FOMC: FEAR OF MISSING CRASH

Bulls claim the term "crash" is way over-used. More appropriately, we should adopt the term "discontinuous price discovery". That way it's left to the reader to decide if they require a change of underwear...

Recap:  October capped off the largest three month decline since March 2020. So far, no sign of panic or capitulation. Whenever the market gets oversold it bounces, and then goes lower. This has been the pattern since the July top. Here we see that the market is in a clear down-trend, with each rally of shorter duration. There was an oversold bounce at the last FOMC pause in September. On Wednesday of this week, the Fed paused rates for the second meeting in a row, for the first time since they started raising rates. This is the scenario bulls have been waiting for all year long.

The Nasdaq is in a similar downtrend and currently clinging to the 200 day moving average.

Today after the close, we get Apple earnings. As I pointed out in my last blog post, Tech earnings have so far been met with heavy selling. Including beats. But Apple is expected to post another earnings decline, so that should be better?

"There are four forces working against Apple in the December quarter: An unfavorable comparison, a strong dollar, iPhone supply issues, and a cautious consumer"

Bulls inform us that it's bullish we avoided a recession and it's also bullish that the Fed has ended rate hikes. However, for the bulls, now every economic data point is a potential landmine that could set-off another round of Fed tightening. For example, Friday's jobs report.

Meanwhile, earlier this week the BOJ further widened their yield band and said that the 1% level is now merely a "reference" point. Which means that if U.S. economic data runs weak, the yield gap between U.S. and Japanese rates should continue to close, trapping bulls in collapsing carry trades. 

In other words, both the "too hot" scenario AND the "too cold" scenarios are now fraught with delusional risk.

In summary, the average stock almost took out the last October lows during the past month, but the cap weighted averages shown above remain significantly above the lows. 

 

Which means that now the bet is whether or not markets collapse between now and the end of the year. 

THIS IS CRASH

Bulls, F.Y.I...

At the beginning of the month, I reminded everyone that October is the notorious month of crash. Ominously, by mid-month, we were told via Ned Davis Research, that the current set-up is eerily similar to 1987, but that is no cause for concern:

"Circuit breakers were installed after the October 1987 crash, making a 20% decline "almost impossible"

There are three regular session stock market circuit breakers which are triggered at declines of -7%, -13%, -20%. On March 12th 2020, at the onset of the pandemic, the first circuit breaker was triggered at the open which paused all trading for :15 minutes. The -13% circuit breaker was almost triggered near the end of that same day, but the rules for circuit breakers prevent them from triggering in the last half hour. Which is why the market was down -13.5% at the close. Which happened to be the biggest one day percentage decline since 1987. So to believe that a -20% decline could not occur again, is wishful thinking. Investors are far more complacent now than they were going into March 2020. And this market keeps on dropping.

This week, Wall Street earnings "beats" are getting monkey hammered, especially in mega cap Tech. Which means that the charade is over. This negative price reaction proves that fundamental analysis is not a reliable predictor of stock direction. Going into this earnings season, Google, Microsoft, Amazon, Netflix, Nvidia, and Apple all had charts that were predicting impending weakness. I posted several of them on Twitter. Every one so far has reversed to the downside after earnings. In addition, the same price reaction already occurred at the July top - across the board earnings beats for mega cap Tech stocks were met with heavy selling. Which of course is something that Wall Street would never predict, and therefore most gamblers were trapped in bad trades. In other words, technical chart analysis was far more useful as a predictor of impending direction than Wall Street earnings predictions which have the veracity of a Magic 8 Ball.

The Nasdaq is now through all levels of support. 

All of which means that as the month has worn on, bulls have become more and more trapped. As a result, BofA (Hartnett) came out this past weekend and said that they were becoming tactically bullish due to the market's oversold condition. They said that extreme bearishness could either lead to a bounce or a crash. Which of course sparked a big rally on Monday:

“Investors are sufficiently bearish” for the S&P 500 to hold above 4,200 points for the next three-to-four weeks...if the index can’t hold at 4,200 with this level of bearishness, then there may be imminent risks of a credit event or hard landing”

Clearly, bulls and bears are on the exact same page now - stocks have ~5% upside, and -50% downside. Which makes this a tradable opportunity for someone with an IQ of a dead gopher. Or hedge fund managers desperate not to underperform the market into year end.

In summary, position accordingly. 

