WORSE THAN EXPECTED

Climate inaction is merely another widely ignored warning for a society in latent death spiral. What they need to learn the hard way is that talk is cheap, until all of the hot air explodes with extreme dislocation...

This week is COP 27, which happens to mark the 30th year of UN climate conferences leading to absolutely nowhere. Which is more cynical, to not believe in man made environmental disaster, or to believe that pretending to care will fix the problem? This climate charade is just another warning for a society in latent death spiral, with not even the slightest will or ability to change its ways. The pandemic was the best test for climate activism we will ever get - because it caused the largest carbon collapse in world history. No flights to anywhere. No commuting. A virtual economy. The price of crude oil went NEGATIVE for the first time in history. Green energy/EV investment sky-rocketed. Fossil fuels were divested. At the apex of the bubble, Tesla had a larger market cap than the S&P Energy sector. 

However, upon exiting the pandemic we now learn that all of the predictions for climate apocalypse have been moved up in time from 50 years to next week. More drought, more wildfires, more mega hurricanes, and more empty lakes and rivers. 

In other words, it's far too late to pretend to rearrange the deck chairs on the Titanic. What we don't know, is whether or not global economic collapse will "fix" climate change after the fact. 

But fortunately we are about to find out...

Who says I'm not an optimist?

Now back to the Casino where all manner of economic risks are likewise being ignored:

As we approach the end of the year, investor cries for a pivot keep growing louder. Zerohedge has been predicting imminent pivot for months. Now Cramer is on the pivot bandwagon as well. Recall, it was only a few months ago that ALL pundits were pounding the table that inflation is NOT transitory and the Fed was far behind the curve. It turns out the Fed actually believed them and they are now in full Volcker mode, meaning "keeping at it", as Volcker did for two years straight.

“Pausing (Pivot) is off the table right now. It’s not even part of the discussion”

What it comes down to is the fact that today's pundits are following the POST-2008 playbook, whereas the Fed is following the PRE-2008 playbook. Meaning the Fed won't pivot UNTIL investors panic. And ironically, Team Pivot is preventing them from doing so. All of which is a tale of extreme moral hazard. Gamblers were bailed out for fourteen years straight during economic expansion and bull market. Now, when the economy is imploding, there is no bailout forthcoming.

Which is why bulls are doomed to explode. 

The primary assumption bullish pundits are making is that Tech stocks will resume their bull market when the deflation trade returns. However, below the Y2K experience shows the Fed pivot effect was very short-lived. 

Nevertheless, today's investors are eagerly waiting for the melt-up to begin. 

The other major assumption that today's bullish forecasters are making is that there will be NO deleveraging caused by Fed tightening. And yet we also see above that in 2007 the Fed pivot  preceded the housing bubble implosion. 

Which makes yesterday's headline very timely. The largest jump in household debt since 2008:

 

In other words, despite massive interest rate increases, household debt is STILL increasing. Which means that as the various bubbles collapse, households will be stuck with massively inflated liabilities. Which, will be highly deflationary.

In summary, the recent collapse of the FTX Crypto Ponzi scheme was merely a warning for what is coming. The CEO claims he had no idea how much leverage had accumulated in customer accounts. So far, there have been NO arrests. Why? Because what used to be considered corruption is now merely accepted as fraud-as-usual. Over the course of the past several decades, this society has systematically de-regulated criminality.  

The same can be said for the global economy - central banks have no clue how much leverage exists in all of its derivative forms. However, they are going to tighten until we find out who has been misallocating free capital. Or as Warren Buffett says:

"When the tide goes out, we discover who has been swimming naked".  

And when that happens, trapped bulls who ignored a decade of warnings are going to need a time machine.

To go back to when they still had a chance to change their ways. 

Before it was way too late. 

PIVOT IS JUST A CRASH AWAY

Today's bulls have FOMC: Fear of Missing Crash...

For the purposes of this discussion I will be referring to the chart below. Best case scenario, bulls stage a short-covering rally each time they implode closer to full bailout. Worst case scenario, they panic and implode straight down to the bottom. 

Either way, until they panic, there will be no Fed bailout. 

What bulls call the impending bailout, I call the impending clusterfuck. 

What we got this week was not a pivot on rates, it was an impending taper on rates. The current Fed funds rate is 3.75% and it's expected to increase .5% in December and another .5% by March which is when the Fed would pivot to neutral. Which means that bulls are front-running the Fed by a full four months on the pivot, which makes this rally a taper rally.

