TGIF

Quick update for the weekend. Happy Cinco de Mayo to everyone...

This week, bulls narrowly escaped meltdown, with the assistance of end of week options expiration and the associated options-driven "gamma" unwind caused by Fed, ECB, Apple earnings and the jobs report. That's a lot of "gamma", meaning a lot of expiring put options that drove market makers to buy stock in an upward feedback loop that has become a common occurrence on Fridays. Next week is a whole other story. As I showed on Twitter, the exact same confluence of events marked the top three months ago: 

As expected, both the Fed and ECB raised rates again this week. Notwithstanding more dominoes falling across the banking sector.

In a week of foolish commentary, one of the dumbest ideas of the week was European pundits asserting that the bank collapse is a U.S. only problem. They have already forgotten that Credit Suisse collapsed a few weeks ago. And they've forgotten that in 2008 what started in the U.S. very quickly went global. 

But the buffoonery did not stop there. Jerome Powell asserted that the banking sector is "sound and resilient". Jamie Dimon asserted that with JP Morgan's takeover of First Republic, the bank run is over. 

When this all explodes to the surprise of everyone, the question for this era will be why did so many pundits believe it's their job to sugar coat bullshit for public consumption? Did they really think they could avoid a global credit collapse by lying constantly?

Yes, they did. This article very adeptly impugns some of today's infantile narratives:

"If Jamie Dimon was pondering a career change as a fortune-teller, he’d be wise to stick to the day job...the speed with which Dimon’s words have come back to haunt him comes as a shock"

The reality is that the establishment is in no position to offer any guarantees...when customers take fright, bank runs are practically impossible to stop"

"Regional lenders successfully persuaded the Fed and the FDIC that they were not systemically important"

Indeed. Careful what you wish for. 

You see another false narrative circulating is that unlike 2007, there is "no subprime" this time around. Back then, large banks were laden with junk mortgages packaged up into Wall Street time bombs. 

This time around, banks ARE the subprime. Their massive asset duration mismatch combined with today's high interest rates have turned banks into ticking time bombs.  

And, what have our policy-makers done this week? They conspired to raise the cost of capital to a three decade high.

The "good news" is that Fed futures are pricing in a pause in June and rate cuts by September. 

By which time, this will all be a smoking fucking crater:

Tequila!!!

BOOM AND BUST

To date, the emergency response to this incipient financial crisis has been the exact opposite of 2008. It's clear that 15 years of continuous monetary bailout has fried the brains of investors and policy-makers alike...

We have achieved Terminal Idiocracy.

In my last blog post I asserted that the debt default "x-date" was not yet known. This week, Treasury Secretary Yellen said the default date is very likely early June, so about a month away. Granted, there is no question a deal will get done. The question now is WHEN will a deal get done. Because in the meantime, stocks have no upside. No large scale investor is going to commit capital on a substantial basis until the debt deal is out of the way. 

Furthermore, in a year when recession risk is already cycle high, stocks now face simultaneous monetary and fiscal tightening. Either Biden commits to reduced spending or the markets explode. Either way, it's deflationary.

In this chart I showed that every small cap death cross since 2009 has led to S&P 500 crash. Four out of five times were due to either fiscal or monetary tightening. This time, we face BOTH fiscal and monetary tightening in a confirmed death cross:

Also since my last update, we now know that First Republic did indeed implode. However, the carcass was bought by JP Morgan over the weekend, which prevented the FDIC from realizing additional major losses. Regardless, the collapse of regional banks resumed this week because investors have figured out that under the terms of the BTFP liquidity lifeline, there likely won’t be any regional banks still standing a year from now. The BTFP merely exchanges balance sheet losses for P&L losses.

What banks need is a recession and lower interest rates ASAP. Because they can’t make money borrowing at a Fed rate of 5% against a bond portfolio yielding 2%. In addition, BTFP only lasts one year so rates need to come down ASAP before the entire sector implodes.

But, rates won't come down until banks implode.

As expected, criminality is exploding on this right shoulder of the two year head and shoulder top. So far, we've seen FTX implode. Adani implode. THREE of the largest bank failures in U.S. history: First Republic (2nd), Silicon Valley Bank (3rd), Signature (4th). And Credit Suisse imploded. 

This week we learned that Carl Icahn is running a "Ponzi-like" structure. The same short-seller - Hindenburg Research - that imploded Adani, went after infamous short-seller Carl Icahn. 

