MELTDOWN REPORT 8/12/2022

Despite the fact that the CPI came in weaker than expected, cyclicals enjoyed a major rally this week due to the fiscal stimulus bill that just passed. Will this bill remediate Global Warming? Of course not. But the attendant short covering rally could initiate global meltdown, which will do more to reduce the carbon footprint than any legislation imagined by any government...

Banks rallied this week, despite the flattest yield curve in 40 years.

This is the first weekly close for crude oil below the 200 dma since the pandemic started:

Inflationists wrong. 

Again.

What is more cynical, to vote AGAINST a bill to finally address Climate Change? Or to vote FOR a bill that is too little too late?

"Once I stood to lose her

When I saw what I had done

Bowed down and threw away the hours

Of her garden and her sun

So I tried to warn her

I turned to see her weep

Forty days and forty nights

And it's still coming down on me"

WAITING FOR OFFICIAL BURIAL

By the time the National Bureau of Economic Research finally declares official recession, their astute observation will be only useful to archaeologists attempting to figure out what happened to the deeply buried Kardashian society...

While playing history's greatest central bank following fools, today's gamblers believe that time is on their side. Nothing could be further from the truth. With each passing day the hole gets deeper. But you would have no way of knowing by reading the mainstream financial media. They have a skill at turning all economic risk into gold plated opportunity. If Bernie Madoff was alive he would be head of the SEC.

We have now crossed over into the back half of the year, well into the months (August/September) that have caused the greatest financial dislocation in the past two decades. It appears that for whatever reason, the worst first half stock market performance in 60 years ignited a massive short-covering squeeze. Many hedge funds that were short in the first half decided to book profit. Which means that now currently there is no short buffer below the market:

Bloomberg July 28th, 2022:

BEARS UNWINDING SHORTS LEAVES STOCKS EXPOSED

"The rally, and attendant change in sentiment, has forced speculators to unwind bearish positions that once served as a key source of (stock) demand...With short sellers retreating, stocks might be exposed to a downdraft if the Fed turns more aggressive on future rate increases or corporate profits start to crater"

This implies that there is plenty of room for CTAs to start building up short positions again.” 

In other words, shorts covered despite the fact that risks have grown steadily since the beginning of the year. Goldman Sachs started the year with a prediction for four rate hikes in 2022 (1%) and they are currently predicting 16 rate hikes (4%). All Wall Street economic growth predictions have now been updated with minus signs. 

We can see the reduction in short positions via the CBOE option skew which is an indicator of short positions in the options market:

Another risk that still never gets mentioned is the Fed's Quantitative Tightening program which in September will be twice as lethal ($95b/month) as the prior tightening in 2018. And yet commodities are already collapsing deja vu of 2008 and from the exact same level:

Basically what happened since the end of the first half is that bearish money managers took profit while betting the worst was over. When in actual fact the worst hasn't even started yet. 

Which is why investors are now praying for recession to get them to their imaginary promised land of a Fed reversal near the zero bound. Their safety net is no longer shorting, their new safety net is believing that the Fed can finish tightening and pivot to bailout fast enough to prevent wholesale meltdown. 

Even at this late juncture I have yet to hear ONE pundit inform the public that a 2.5% Fed Funds rate is not enough to prevent economic depression, much less deep recession.

Yield curve inversion is now the flattest in forty years, meaning that long-term rates are significantly lower than short-term rates as the bond market predicts the Fed is making a COLOSSAL mistake by overtightening:

So it is that investors now believe that all bad news is good news for stocks. Their new buying mantra. A mantra that has been assiduously cultivated during the era of financial Disneyland that has abided since 2008.

Today's CPI showed that inflation may well be peaking, however some context is in order, because the CPI is still a long way from where the Fed will stop raising interest rates. If the past twenty years is any guide, that level comes in at about 4.5% on the CPI:

Deja vu of the March rally, this latest rally is an overthrow of the June high and a backtest of the 200 dma, coming off of the lowest volatility of 2022. In addition, VIX below 20 attracts a lot of bulls who believe it's a sign the bear market is over. It was a bull trap in April but for these amnesiacs that is long forgotten.