HARD LANDING

What we are witnessing is the fourth and last phase of Fed policy error...

The first phase policy error took place when the Fed foolishly doubled their balance sheet during the pandemic from $4.5 trillion to $9 trillion. The equivalent of 200 years of monetary largesse unleashed in one year. That unprecedented amount of monetary dopium found its way into every asset market on the planet from the housing market to junk IPOs/SPACs, Ark ETFs, Crypto Ponzi schemes, Reddit pump and dumps and most recently mega cap Tech stocks - What today's pundits are calling the "Magnificent Seven". Seven massively overvalued Tech stocks that account for all year-to-date market gains. Up until very recently, the Fed has been way behind the curve soaking up this excess liquidity. But now they are making up for lost time. 

The second order policy error was keeping interest rates at 0% for far too long even as inflation was already soaring. During 2022, the Fed made up for lost time by increasing the Fed rate 3x what it was prior to the pandemic. From 1.5% to 5%. That was policy error number three - panic rate hiking after being asleep at the wheel.  

By over-raising rates, the Fed committed a massive policy error, due to the policy mismatch of over-tightening on rates while under-tightening on the balance sheet. Meaning it was easy to issue junk bonds, but increasingly difficult for consumers to get access to credit. That Fed policy divergence is now collapsing the middle class. Below we see that homebuilders held up well during the rate hiking cycle. However, the 30 year long bond yield which is in the lower pane, has sky-rocketed since the Fed paused. This has caused homebuilders to collapse. The market is signaling that the Fed should pause quantitative tightening - balance sheet rolloff. However, the Fed plans to continue "normalizing" their balance sheet for several years.    

Which means that we are now in the fourth and final Fed policy error. During Powell's interview today he said that the long bond collapse (yield spike) is now doing the Fed's job for them. Indeed, and then some. As I remarked above, the Fed had been far too slow reducing their balance sheet. However, at this late juncture, the bond market is now bidless. While I was watching Bloomberg Asia on Tuesday night, Rishaad Salamat was asking his guest market analyst if "we are all just waiting for something to break". She agreed - The Fed, Wall Street, investors, Zerohedge, are all desperately waiting for markets to break because then as the story goes the Fed can come to their rescue. It's the exploding market bailout hypothesis. Needless to say it has a dubious set of believers and an even more dubious chance of working.  

The problem lies in what I said above - policy error #2 - the Fed has over-tightened on the middle class. It's far too late to seamlessly pivot to a bailout stance to avoid recession. This chart shows that in all three most recent instances, bank tightening of this current magnitude preceded recession. And, all three times, the Fed was already easing. But not this time.

This time, will be the "soft landing".

In summary, last October investors made a big bet on a Fed pause, which took almost an entire year to become reality.

Now, they are betting on a Fed bailout. Which will come far too late to save anyone who believes in it.

Unless, they're just a slack jawed pundit with no skin in the game. 

 

CONDITIONED TO EXPLODE

Fifteen straight years of bailout has conditioned gamblers to explode. All because they believe that printed money is the secret to effortless wealth...

Currently we are witnessing a suppression of volatility similar to what was seen in late 2017 prior to the famous Feb. 2018 "Volmageddon" event. The only reason this suppression of volatility is considered bullish is because most of the people putting on this short-term trade are playing with other people's money. Over the past 15 years of non-stop monetary bailout, investors have been systematically conditioned to ignore risk. Which means that this can only end one way: With systemic meltdown.

Oct. 10th, 2023:

“If you remember 2017, right before we got into Volmageddon in February 2018, the volatility environment smelled similar to right now”

Derivatives specialists have argued that options-selling funds are acting as a market tranquilizer, day in day out - all of which essentially serve as indirect wagers on stock calm"

“It works until it doesn’t”

Wall Street's favourite business model - something that mints coin until it explodes at public expense. 

Below is what this looks like visually via the short VIX ETF. The big drop was Feb. 2018. Keen observers will note that this rally in complacency is almost 2x longer than the previous two vacations from reality.

The risks are so obvious today, that everyone merely assumes they must be "priced in" to this Disney market. In the same way that the most obvious subprime was NOT priced in last cycle. 

Recently even Nassim Taleb - author of the "Black Swan" event, called today's risks a "White Swan" event i.e. common and obvious. 

“Systems don’t correct themselves without some kind of pain.”

“A white swan! It’s a white swan event,” Taleb said during the interview.