Reading through their analysis is highly reminiscent of Bernie Madoff's strategy. Basically, a fixed rate of return (+15%) which was in no way backed by asset increases to match the rate of return:

"Icahn Enterprises’ current dividend yield is ~15.8%, making it the highest dividend yield of any U.S. large cap company by far, with the next closest at ~9.9%...The dividend is entirely unsupported by IEP’s cash flow and investment performance, which has been negative for years. IEP’s investment portfolio has lost ~53% since 2014"

And yet with each fraud revelation, complacency among investors remains extreme. Here we see the Nasdaq VIX collapsed down to the same level as May 2021 which as we recall was the left shoulder.

We have only scratched the surface of impending revelations of rampant fraud.

In summary, I was going to wait until after the FOMC decision to make this post, but why wait. I think today will be the last rate hike of this cycle, because gamblers are now exchanging a long-awaited Fed pause for incipient economic and financial meltdown.

This Congress can't even agree to avoid a U.S. debt default, so how could they ever arrange a just-in-time financial bailout? That is wishful thinking of the highest order. 

Hence, it's consensus across Wall Street.

FOMC: FEAR OF MISSING CRASH

In 2023, bulls are trapped between the Scylla and Charybdis of Monetary and Fiscal dumb and dumber. It's a good thing they have artificial intelligence on their side...

The so-called "x-date" for U.S. default is now somewhere in June or July. No one knows for certain. Suffice to say, it's close enough to start garnering the attention of *some* markets. As of last week, the bond market had priced in a six sigma premium on the 3 month t-bill. However, that premium dropped when the House passed their smoke and mirrors spending bill:

WSJ: Democrats Reject House Spending Bill 

As we see below, the bond market is far more worried than it was in 2011.

The problem is that this debt ceiling fight has now become all about the 2024 election. Biden this past week said he is running for re-election. Therefore House Republicans see this as their best chance to implode his presidency. Neither side is willing to compromise because both sides are convinced they MUST "win" this battle or admit failure to their own base of morons. This is all politics now. 

Which means there will be no winners. Bulls are now hostage to the extant Idiocracy. This house of cards won't withstand a repeat of 2011 when stocks imploded -20% upon a deal being reached.

Here we see the gap between the Treasury VIX (Move index) and the S&P 500 VIX is the largest since 2008:

Also this week, bank explosion re-started after a six week hiatus. The issue for banks is that the pandemic flooded them with unprecedented deposits and they invested those deposits into long-term bonds, creating history's largest duration mismatch. Next, the Fed panic raised interest rates at the fastest pace in history, causing unprecedented bond losses. 

Now, deposits are leaving banks for higher yields, because money market funds are yielding 10x higher than typical deposit accounts. 

It's looking more and more likely that First Republic will be the next shoe to drop and very likely the first bank NOT to receive a FULL bailout. Meaning that the standard FDIC depositor limit of $250k per account would apply. 

Should that happen, we would very likely see mass panic across the ~$7 trillion of uninsured deposits still sitting in banks.

That's when that middle pane black line would meet the blue dotted line and keep on truckin'.

You DON'T have to be a genius to figure this all out. But you DO have to be able to fog a mirror.

All of which gets us back to the much-loved 1930s monetary "pause" rally. 

Since bank stocks imploded in early March, Tech domination has reached three decade breadth extremes.

"The S&P 500 at a forward price-to-earnings ratio of 19x would be a high hurdle even at lower rates let alone one where the growth outlook is diminishing, monetary policy is tight with risk-free yielding about 5 per cent, and event risks are increasingly disconnected from VIX"

Overvaluation, profit recession, monetary tightening, unprecedented event risk. 

Sound familiar? It's the bull case in a nutshell.

Tech over-weight has been further stretched this week by Tech earnings which have come in "better than feared". Which is the new Wall Street mantra for sucking dumb money into the casino.

Because, let's face it, that's where it belongs.

DENIAL IS DEFLATIONARY

Right around Earth Day each year my rage peaks. It's times like now when I have to remind myself that living in a denialistic Idiocracy has environmental advantages...

Case in point, the pandemic caused the largest carbon collapse in modern history. Oil demand dropped to a 25 year low overnight. Next, the pandemic deleveraging phase will re-collapse oil demand back down to the pandemic lows. In other words, we've achieved peak oil and we didn't even know it. It all happened while our leaders were flying around to climate conferences making promises they had no intention of keeping. 

All of this happened because the consumption Borg panicked over what turned out to be a relatively innocuous virus. There was no point during the pandemic when COVID was the leading cause of death. In 2020 and 2021, McDonald's killed more people than COVID. You know what I mean, shit lifestyle:

CDC:

 

Meanwhile, the FULL cost of the pandemic is still spiraling inexorably larger like a sky-rocketing medical bill for an uninsured geezer on course to supernova bankruptcy.

As we see above, oil demand never recovered after the pandemic, because the economy was virtualized by Cloud Technology. Cloud technology, AI - it's all very deflationary because it allows knowledge workers to be replaced by technology. In other words, the pandemic completed the last stage of the full scale commodification of humanity. 

