FRONT-RUNNING EXPLOSION

It's that time again when bullish investors are tripping over each other to onboard risk ahead of year-end. All signs indicate bulls may have peaked too soon. Again...

Below we see the S&P 500 volume oscillator. While there have been many bear market rallies from this level of oversold, there were no long-term buying opportunities at this current level. In addition, we see that this indicator is now three wave corrective. 

Compare this current set-up to the one last year.  

On the monetary policy side this week, several Fed members  including Powell were yet again forced to inform markets that inflation is not yet under control. This repeating cycle of markets front-running Fed easing followed by a tighter Fed has been repeating for over a year now. 

Nevertheless, it's that time of the year when the "seasonals" are positive which means that fund managers are aggressively putting money to work. In addition retail investors have also aggressively switched from bearish to bullish. Notice the pattern below (AAII) of u-turn positioning is deja vu of the all time high in November 2021. Also, crypto Ponzi schemes have been leading the market lately as proof that risk appetite is fully lubricated. Nevertheless, we are informed that crypto Ponzi schemes are a "safe haven" from global markets, just not a safe haven from rampant criminality. It's totally fitting that in the week after Sam Bankman was indicted for massive fraud, that this society is now embracing a level of general market fraud that will make his pissant FTX seem like chump change. Deja vu of Bernie Madoff circa 2008, all eyes are on the small scam artist while the big guys are getting away with deception on a biblical scale. It's like the scene in Airplane! where the old lady is getting the shakedown from security, while armed mercenaries are walking through with machine guns. 

One article I read this week couldn't understand how Bankman's upstanding Stanford Professor parents allowed him to commit such fraud. It's easy - we live in a morally dead society. Case closed. No ads to sell.

On the topic of flirting with disaster, global carry traders are now ALL IN the $USD/Yen carry trade despite the fact that the BOJ is removing all easing and the Fed is trying to pause. 

This chasmic central bank policy divergence that grew larger and larger for the past two years is now closing, and it's the biggest risk that no one is discussing.

Notice the difference (lower pane) with the $USDJPY now versus during prior Fed pivots:

Another colossal risk being ignored is the total collapse in market breadth. Today, Microsoft made a new all time high which was unconfirmed not only by the Nasdaq 100, but also unconfirmed by every other mega cap Tech stock.

Which is why the Tech/equal weight ratio is now vertical.

And then there's this impending government shutdown which  perfectly sets the table for a totally non-functioning government in the depths of winter meltdown. The last Speaker (McCarthy) was shit canned for making a deal to keep the government open, so we are told the new Speaker who is even more conservative will make another deal with Democrats?

Putting it together gives the worst end of year risk profile since 2018. Which was the last time markets imploded at year end. 

Bought with both hands. 

2023: REVISITING REALITY

It's time to step back for larger perspective...

From time to time, one must step back to put today's economic events back into their broader context. In retrospect, we now know that the 2008 global financial crisis placed the U.S. and developed world in a state of deflationary Japanification. No growth and 0% interest rates for a decade straight. It was a frustrating time to be an investor, because fundamentals no longer mattered. Only monetary policy mattered. 

Fundamentalists believe that the economy and profits are what drive stock prices. Whereas Elliott Wave purists believe that sentiment and social mood are what drive the economy and stock prices, fundamentals merely follow. I am in the middle camp. I believe that there is a feedback loop between fundamentals and sentiment. When sentiment is RISK ON, demand increases, the fundamentals improve, profits follow. Higher profits stimulate asset prices which in turn raises speculative appetite. 2008 changed all that. Central banks were in direct control over markets for over a decade.

However, now the pandemic has put markets back at the mercy of sentiment and fundamentals. Central banks are no longer supporting markets at this late juncture. Whereas fundamentals can be hard to predict, sentiment is much easier to observe. In late 2021, global risk asset markets hit all time highs, followed by the 2022 bear market. 2023 has been a retracement correction of that bear market.  

This is my weekly wave count. Note that the bear market of 2022 started the same way this decline is starting. With a falling wedge to wave 'i' down, followed by a bear market rally to wave 'ii' up.

Given that we saw this exact same pattern last year, today's unfolding collapse should be very clear to everyone, but it's not. Why? Because Wall Street relies solely upon their proprietary profit models to predict stock prices. What I call the Magic 8 Ball. Their predictions always fail at the end of the cycle.

Which is why it has never been more important to observe risk sentiment in order to confirm market direction. Below is a chart of airline stocks and consumer sentiment. What we notice is that both airlines and sentiment peaked prior to the pandemic. Subsequently, airlines have enjoyed two counter-trend rallies, each of smaller magnitude. Recently, airlines broke below the 2022 bear market lows, in an ominous sign for the rest of the stock market. During the pandemic, global travel was curtailed for two years straight. If any sector should have benefited from re-opening, it's airlines.  

Another indicator of collapsing social mood can be viewed in the artificial intelligence Tech sector, which was the biggest bubble of 2023. These stocks have fallen into a bear market. Note also that they peaked back in late 2021 at the same time that monetary stimulus peaked. More proof that central banks exert tremendous control over markets. More than fundamentals AND sentiment combined. 

This past week, investors bought the dip on the belief that stocks rally for about a year after the Fed pauses. But guess what, we were told the exact same thing last October. Which was the catalyst for a year-long rally. Now bulls are buying a recession rally, not realizing there is no such thing. 

 

Next, let's talk about inflation and the impending return of deflation. The sources of inflation emanating from the pandemic were first and foremost the unprecedented monetary quantitative easing which dwarfed the stimulus applied after 2008, or any other period in history. QE drove asset prices across the board to ludicrous extremes. Elon Musk saw his wealth increase 10x in less than two years. Yes, you read that right - from $30 billion to $300 billion. Owners of assets - homes, condos, and stocks - were made instant millionaires. Mostly Boomers. Meanwhile younger generations were locked out of  over-priced markets and then systematically bilked by rampant pump and dump schemes. Think of the collapsed FTX crypto exchange and Sam Bankman who was just convicted this past week of rampant fraud. The Big Short author Michael Lewis  was calling this criminal a "genius" right before FTX collapsed. You can't make this bull shit up. The amount of fraud in this era eclipses any other era in modern history. Nevertheless, the millionaire/billionaire wealth effect continues to drive inflation across the economy. Meanwhile, retailers are warning that middle class and low income consumers are imploding: 

“Wealthier folks are still spending, especially on international travel, blowout entertainment and other services and experiences”

"...low-income families are pulling back now that federal stimulus and pandemic-era savings have run out, and middle-income families, who are “selectively trading down” by buying paper towels at the dollar store"

Pandemic stimulus was a source of inflation, but those programs ended two years ago. Interest rates cuts fueled inflation for a time, but rates have now tripled from their levels before the pandemic. Which leaves interest rates above their 2007 levels. 

In other words, we are to believe that the post-2008 deflationary paradigm is over, having been replaced by even more extreme asset prices, far more debt, and sky-rocketing interest rates. 

Here we see that home prices have continued to defy gravity. However, back in 2007 home prices didn't implode while rates were rising, they imploded while rates were declining.

And guess what, interest rates are set to now decline.  

In summary, the party is over. But the wealthy are still partying like it's 1929. Because, guess what, for them that's what this is.

Position accordingly.

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.