"He believes the economic risks we currently face are obvious. After years of ultra-low interest rates in the U.S., Americans have piled on unsustainable levels of debt"

I've said this exact same thing for many years - but I'm not famous enough to first invent a fictitious financial term and then reject my own theory publicly. Because in the world of finance there is no such thing as a true "Black Swan" event. Per Minsky theory, money managers steadily increase risk over the course of the cycle until something explodes, then they tell their investors it was a "Black Swan" event, in order to exonerate themselves. In this elongated post-2008 cycle, conflict of interest has been put on steroids. Fifteen years of continuous monetary bailouts has conditioned investors to ignore even the most obvious of risks. 

The Fed has many times attempted to re-calibrate their financial risk index in order to more accurately predict financial crises. However, each time they do so, investors onboard even more risk. Which means that this latest financial meltdown will come as a total surprise to unprepared central banksters and volatility selling gamblers alike. 

Which gets us to this war in Israel. The current war started 50 years (+1 day) from the Yom Kippur War of 1973. Back in that war, Israel was caught off guard by a simultaneous Arab attack via the Golan Heights and the Sinai Peninsula. It was almost a total disaster for the Israeli side, but in the end the attack was repelled. After the war, Golda Meir resigned in shame. 

In similar fashion this latest incursion came as total surprise. All because an interlude of stealth war preparation was widely conflated as Middle East peace, delivered by The Punisher Netanyahu. 

That's where the comparison between these two events largely ends. The 1973 war triggered the OPEC oil embargo because the Arab nations wanted to punish the U.S. for siding with Israel. That embargo coincided with the closing of the Nixon gold window, both of which fueled the infamous 1970s stagflation. To believe the same massive commodity shock could be absorbed now is a fool's errand. As Taleb asserts above, current levels of debt are totally unsustainable. At best this Middle East conflagaration will serve to accelerate the Lehman Moment.

Something like this:

 

GLOBAL MARGIN CALL

The month of crash has officially begun. 

Since the Fed "pause" last week, global bond yields have sky-rocketed. Under this new paradigm, the Fed won't have to tighten again because the bond market is tightening for them. 

No one seems to have any answers for why this is happening. Bulls are at a total loss to explain how a Fed pause caused long rates to explode. The most obvious explanation is that the global bond market is now going bidless due to relentless central bank tightening. Real yields are rising which is a sign of central bank policy error. However, central banks are now trapped between the threat of further inflation and the need to support asset markets during an incipient meltdown. Consider the stark difference below between March 2020 and this current situation.

Central bank policies are currently at the opposite end of the bailout spectrum relative to 2008 and 2020. But to hear bulls tell the story, CBs can just flip a switch and instantly bail out everyone. As I said on Twitter, this time there will be a long line for bailout. A long soup line.

Because by the time central banks get the bond market back under control, the stock market will be a smoking crater. 

Over the past weekend, the government shutdown was temporarily avoided for six weeks, but it came at the expense of Speaker McCarthy's job. I had predicted a market meltdown if this happened, but instead of course the market rallied.

One more obvious risk to ignore. 

It appears that gamblers have yet to consider the implications of a market meltdown with a non-functioning Congress. They seem to forget that in 2008 and 2020, Congress backstopped both the FDIC AND the corporate bond market. So it's only fitting that corporate bonds are currently breaking the lows of last year and soon banks will be at new lows as well. 

Which begs the multi-trillion dollar unasked question - at what breaking point does inflation risk morph straight into default risk? And the answer is when the deflationary impulse returns which should be any minute now. Because the deflation paradigm will cause a massive re-allocation of capital from stocks back to T-bonds when everyone realizes that today's earnings estimates are off by a minus sign.

Consider that rotation scenario in the context of Utility stocks that are ALREADY imploding the fastest since 2008.

THESE are the stock market safe havens. Where will investors hide when the rout accelerates.

Netflix?

In summary, in the first week of crash month, it's only fitting that the average U.S. stock has now given back all 2023 gains and is now sitting at a loss for the year. Meanwhile, gamblers remain totally complacent. 

Because in a groupthink Idiocracy, the realization that they own an epic clusterfuck will dawn on them at the exact same moment.

aka. Too late.

 

OCTOBER: MONTH OF CRASH

The reign of complacency has continued to the end of September, despite the fact that the market peaked two months ago at the end of July. So as we enter the infamous month of October, it falls on those of us who can still fog a mirror to ask, what could go wrong?