This week, Wharton Professor Jeremy Siegel was saying that if the Fed pivots in December then this rally is for real. 

Siegel:

Inflation Is Over. It's Rally Time

"There's still a chance we can avoid a hard landing if the Fed pivots in December"

Today (Sunday), the Fed came out and said they are not planning to pivot in December. Why? Because every time risk assets rally, they are forced to move back their pivot in terms of timing and magnitude of rate hikes:

"The U.S. Federal Reserve may consider slowing the pace of rate increases at its next meeting but that should not be seen as a "softening" in its commitment to lower inflation, Federal Reserve Gov. Christopher Waller said on Sunday"

Markets should now pay attention to the "endpoint" of rate increases, not the pace of each move, and that endpoint is likely still "a ways off"

What no bullish pundit is considering right now is what will happen when in fact the Fed does pivot from hiking to neutral which will only come amid MASSIVE market turmoil. They are all using the 2018 playbook of massive face ripping rally. However, what they ignore is that the inflation trade has been the dominant theme of 2022. These are the most successful trades of the year. I am of course referring to value stocks, commodity trades, dollar carry trades, and long stock short bond trades. Picture what will happen when all of those trades implode. There will be no leadership in the market. UNLESS one believes that Tech will exit its bear market and lead the market higher once again. 

What today's pundits don't seem to know is that overvalued Tech stocks are now dead money, and will be dead money for years to come. There hasn't been a single bubble in history that popped and then immediately resumed its ascent. After Y2K, it took 17 years for the Nasdaq to make a new high.

Still, investors are in no way giving up on the Tech trade, as recent unprecedented VXN flash crashes have proven:

 

 

In addition, when U.S. bond yields fall then the carry trades will unwind and the vaunted "TINA" trade will implode. A process that has already started as we see below, the $USDJPY having it's biggest collapse since the START of the pandemic. This means that the hot money that flooded the U.S. due to hawkish Fed policy, is already leaving the U.S. ahead of the pivot. Meanwhile, bullish gamblers are piling into the casino ahead of the pivot. 

Next, we talk about the value trades which are led by the Energy sector. This sector already imploded back in June and has enjoyed a three wave rally. Including Exxon and Chevron, the XLE is at new all time highs. However, on an equal weight basis the Energy sector is three wave corrective. What this chart shows us is that the 'b' wave retraced all of the 'a' wave gains, which means it's a weak rally. Confirmed by the fact that NYSE lows spiked each time Energy came down to the origin of the rally. 

To confirm this theory, we look at Warren Buffett's Berkshire Hathaway conglomerate which is considered the best deep value fund in the market. It's heavily weighted with bank stocks and other cyclicals, and of course a heavy allocation to Apple. 

Look up to the chart above, and look below. They are the same wave pattern on the same timeline only Berkshire is an even weaker version of the Energy trade, the stock has gone nowhere for six months.

All of which means that social mood peaked earlier in the year and is now making a new lower high in speculative appetite.  

In summary, for fourteen years straight, central banks bailed out stock market bulls. Now they are saying you are on your own. Which leaves bulls praying for a crash and a recession, so they get their long awaited pivot. However, the ongoing delay in capitulation means that by the time it arrives it will be far too late for "soft landing". And what will the Wharton Professor say?

Oh well, I was wrong. It wasn't the beginning of a new bull market, it was the end of the cycle, and at the end of the cycle, low rates come with a caveat: careful what you wish for.

DOUBLED DOWN ON COLLAPSE

The one thing this market has going for it in spades is mandatory delusion. The current level of delusion is indicative of imminent financial and mental breakdown...

The mid-term elections came and went as expected. Impending gridlock is widely considered to be bullish for stocks, which is the theory I debunked in my last blog post. Bulls are now citing the exact same historical market statistics they data mined back in 2018 to rationalize a year-end rally. The latest CPI shows that inflation is beginning to roll over, albeit very slowly. Back in 2018, the CPI was 1.7%, today it's 7.7%. Fed futures predict there will be another full 1% of rate hikes between now and March. All of which makes this set-up far more lethal than the one that imploded markets back in 2018. Nevertheless, gamblers are wasting no time going ALL IN on expectations of a big year-end rally. Today is the biggest rally since December 2018 which took place AFTER the Fed pivoted. In other words, bulls are doubling down on collapse.

