MELT-UP TO MELTDOWN

Most investors don't understand or subscribe to Elliot Wave Theory. That's why it works. If everyone was aware of social mood and their proclivity for getting caught up in market FOMO, they wouldn't be doing what they are doing right now, which is going ALL IN...

Once upon a time, I used to worry about making accurate predictions across all of the various markets. Just like Zerohedge and Jim Cramer, I wanted to be "right" all the time, except not by reversing all of my own calls at the close of trading. Unfortunately, in this type of market that is not possible, because since the global all time high, we have watched as risk and complacency have BOTH grown in lockstep. Which means that bulls can be tactically "right", while being totally wrong as to the inevitable outcome. Think of it as a winning gambler who doubles down with each hand until he ultimately gives it all back. In other words, the sheer magnitude of this impending disaster vastly eclipses any micro call being made by the financial punditry. Everyone who is riding this Ponzi rally higher has NO exit strategy other than to believe they alone will get out first. No one has informed them, that's not possible. And they can't figure it out for themselves. 

Yesterday was the highest greed reading in at least two years, likely far longer, however the dataset is limited:

This week, the Fed finally paused rate hikes for one meeting while still vowing to tighten later in the year. The ECB tightened again yesterday. And Friday (today) the Bank of Japan continued their disastrous free money experiment which now looms like a Damocles Sword over global markets. A $3 trillion global margin call merely waiting for RISK OFF. Carry trade unwind does not require a BOJ monetary policy change, all it requires is a massive Yen rally the likes of which took place last Fall during the Yen intervention. Or, a global RISK OFF event would cause massive short covering as we see in the middle pane below.  

Either way, note the correlation between Tech stocks and the $USDJPY carry pair since the Yen intervention last October. Whereas before they were negatively correlated now they are 90% correlated.

June 5th, 2023:  

The irony for bulls is that the more they front-run a REAL Fed pause, the less likely it is to happen. Why? Because investor FOMO feeds back into risk premia and loosens financial conditions. Which means that investors can only get themselves more and more lubed up ahead of ANOTHER tightening.

What investors seem to forget is that the last FOMO melt-up also took place during the week of an FOMC meeting in January of this year.

That was merely wave 'a'. This pullback will make that one seem like a picnic.

In other words, the only way the Fed can stop tightening is if markets crash. Otherwise, they have to keep tightening until markets crash.

That is the bull case in a nutshell.

Also, what happened in 2008 and more famously in 1981 was that inflation re-accelerated as soon as the Fed paused.

If we get a higher inflation print at any point in time from this week onward, then markets will be in meltdown mode.

It will be Volcker 2.0.  

Another crowded trade is short Treasury bonds, which makes no sense whatsoever. Speculators are betting that the Fed can thread the needle between rate hikes and hard landing. So they crowd Tech which is a deflation trade while shorting bonds which is a more extreme deflation trade.

Nevertheless, as we see they don't have a good track record.

In summary, what it all comes down to is the fact that cycle DENIAL is a VERY crowded trade.

"The German multinational bank's top research team believes Washington has sparked a boom-bust cycle that now is nearing its end stage"

YES, IT'S A NEW BULL SHIT MARKET

Six mega cap Tech stocks becoming the entire "market" has been conflated as a new bull market. You have to be brain dead to believe it, hence it's the new consensus...

Let's see, CPI tomorrow. FOMC Wednesday. ECB Thursday. BOJ Friday. 

What could go wrong? Apparently nothing.

It appears that the combination of last week's debt deal and this week's Fed "pause" has created a FOMO melt-up as investors believe that monetary and fiscal policy are now at their back. Sadly, nothing could be further from the truth, because what gamblers are buying with both hands is a hard economic landing with minimal bailout.  

Google searches for "bull market" are at a record high from 2004.

Note that gamblers were right in 2020 compliments of the massive Fed bailout. In 2008, they were four months early and took another -40% drawdown. This time, they are coming in at the end of the cycle. For maximum pain.

What you would expect after 15 years of non-stop monetary bailout - They have been conditioned to implode. Today's bullish pundits are using the post-2008 playbook which assumes just-in-time bailout. 

Coming into  this seminal "pause" week, Tech overweight has reached a new record high relative to the average stock. Investors today actually think that the average stock is going to "catch up" to the massively overbought Tech sector. Unfortunately, that's not what happened the last two times. 

The pullback in August 2020 was mild (-15%) for the Tech sector. The pullback in December 2021 was a full scale bear market -35% for the Tech sector. Both times, the entire market fell at the same time. There were no safe havens. 

Still, investors believe this 3rd and largest Tech mega bubble will be the bull market. Recall that the entire reason to buy Tech stocks in 2023 was due to the impending Fed pause which kept getting pushed later and later into the year. So, it could be priced in. 

Here is where it gets interesting. Way back three years ago in June 2020 the entire "reflation" trade imploded. The rally was over until the 2020 election. From that point forward it was a Tech-only rally.

Now we see below that bank stocks this year imploded in March and have rallied back into June. Deja vu. 

However, if you look at the chart above, you see the pre-election Tech crash in August 2020 is now aligned with the reflation peak of June 2020.

Everything is peaking at the same time. This time. 

Here is what the sheeple are being told right now:

"Once stocks are greater than 20% off bear lows, did you know a year later stocks have never been lower?"

Since 1956, that is true. 

However, in 1930, that was false. The signal was wrong when it had its most catastrophic failure. 

It's called "data mining" and it is the last resort of today's trapped bulls. 

In summary, the average stock just entered a death cross on the weekly chart. In the past 35 years, that has signaled impending recession/bear market EVERY TIME.

And no, they don't see it coming.

 

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.