Here we see via AAII positioning data, the shocking divergence in cash balances from 2008 versus now:

https://www.aaii.com/assetallocationsurvey

In summary, it's abundantly clear that today's investors missed the "pivot" from inflation to deflation and from fantasy to reality.

And who can we thank for that but all of the pundits who told them that inflation was NOT transitory in 2022.

Wrong again. This time with no cash buffer AND no monetary safety net. 

BULL CRAP

Doom and gloom is pervasive across a variety of risk factors, which is why this society excels at ignoring it. There is a belief now that as long as everyone sees something coming, it can't happen. Which is sheer denialistic fantasy of course. This society now specializes in talking about problems full time while doing nothing about them. Always taking the easy way out. Which means that all of the "change" has been delayed and therefore all of the various crises will come crashing down at the same time...

 

Fortunately, I did not shred my credibility by attempting to guess Friday's jobs report which came in more than double what economists expected. These are the people that this society depends upon as experts. They've been substantially wrong for every jobs report in 2022. In just one week, the odds of a .75% rate hike in September jumped from 28% to 68%. Remember the Fed pivot? That is history. 

The pivot theory actually started back in June with the first .75% rate hike. The theory was the Fed would "front load" all of the rate hikes in June and July and obviate the need for further rate hikes. Here we are in August and the theory is already dead. 

Far too many bulls are STILL trying to front-run the Fed which has the effect of compressing risk spreads and otherwise EASING financial conditions. Which forces the Fed to keep tightening. 

From an economic standpoint, the Fed remains fixated on lagging indicators while ignoring leading indicators. The number of McJobs created in any given month has no bearing on inflation. During the 1970s, job creation continued well after the economy was already in recession in 1970, 1974, and 1980.

We are still struggling with the after effects of the pandemic when job openings sky-rocketed. But now we see they are beginning to roll over:

The labor participation rate for the key younger demographic still hasn't recovered to pre-pandemic levels. Which means that a lot of people are now going to be long-term unemployed. 

Now on to everyone's favourite topic - Disney markets and imagined realities. 

This is now the second headfake rally in 2022. 

There is now a desperate belief that institutions which have been selling all year long will soon be bidding up the stocks of retail bagholders. That has NEVER happened in the history of markets. What happens next is that retail bagholders puke out stock into a collapsing market, the Fed is forced to reverse, and THEN institutions come off the sidelines. This idea that the dumb money is now the smart money and vice versa is the height of desperation. 

This second rally of 2022 looks almost identical to the first one, and shares many of the same attributes: Extreme low volatility, overbought oscillator, overbought volume momentum, three wave retracement and of course it confirms the second quarter in a row of negative GDP. Qualitatively it's clearly different than the rallies that attended Fed bailouts in 2018 and 2020. This rally has yet to take back the 200 day moving average. Which means bulls are now facing the second failure at the 200 dma - something that has not happened since 2008. 

All of which is why I call this the "recession confirmation rally".

If you can't understand it, it's because your IQ hasn't collapsed like a cheap tent. 

Here is the Nasdaq on the weekly. This rally percentage wise is basically identical to the first one:

This week, crude oil decisively broke the 200 day for the first time since 2020:

Here we see stocks are tracking copper very closely as the world economy implodes in broad daylight:

In summary, by the time we get official confirmation of recession, bulls will be officially buried.

Like last time, except far deeper and with no hope of bailout.

ECONOMIC APOCALYPSE NOW

Bulls will be happy to know that I have officially downgraded my economic forecast to economic armageddon aka. "BTFD"...

mor·al haz·ard

“lack of incentive to guard against risk where one is protected from its consequences”

The Fed is clueless. Investors are complacent. Wall Street is corrupt. What's new?

Before considering any market forecast one must first discern whether or not the pundit is operating under the post-2008 rules or pre-2008 rules. The vast majority of today’s commentators are operating under the continuous monetary bailout rules that have abided since 2008. Those readers who believe THAT era still applies, should proceed straight to CNBC and Zerohedge for your daily financial infotainment enema.

This is for those who believe that the era of continuous investor bailout was always going to end with a widely embraced swan dive straight into the economic pavement at the zero bound. 