The operating theory behind a pivot rally is that once the Fed stops raising rates, gamblers have a period of time to enjoy one last melt-up rally before the wheels come off the bus due to rate hikes. It never enters their minds that the melt-up already occurred and now they are sitting in a bull trap.

The year-end melt-up was a bust in both 2007 and 2008 but never mind those inconvenient facts. 

Another risk factor that raised its head this week is the renewed collapse of the Crypto Ponzi sector. Recall that Bitcoin had been seeing the lowest volatility of the year recently, then it headfake rallied last week, prior to imploding lower this week. Something called an "FTX" had been buying up all of the other collapsed Crypto Ponzi schemes earlier this year when it too caught the collapse contagion. It turns out that combining multiple Ponzi schemes into one big one does not diversify risk. Echoes of the  lesson NOT learned during the subprime disaster circa 2007, when Goldman Sachs would package up toxic subprime mortgages from all corners of the country and package them as AAA rated securities. No one on Wall Street thought it was a bad idea. Bear in mind, today's Crypto-loving Wall Street analysts were all playing Halo in the 8th grade back in 2007.

So how could they know that all of this is 100% idiotic? 

All of which merely leaves another technical stock rally now running on glue fumes. Make no mistake that hedge funds are no longer hedged and therefore the put wall that has held up this market up until this point in the year is now substantially non-existent.

A necessary and sufficient condition for final collapse. 

Option skew is the lowest since 2008:

In summary, this is either a year-end Wall Street bonus rally, or the biggest bull trap in history. In technical terms, the quality of this rally is dog shit - my own proprietary definition. This is merely the latest short-covering rally now running on glue fumes. Led of course by the Nasdaq which is on the way to becoming totally bidless. This latest overbought notion of an impending Fed pivot being once again pure fantasy.

One year ago the Fed warned investors that risky assets were set to implode. They specifically mentioned Crypto Ponzi schemes. So trapped gamblers have ignored their warnings for a full year now.

Nov. 8th, 2021:

“Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate"

"The central bank also said stablecoins pose an emerging threat, that fragility in China’s commercial real-estate sector could spread to the U.S. if it deteriorated dramatically, and that “difficult-to-predict” volatility similar to this year’s meme-stock frenzy could become more frequent as social media increasingly influences trading"

THE END OF THE INFLATION TRADE

Impending government gridlock will very likely attend deflationary ice age...

First off, the Wall Street view per Zerohedge is that a "Red Wave" would lead to fiscal reduction which would be deflationary. However, they also believe this would be good for stocks. Sadly, this fact-challenged view ignores all recent history. In the most recent years, the market has performed best when both monetary AND fiscal stimulus were the strongest i.e. 2020 and 2021. Zerohedge admits that deflationary gridlock would lead to a Treasury rally i.e. yield collapse. However, they don't acknowledge that the Tech/deflation trade is already imploding deja vu of Y2K. Which is precisely the impending rotation failure I discussed in my last blog post.

Which is where this all gets interesting. Consider this factoid:

"In 19 midterm election years since 1946, stocks have advanced from late October through year-end every single time except 2018"

2018 happens to be the ONLY year in market history that featured rate hikes, quantitative tightening, and mid-terms - before this year. And leave aside collapsing Tech bubble, collapsing housing bubble, high inflation, and EM currency collapse because no year in history had ALL of today's risks. In other words, these two mid-terms have more in common than any of the past mid-terms. And yet according to Zerohedge, 2018 is the year to ignore. You see, the formula for bulls is to use historical statistics that are blindly ignorant of all correlated risks by assuming that all years are statistically independent. Because if risk variables are NOT independent, then data mining history would be totally useless. Dependent variables do not reduce risk, they compound risk. In other words this blind prediction strategy is a formula for  sounding smart while ignoring ALL risk.

Following Zerohedge logic, we are on the verge of a big Tech/growth rally:  

The other deflation trades of course are recession stocks. And those are played out as well. Something about a one year bond yielding 4.5% will do that. 

THESE are the safe havens:

 

That covers the market.  

But now more interestingly, consider the inflation trade in particular. When Trump was President the (fossil) energy sector lagged the market massively while the green energy sector sky-rocketed. But when Biden was president AND had Democratic control over House and Senate, the fossil fuel sector sky-rocketed and green energy collapsed. 

Why? Several reasons. First obviously the pandemic. Secondly however, Trump endured the fossil fuel divestment movement which saw massive pension funds and endowments dumping ALL fossil energy stocks to buy green energy stocks. When Biden got elected, the vaccine was rolled out, the economy re-opened, the green energy trade was massively overvalued, and therefore fossil fuel stocks led the market higher for the past two years. 