 

Going back one year, stocks bottomed last October on the premise that the Fed was done or near done raising interest rates. There have been two rate pauses subsequently, but overall interest rates have continued to rise. 

Throughout the past year, consumers have continued to spend due to the inflationary impulse. In an inflationary paradigm, consumers believe that their increasing debts will be offset by rising wages. Unfortunately, interest rates have risen far faster than wages, which means that the debt burden has increased over the past year, NOT decreased. Which means that they are now trapped with higher debt levels AND higher interest rates at all time low unemployment. Once the deflationary impulse returns, they will be buried under a mountain of unaffordable debt. One can presume that they will not be happy to have been led to believe that the economy is strong. 

Meanwhile, the entire stock market rally has taken place under a backdrop of declining profits and rising real interest rates. The worst case scenario for stocks. 

Homebuilder stocks are a prime example of the mis-pricing of risk. One year ago, these stocks took off with yields at cycle high on the premise that bond rates were coming down. But since that time, bond yields have gone up.

WSJ: Rising Rates Finally Catch Up With Homebuilder Stocks

I've been showing this same chart all year, showing homebuilders rallying against the backdrop of Fed rate hikes, but nothing mattered.

Until they spontaneously exploded.

This positive correlation between homebuilders and interest rates doesn't seem to make any sense until we look back at the 2007 housing bubble. Then as now, home prices actually rose during the rate hiking cycle and then rolled over when rates came down. Why? Because the economy was imploding. 

We can expect the same thing to happen now.

This past week, Zerohedge posited that a "bounce" is due at any time. They also believe that non-Tech stocks will lead the rally from this point forward. I agree that an oversold bounce could occur at any time, but the experience of Y2K informs us that it won't last long. When the Dotcom bubble burst, "short duration" cyclicals outperformed growth stocks on a relative basis, but they still declined on an absolute basis. 

In other words, bulls are watching the Tech bubble implode and yet STILL making up excuses to own stocks.

In summary, anyone with amnesia can make up excuses to own stocks right now. But you don't have to just forget 2008 and Y2K, you also have to forget last year when that bear market started the exact same way it's resuming right now. I have yet to read one bullish pundit making year-over-year comparisons. Why? Because if they did they would be forced to conclude that we are heading for the first back to back yearly bear markets since the 1930s. And that their totally fabricated rate pause "bull market" has now reversed back to the breakout level.

So it is that I make a bold prediction. That by the end of October we are challenging the lows from last October as if nothing had even happened for the past year.

Because guess what, nothing did happen.

A COMPLACENT MELTDOWN

The week after Lehman anniversary, and markets are doing what was unexpected of them...

Throughout this tightening cycle, global risk markets have been front-running the end of rate hikes. Each rally has proven to be a false dawn. It has never occurred to bulls that THEY are the reason this tightening cycle can never end. Recently, the oil market has been spiking in 100% correlation with every other global risk market. Which is why, as I said would happen, economists  are now saying that a higher CPI is assured in the coming weeks. Which, will put the Fed back on the tightening path after only one pause. Deja vu of what happened this past June:

"We already know that due to base effects, the roll-off of the CPI is going to lead to very likely inflation going back up"

On a global basis, recall that last week, the ECB was also hawkish. Today, the Bank of England paused for just the first time in almost two years. Next, we are waiting for the BOJ to render their decision tonight (Friday in Japan). 

Also leaning hawkish, Japan is now declaring victory over deflation while being on the cusp of the most deflationary market event since the 1930s.

"We won"

All of this hawkish tightening is finally catching up with markets. 

Or should I say, catching down.

Here we see the S&P Tech index has taken out the key support level from August, but we also see that the Nasdaq VIX still signals complacency.

In this chart we see that the Nasdaq (100) equal weight is below where it was in August, but the oscillator is above where it was in August. Which signals the market is not yet oversold.

Away from Tech, here we see that the Industrials rally was a bull trap.

In summary, the VIX has now closed below the 200 day moving average for 128 trading days in 2023. That is the longest streak of reduced financial anxiety since the END of the financial crisis. The only difference is that back then the VIX was coming down from 100. This time around, the VIX is coming down from the March level which was 30.

Which begs the question - do bulls even know what is the difference between the end of a financial crisis and the beginning?

And the answer is $Everything.