First off, we are witnessing an unprecedented event wherein the economic data is deteriorating faster than the markets. Which is a function of a Fed believing that inflation is "sticky" and therefore willfully ignoring all escalating signs of economic risk. It's clear they are not concerned that their actions are accelerating economic meltdown. The Fed has never been adept at managing soft landings and currently their own economic models predict only 10% chance this time. Hence it’s the consensus bet on Wall Street.

The Fed and investors have reached a deadly standoff. The Fed needs investors to reduce risk to bring down asset prices. Investors however expect the Fed to capitulate and bid up markets. Neither side has blinked. Yet. Therefore, the Fed is forced to continue tightening until investors capitulate. In the meantime, the economic data continues to steadily worsen.

So far, there is NO sign of fear from investors.

Institutions have been taking down their market exposure all year due to the rising economic risk. However, this has been a very orderly de-risking process with no sign of panic. As opposed to 2020 when both the VIX and market volumes skyrocketed. 

Individual investors have largely stayed the course and remained over-invested in stocks going into recession.

The housing bubble has now become the locus of primary risk. Home prices are collapsing at the fastest pace since 2008. Housing inventories are rising at the fastest pace in history and are already at a level previously associated with deep recession and economic deleveraging. Add in an over-priced auto market beginning to implode, durable goods slowdown, consumer debt skyrocketing, semiconductor glut, PC/mobile phone decline and soon you are talking about the entire market ex-narco-pharma and Disneyland.

Coming off of last week’s Fed rate hike, many pundits are saying it’s too early for a Fed pivot. Nothing could be further from the truth. It’s too LATE for the Fed to pivot, because economic risk is already past the point of timely bailout. At this point the Fed should jack rates up as fast as possible so they can turn around and slash them back to zero. Gain some altitude before the crash. 

The Fed will never be able to pivot in a way that rescues today’s investors who are already over leveraged on risk. The Fed pivot will be a step along the way to investor wipeout. Investors are now trapped by the bailout rules that applied since 2008 and the pundits who espouse them: Meaning, the worse the reality of the economy becomes, the greater the expectation of large scale bailout.

Russian roulette with no spare chamber.

None of what I am saying makes any sense to those who have no memory of real markets prior to 2008. Back then valuations mattered, bad news was bad news, and the mantra was don’t fight the Fed. Now, all of that has been turned on its head.

Market reality has been on vacation for 14 years and now it’s returning home to economic apocalypse. Bought with both hands at the zero bound.

The unforeseen cost of bailing out financial criminals who are now predominant across the financial media.

Booya skidaddy!!!

THIS IS NOT A DRILL

You are not imagining things, this is all far worse than it looks...

This is not the end of the world, this is the end of a Kardashian society doing everything possible to keep their facade from crumbling.

We are witnessing escalation towards all-out war in Europe (U.S.).  Escalation towards war between China and Taiwan (U.S.). The total destruction of Ukraine. The end of Russia as a functioning nation state. Mass shootings not just in the U.S. but worldwide on an unprecedented scale. Political bifurcation bordering on civil war.  40 year high inflation. Societal breakdown reaching a boiling point. And of course environmental apocalypse in real-time. 

To top it off we are now in recession with a Fed still in tightening  mode and Wall Street telling investors THIS is the start of the new bull market. When this gambit fails, don't worry about Wall Street, there won't be one. 

If you want to see a prime example of epic mass confusion, look no further than Zerohedge who have the unique ability to contradict themselves continuously and yet always be "right".

Things Can't Get Any Worse. Fed Pivot Coming

Wall Street Expert: Too Early For Fed Pivot

Pivot Hope Sends Stocks to Best Month Since April 2020

Why the Pivot Rally Will Fail

In other words the disinformation overload worked great. Mass confusion has led to mass financial complacency.

I would caution anyone who believes this Wall Street fairy tale that there will be recession for the middle class at the zero bound and a bull market for stocks. The CPI is now the biggest enemy of the economy AND stocks. It precludes the Fed from bailing out ANYONE on a timely basis. Which means that BOTH markets and the economy are at a high risk of crash. Which will be deflationary. 