All of which can be clearly seen in the Energy sector chart below. This shows that Energy stocks massively underperformed the broader market long before the pandemic. And now they are the ONLY sector making new highs. 

Clean energy was bid way before the pandemic and imploded soon after Biden was elected. 

You don't have to be a genius to figure any of this out, but you DO have to be observant of history. In addition, markets are far more intelligent than the typical pundit and they usually react the opposite of what conventional logic would suggest. For example, consider all of the people crowding into Energy stocks AHEAD of a possible red sweep. 

The kiss of death:

The darker side of gridlock is not just impending deflation, it's the fact that gridlock will amplify whatever economic chaos arises from the impending monetary meltdown. Why? Because gridlock will prevent the type of safety net programs which avoided full scale economic depression during the pandemic. 

How long until Zerohedge figures out that after the mid-terms there will be no chance of a Wall Street bailout. Because without combined monetary and fiscal stimulus there will be no middle class bailout.

In other words, this election is the final step towards setting the stage for extreme market and societal acrimony on a scale that no one on Wall Street predicts. 

Because let's face it, no one predicts their own collapse. 

 

THE EFFICIENT MELTDOWN HYPOTHESIS

It's bulls versus the Fed. Get some popcorn and stand back...

On first glance this past week's FOMC statement appeared dovish, leading to a manic melt-up algo rally. However, at the press conference Powell threw cold water on the rally when he said there is more work to be done on rate hikes. That's all it took to implode the most recent "Pivot" rally. The remainder of the week was highly volatile due to options unwind and the jobs report which was hotter than expected but not as bad as feared.

It's clear these pivot rallies have been making the Fed's job of bringing down inflation, that much harder. As a result, these rallies keep pushing out rate hikes, so it's Powell's job to come in every FOMC meeting and pound markets back down. The Fed has finally realized that inflated asset prices are driving  economic inflation. While it's true that options algos have been pounding volatility down, at the same time the Fed keeps pounding stocks down.  Which means they are on a collision course, and I suggest the Fed will win.

The Fed is not going to stop raising rates when they can see that their Financial stress index keeps going down with every pivot rally:

In addition, we learned this quarter that Tech earnings are imploding. Which means that the entire growth/deflation trade is now going bidless, which happens to also be the pivot trade. Therefore if/when the Fed does pivot, there will be no leadership in the market. Putting it all together and the Fed will tighten until they break markets, and then everyone will be shocked at how quickly this house of cards explodes.

We are seeing very unusual action in the Nasdaq VIX market lately. There have been seven flash crashes in the Nasdaq VIX in the past twenty days. And only 18 total flash crashes in the past 27 years.

In summary, the Fed is going to break some shit, and bulls have conflated that meltdown moment with their long awaited bailout. 

The inevitable consequence of being told for 14 years straight that bad news is good news.

MELT-UP TO MELTDOWN

Global central banks will tighten more in this fourth quarter than they've tightened in any fourth quarter in the past forty years. Nevertheless, gamblers see a headlight at the end of the tunnel...

At some point, we all know that an oversold bounce will morph into a long-term rally. That's how it happens at every important low. It begins with short-covering and then transitions to REAL buying. The only thing bulls and bears now disagree upon is when that will happen. Bulls are very eager to pull forward that event as soon as possible. In the process they are happily ignoring the various risks that have been growing steadily throughout 2022. Therefore it's now obligatory to believe that the Fed is the ONLY risk to markets. Once they're done tightening, everything will be tea and crumpets for "stocks". I assert that the Fed has already over-tightened but the "front-loading" of Volcker magnitude rate hikes has yet to make themselves known.

First off, the inflation trade is STILL on in full force. This means that late cycle Energy stocks are leading, growth stocks are imploding, and Treasury bonds are getting hammered. The stock/bond ratio has never been more overbought than it is now. One can make the case that stocks are MORE overvalued now than they were at the top a year ago. Why? Because of the dual effect of reduced earnings and higher interest rates. Wall Street has been very slow to bring down earnings forecasts, and companies have been even slower to guide down for 2023. So now next year sits there like a big black hole of earnings visibility.

Perfect for those who don't want to believe that recession is inevitable.

