle could lead to mass extinction as a minor side effect of improving mankind. 

Tuesday's debt ceiling rally: 0%.

Also today, the debt debacle cleared a procedural hurdle leading towards the official House vote tomorrow evening (Wednesday). It's likely that the bill will pass since a majority of moderate Democrats and Republicans can finally agree on one thing - they don't want their own stocks to implode. 

In my last post I said the market would likely selloff into the "vote" which would mean a rollover from this "deal rally" of 0%. I still believe that continued downside is the path of least resistance, however persistent short-covering *could* save bulls until the deal is finalized. Or the market could explode any time. 

Bulls have this much margin of error:

Aside from this debt ceiling saga, the main event continues to be the Artificial Intelligence melt-up rally. As has been mentioned many times, it's an extremely narrow rally focused almost entirely on the largest cap stocks. Market concentration at the end of the cycle is the hallmark of every bear market, because passive dumb money keeps plowing into the cap-weighted indices while the broader market collapses amid widely ignored recession: 

"This years winners are few, but the losers are many, including: energy, utilities, healthcare, real estate, consumer staples, materials, industrials and banks"

“If you stray from a small portion of the tech complex, you’re gonna be destroyed.”

When I read that, I thought I must be bullish too, because sometimes when you read Cramer, it's hard to tell if he is bearish or bullish until you remember that he is always bullish. In what world is it bullish to only own one erroneously believed "recession-proof" sector while the rest of the market gets destroyed? If you're a bull, you have to have the IQ of a dead gopher to call that bullish. Hence it's consensus. 

Which gets us to AI mass extinction the most crowded trade.

All hedge funds and all speculators are now crowded into a handful of massively overbought and overbelieved stocks. Which is a recipe for a super crash. The selloff will be fast and brutal.

This is the most lopsided market since March 2000:

"The last time this happened, the S&P 500 topped during the dot-com bubble and subsequently lost almost half of its value"

"20% of the S&P 500's components are beating the index on a trailing-three-month basis. The last time such a small percentage of S&P 500 stocks were outperforming the broad-based index was March 2000"

This month marks Google's best three month run since the 2007 top:

Microsoft's best 3 month *bank* run since 1999

In summary, today's bulls tell us that "overbought" can always become more overbought. 

History will say that the only thing that was over bought in this era was artificially intelligent bull shit.

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.