In this chart we see the level of option hedging in the top pane is lower than all prior market events. And we see the CPI in the lower pane. In ALL prior Fed bailouts, the CPI had been falling for at least six months and was below 2%. Except, the pandemic when markets were limit down six times in two weeks. THAT is what it will take for another bailout. 

Unfortunately, this whiplash u-turn from an inflation narrative to a recession (deflation) narrative has come far too fast for investors as a whole to adjust. It ensures that hardcore inflationists are about to go through the windshield.

This week's confirmation of recession means that it's now clear for institutional investors to rotate from stocks and cash back to Treasury bonds. Whether you believe in Wall Street's "soft landing" fantasy or the hard landing reality, Treasuries SHOULD rally.  However, unlike Treasuries, in the hard landing scenario, stocks will crater. Treasuries are a safe haven from deflation and global meltdown. Whereas stocks are massively overvalued relative to Treasuries and in recession, earnings AND profit margins will implode.

As we see from 2018, after the Fed pivoted both performed the same. However, at the start of the pandemic, stocks crashed while T-BONDs continued to rally. I see 60% or more upside from Treasuries in the next 12 months which will take yields back down to the zero bound.     

Why am I telling you this?

Normally, I don't give financial advice. However, I feel an obligation to point out this one time that T-bonds present a rare opportunity for outsized gains over the coming 12 months. 

Here are my caveats: One, I have a core position in Treasuries that I plan to trade around. So, you know I have a bias. Secondly, if you notice above, Treasuries crashed in the early part of the pandemic for a very brief amount of time. That's because a lot of institutions panicked and sold everything to go to cash. 

I suspect they will do the same thing this time around, to gain liquidity for the impending avalanche of redemptions. You see the problem is that due to the inflation narrative, most investors are far too light on cash. And that poses a huge liquidity challenge for the Fed. It means that markets are about to get out of their control. 

If the Treasury market crashes, two things will happen. First stocks and everything else will go limit down. Second, the Fed will panic and Japanify the bond market back to 0%. Personally, on a crash I will back up the truck to buy Treasuries.

The third and last caveat of course is what if inflation continues to escalate. I have every confidence the Fed knows how to implode markets and the economy to bring down inflation. So far, I give them an A+ in 2022. Their level of recklessness is insane and the bond market happens to agree with me.

In summary, if you think that the system is rigged and you want to stand as close to the printing press as possible, buy Treasury bonds and wait until the Fed has no choice but to take you out of the trade at a much higher level. And don't tell anyone you are now part of the "elite". 

GAMBLE AT YOUR OWN RISK.

THE MELTDOWN REPORT 7/29/2022

Many new traders wonder why the market would be up in a week when there is a triple rate hike AND confirmed recession. When traders buy weekly put options on the anticipation of bad news then the market makers on the other side of the trade hedge their long put position by shorting the market. This causes the market to dip ahead of the bearish event. However, once the event passes, then a combination of time decay and price movement causes those expiring options to lose value. Market makers reduce their hedges by buying back stock. This creates a feedback loop towards the end of the week as the stock buying pushes more of the put options out of the money. Ironically, bearish option traders create the rally.

However, it's not a long-term phenomenon. It has its greatest effect during central bank meetings, monthly opex (third week), and of course the end of the month during window dressing.

As we see, this three month pattern is very similar to the one ending in March. That was a bull trap, and I suspect this is a bull trap as well. When the March rally ended, the market fell -20% in six weeks. 

If the cycle repeats then the market will be in confirmed bear market territory.

For all of the fake excitement over Amazon earnings, that stock has the same form it had the last time it imploded.

This week, despite Fed tightening, yields broke to new lows:

The global Dow, fourth lower high:

Metals and mining stocks, a very similar bounce, this time off of key support:

No sign of capitulation

March and July are the only two up months for the Nasdaq in 2022. 

The summer rally is very likely over. Now comes the month that has seen the biggest crashes since 2008 (pandemic aside).

In summary, the U.S. is in confirmed recession ahead of Europe, China and the rest of the world.

Which means that hot money will now exit U.S. markets at the speed of yield collapse.

What comes in too fast, goes out too fast.

 

DANCE WHILE THE MUSIC IS PLAYING

Back at the market top in 2007 Wall Street was making all manner of excuses for investors to stay the course. They are doing the same thing right now. Trying to keep the sheeple from bolting...