The rate of tightening combined with the rate of home price increase has left the housing market effectively bidless:

 

"Homebuilders say 2023 is going to bring an even sharper downturn in the market, as high interest rates scare away buyers"

“There’s this cliff that’s happening in January...”

Single-family housing starts fell a stunning 80% from January 2006 to March 2009, but Myers notes that it was a slower turn compared with what is happening now"

The bull case is that the Fed will soon stop rate hikes and hold them at this level until inflation comes down. Unfortunately only recession and asset crash will bring down inflation. And it will bring down record corporate profit at the same time. 

Investors are no way positioned for recession even though they need one in order to effect their next bailout. The moronic irony can't be overlooked. A consequence of the Fed balance sheet-induced wealth effect being in lockstep with the CPI. So in the meantime - while inflation is NOT coming down - the real economy implodes. 

 

But what does this have to do with end of year melt-up?

First off, this latest oversold bounce began two weeks ago, so it is nearing the point where it must transition to the next phase of  real buying. Or else it will suffer the same fate as the last three failed "pivot" rallies. The Dow is record overbought and just had its best month since 1976. The S&P is the most overbought since the Fed's actual pivot in late 2018.

The critical difference vis-a-vis 2018, is that the Fed/ECB/BOE et al. STILL have many more rate hikes in store for these next two months. Whereas back in 2018 when the oscillator reached this level, the Fed had already pivoted and no other central bank was raising rates. 

I don't know what Powell will do tomorrow. As we see above he's been hawkish for two months straight - each time pounding markets lower.

What we need to understand is that bulls have now decided that even a .75% rate hike this week followed by a .5% rate hike in December would be BULLISH. What would have been considered unthinkably bearish a year ago, is now the bull case for the end of the year. Fed futures have a 95% probability of AT LEAST 4.25% Fed rate by the end of the year:

CME FedWatch Tool

So why bother being bearish when the bulls are just going to co-opt all of our concerns and conflate them as being bailout friendly?

Let's say Powell hints at a "step down" in rate hikes tomorrow. Sure markets could explode higher for a few hours or days. But ultimately this is still only a technical rally. So everyone must decide for themselves if they are a short-term trader or a long-term investor. 

Because now the bull case and the bear case are essentially the same, the only difference is what happens AFTER the glue fumes wear off.

Position accordingly.

FOMC: FEAR OF MISSING CRASH

It's that time again when bulls play Russian Roulette with their life savings. What could go wrong?

First off, the Fed is now hiking at TWICE the pace as in 2003-2006. The Fed rate is currently at 3%. If the Fed hikes two more times this year as markets expect, the number of 1/4 pt rate hikes will equal 17, the same as between 2003-2006.

In 9 months vs. 18 months.

Two massive policy errors, two years in a row. 

Hedge funds have a severe case of end of year bonus FOMO, so they are continually front-running the pivot. On Tuesday, the S&P became as overbought as in January 2019 which was AFTER the Fed pivot. This time they are front-running an event that is at least two months into the future.

This is the third oversold pivot rally in 2022 and any blind man can see it's the weakest. It's clearly three wave corrective, which I will discuss further below.

 

On Thursday this week, the ECB is widely expected to raise rates by .75% for the second meeting in a row, to quell inflation. Even though the economy is entering recession. Then next week, the Fed is expected to also raise rates by .75%.

World markets are at the precipice.

China has been in meltdown mode ever since the Chinese Congress meeting wrapped up last week. The general message from the Chinese government to investors is don't expect any more bailouts. 

Ironically, for the first time in 2022 bulls and bears agree that the Fed will soon be forced to pivot. The only thing they disagree upon is at WHAT LEVEL the Fed will pivot AND what happens after that. Bulls are of the belief that this will be another 2018 type of pivot soft landing.

Unfortunately, they have zero margin of error because the 200 week moving avg. was just tested two weeks ago. Which was where the Fed pivoted in 2018. 

Doh! 

Getting back to the point above about the S&P being three wave corrective - EVERY global risk market now has the same three wave corrective pattern. Which means that global central banks will have another March 2020 meltdown on their hands soon. It's only a matter of time before Rishi Sunak realizes he already lost the election. 

Lastly, it appears that Microsoft just gave Tech investors their "John Chambers" moment. In addition, both Google and Texas Instruments missed their quarter as well. These stocks are all core bellwethers that are NOT highly economically sensitive. All saying the same thing. It's getting worse.

  

In summary, there has never been a more NECESSARY time to bet against Wall Street groupthink than right now.