During the pandemic, major corporations allowed office workers to work from home. Many companies such as Facebook encouraged workers to move out of state. Two years later and they are now instituting mass layoffs on an industrial scale. Companies are now giving employees ultimatums to return to the office or face layoff. What used to be an employee benefit is now an employee liability. And it's so much easier to lay off people when they are not in the office. Just send them an email informing them that they are terminated.

Enter earnings recession - meaning two quarters in a row of earning decline. Today's S&P companies are "beating" the quarter by having an aggregate -6% year over year decline in earnings. Wall Street will demand fresh layoffs in the new quarter or the stocks will get punished.

Here we see Challenger layoffs on a five month moving average. The highest since 2008. Note that I suppressed March 2020 due to the unprecedented pandemic mass layoff.

Another related impact of the pandemic was the downsizing of office space caused by all of this virtual working. Companies are finding that their post-pandemic office space requirements are a fraction of what they were pre-pandemic. Enter another cost cutting opportunity.

 

Which gets us to the fiscal clusterfuck, which is also deflationary.

Remember this guy Kevin McCarthy, the House Speaker who got voted down by his own party multiple times back in January? Well it turns out HE has to get Republicans and Democrats on board with a debt deal to avoid U.S. default within the next month.

What could go wrong?

"The clown car that has been Rep. Kevin McCarthy’s speakership spluttered to a halting start over 15 long ballots in January and hasn’t had a second of a smooth ride since"

Goldman Sachs economists echoed earlier warnings from Treasury Secretary Janet Yellen that default could occur as soon as the first half of June, due to “weak tax collections.”

Tick tock.

Put it all together and in the coming weeks, we have a clown car of incompetence heading over a fiscal cliff.

We have an earnings recession in which the most-overowned and over-valued sector (Tech) is facing the worst earnings decline of any sector.

And another Fed rate hike. 

All signs point to a well deserved hard landing.

RALLY INTO RECESSION

The entire bull case now hinges on recession and just-in-time bailout...

We have now officially entered the age of Artificial Intelligence. Why that's good is not for me to say. 

Strange days indeed. Normally it's bears who are waiting for recession, however this time around it's bulls. This lethal turn of events became inevitable when Fed stimulus became the ONLY factor that matters to stock prices.

If you don't believe me, here we see that the entire rally since the October low took place amid falling bond yields. We also see what happened in March when yields flared up again. Bank run.

So it is that stocks are happily rallying into a latent depression deja vu of 1930.

 

On the monetary policy side, things get even more dire near-term given the ~85% probability of another rate hike in two weeks time. 

Here we can compare what happened in late 2018 when the Fed blew up banks versus now. Back then, they paused and bank stocks rallied back above where they were pre-rate hike. Whereas now, six weeks later, regional banks have gone nowhere.

Another rate hike seems like a bad idea given that 2018 is the ONLY example when the Fed pulled off a soft landing. And now they have thrown out that playbook. 

Then there is the looming fiscal fiasco. So far, this year is turning out to be similar to 2011. Back then, the incoming GOP House majority was hellbent on imploding the Obama budget. Funding ran out in May. This time, funding already ran out in January. The Treasury is already resorting to "extraordinary measures" to keep the budget from imploding. 

As we see below, in 2011 the U.S. never actually defaulted on the debt, but GOP politicians dicked around until markets went RISK OFF. After that, the deal was ignored. Similar to October 2008 when the TARP bailout passed after it failed the first time. The market imploded. Similar to March 2020 when the Fed cut rates and restarted QE during the incipient meltdown. The S&P futures went limit down. 

You get the idea. These fucking morons are wasting time while bulls get more optimistic by the moment. 

 

In summary, party on Garth.

BTFP

The pause rally which began last October just passed six months. Which is the same length of time the Dow rallied in 1930 from the October 1929 crash low. Then the wheels came off the bus for good...

This has been the pause rally. Never mind that there was no rate pause - it's imaginary. Like everything else in Disney World.

An unnamed bull claimed recently that more money was lost trying to avoid bear markets than from the bear market itself. Tell that to those who hung on after 1929. It took 25 years to get back to breakeven. Not everyone has that kind of time. 

Bulls continually make the most optimistic assumptions to arrive at their fairy tale conclusions. Wall Street is currently predicting a -4% earnings recession in 2023. 

Below we see that in 11 out of 11 recessions since 1950, corporate profits as a share of GDP fell back below 6%. The pandemic was the twelfth recession, the shortest recession in history, and the only time profits grew during the recession. Bulls are now betting it will happen twice in a row.

If they are wrong, they have -40% downside. Minimum. 