July 2007:

Citigroup's Chuck Prince Wants To Keep Dancing. Can You Blame Him?

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance"

THIS is how the era of continuous monetary bailouts and extreme moral hazard was doomed to end - with an Idiocracy now questioning the definition and even the possibility of recession while the walls are closing in on them from all sides.

This chart shows that the two quarter moving average of GDP decline now exceeds Y2K, which was an "official" recession. 

Most young investors are of the belief that the 2020 v-bottom recovery was typical - a four week recession and bear market followed shortly after by new all time highs. CNBC and Zerohedge pundits apparently don't have any recollection earlier than December 2018 which was the last time the Fed successfully "pivoted" from tightening to neutral and the market took off. The difference of course is that this time the economy is now in a confirmed recession. Stock valuations are higher now, the housing market is imploding, the car market is imploding, and inflation is at a 50 year high. Meaning consumers are TOTALLY tapped out. Which is the message coming through this quarter's earning announcements, however CNBC and Wall Street have done a great job of putting lipstick on the pig. The mantra of the day is: "Not as bad as feared". Meaning the company "beat" collapsed expectations. Bearing in mind that most of the guests on CNBC are money managers who have to put money somewhere. So all they care about is which stocks will go down the least in a recession. Apparently they've forgotten the lesson from Y2K.  

Back in the Y2K bubble, first the profitless junk stocks imploded. When that happened money rotated to the mega cap stocks: Microsoft, Intel, Cisco, and Dell on the assumption they were Tech safe havens. As a result those stocks became massively overvalued as growth slowed. And then those "safe havens" imploded. The same thing is happening now.

Meanwhile, mega cap Tech stocks remain top holdings in every portfolio.

Apple is an excellent example of Wall Street smoke and mirrors. We were told the company "beat" earnings expectations, but profit was down -11% year over year. If you take into account CPI however, REAL profit was down -20% year over year. 

CNN Business: Apple Profit Declines -11%

In other words, it was a very bad quarter and the company is using inflation to hide how bad it was.

Despite lowered expectations vis-a-vis last quarter, Microsoft missed, Google missed and Facebook missed. Amazon took expectations down to rock bottom ahead of the quarter, and Apple covered up a year over year profit collapse with the assistance of media con artists.  

Zerohedge: Apple Beats On Top And Bottom Lines

"AAPL did not disappoint...easing concerns that supply chain snags and a shaky economy would ravage the tech giant’s sales"

Sure. 

The CPI is hiding economic collapse in broad daylight. 

Here we see real wages have collapsed -3%, the most in 20 years and more than 2008. It's fortunate that so far GDP is only down -1%. Clearly consumers are digging into savings. 

There are eight weeks until the next FOMC. In the meantime, the economy will be weakening as the lagged impact of these most recent rate hikes takes effect. Meanwhile economic reports which operate on a lag will continue to show elevated inflation and economic activity while the real-time indicators are collapsing. During this lag period, Wall Street will be doing everything possible to paper over collapse with their standard end of cycle chicanery. 

Pundits are already telling people that inflation has peaked and it's time to pile back into the market:

“When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.”

Here below we can see that when the Fed stopped raising rates and began lowering them in 2007/2008, that was the period of maximum drawdown. We also see that it took the National Bureau of Economic Research a FULL YEAR to declare official recession. By that time the market was down -50%. When the Fed met at their fateful Lehman meeting in September 2008 they had no idea the economy had already been in recession for nine months. 

Going into the steepest part of the decline, only 5% of Wall Street recommendations were sell:

Ritholtz May 2008:

Only 5% of Wall Street Recommendations are "Sells"

In summary, this is a BULL TRAP of biblical magnitude.

One thing I agree with Cramer on is that the Fed is likely done hiking rates. Which means they are now going to "pivot" at a 2.5% Fed funds rate. In other words, Wall Street’s best case scenario is actually the worst case scenario. Non-normalized rates in a deep recession.

How the age of MORAL HAZARD was always going to end. With investors believing that global depression was their last buying opportunity.

Because they trusted proven psychopaths. AGAIN.