Corporate profit / GDP (blue horizontal line is 6%):

We are in a demographic super bubble. The pandemic arrived at the worst time possible for Boomer retirement. Twenty million mass layoffs in March 2020 - aka. a decade worth of jobs - forced two million Boomers to retire early. Subsequently, the economy has been beset with inflation especially in the low paying service sector. The Fed has made almost ZERO progress in bringing down service-side inflation. Which means they will continue raising rates until something else breaks. 

Fed policy throughout this debacle has been highly regressive. Which means that it has been good for the wealthy and very bad for everyone else. They have kept their balance sheet at double the pre-pandemic level while raising rates TRIPLE the pre-pandemic level. The middle class is about to implode, but the wealthy are totally clueless. In 2023, both fiscal and monetary policy will be highly restrictive. Fiscal policy will be constrained by the impending debt ceiling crisis which hits no later than July.

Which gets us back to the casino.

The pause rally is now six months old. During this time, markets have fully discounted a rate pause. What they haven't discounted is a recession. 

If the Fed eases it will because of recession. As we see below, when rates came down, stocks imploded. 

  

 

Many bulls are saying that October was the low because sentiment reached an extreme. However, what they are ignoring is the fact that stocks remained historically overvalued relative to Treasury bonds. 

Below is the equity risk premium which measures the S&P yield relative to the 10 year bond yield. In 2008 and 2020, the ERP soared. In October 2022 the ERP hit a cycle low. 

Entering earnings season, bulls are counting on RECORD corporate stock buybacks to paper over the incipient collapse in corporate earnings. We are on MAXIMUM smoke and mirrors. 

One must ask the obvious question, if corporate buybacks are  so high then why are the stocks with the largest buybacks imploding?

In summary, volatility has collapsed back to where it was at the all time high. 

Which means, BTFP.

A BUBBLE IN COMPLACENCY

What we are witnessing in real-time is monetary policy failure. The full cost of which will be revealed during the deflationary phase...

There has never been a rate hiking cycle without a recession and there has never been a recession without a significant rise in unemployment. Therefore, today's bullish pundits are of the mind that  for the first time history, we will have both - no recession and no significant unemployment.

Unemployment rate (red)

Fed funds rate (green)

The two most recent cycle downturns were the Tech bubble in Y2K and the housing bubble in 2008. This pandemic hangover bubble features both six sigma Tech overvaluation and RECORD housing overvaluation yet pundits don't predict a meaningful correction in either market. What we are witnessing is 15 years of central bank moral hazard unwinding the hard way. Amid abject denial.

Here we see homebuilder stocks inversely correlated to homes sold, for the first time in history. Which is why the ratio of homebuilder stocks to homes sold is at a record high (bottom pane).

In Tech-land, delusion is likewise rampant. The best performing sector so far in 2023 is about to see the largest earnings decline of any sector:

"This year’s rally in the shares of the biggest technology companies is the best thing going for bulls. It’s about to run into an earnings season that’s expected to deliver the biggest profit drop for the tech sector in more than a decade."

The (15%) projected drop for tech earnings in the first quarter would be the biggest since 2009. The consensus has been consistently weakening: Six months ago, analysts in aggregate were expecting that tech-sector earnings would edge up by 1%"

Q4 2022 saw the biggest decline in Tech spending in U.S. history:

At the beginning of a Tech bubble, the stocks hiring the fastest perform the best. When the bubble collapses, the stocks laying off the fastest perform the best. 

"Tech already has cut 5% more than for all of 2022, according to the report, and is on pace to eclipse 2001, the worst year ever amid the dot-com bust"

We saw all this before of course in Y2K. Back then it took 17 years for the Tech sector to overcome the bubble high. This time, gamblers are expecting new highs any day now.

We just got "better than expected" CPI, but the core CPI re-accelerated. There has never been a time when the Fed paused rate hikes with the core CPI above the Fed rate. So another rate hike is a lock for May.

The Fed has raised rates 4.75% but the core CPI has only come down 1%. Which means we are witnessing monetary policy failure for the first time in history:

Warren Buffett says more bank failures are inevitable, but ALL deposits are safe. Which is totally delusional. 

Article 1:

"Investing legend Warren Buffett believes there could be more bank failures down the road, but depositors should not ever be worried"

Article 2:

"Buffett said the government would likely step in to backstop all depositors in all U.S. banks if that was ever necessary, though he did note that would require Congressional approval"

Buffett, 92, said he so confident that U.S. depositors are safe that he would put a million dollars of his own money in a bank"

A multi-billionaire doesn't even have $1 million of his own money in a bank, but he says it's 100% safe.

Because if it's not, HE is not getting bailed out this time.