"GREAT NEWS, NO LANDING"

The end of cycle fool's rally is ending, as it appears the last fool was finally found. Since the start of the year bullish pundits have been rounding up useful idiots to feed into the Dow Jones hopper, however the almighty Dow Jones Illusional Average has now given up six weeks of gains in three days. Amid record retail investor inflows...

Over the course of the past year, the bullish thesis has shape shifted from hyperinflation to inflation, stagflation, soft landing, and now no landing, meaning no inflation AND no recession, the delusion du jour. You have to be brain dead to believe it, hence it's now Wall Street consensus:

The "No landing" fantasy was fabricated in order to allay investor concerns that an ever-more hawkish Fed will implode the economy, as they have every other time in history. So, the *new* fairy tale is that Fed over-tightening can bring down inflation while the economy continues to grow robustly. It's abundantly clear by this level of end of cycle denial that the latest uptick in social mood has completely fried the brains of today's financial punditry. 

Nevertheless, one must ask the critical question, why is Fed tightening causing the economy to reaccelerate at the end of the cycle? The main reason is because investors are front-running the Fed, causing financial conditions to ease. Consider that financial conditions have now gone nowhere for the past year, despite the fact that the Fed has raised rates MORE than they did back in 2007. However, the problem is that wages are lagging inflation, meaning "real" (inflation-adjusted) wages are negative.  Therefore, consumers are increasing their debt load in order to keep up with inflation. This is manifesting in sky-rocketing credit card balances AND delinquencies. So sure, this is an "inflationary" moment, however it is far from sustainable. The inflation mentality has led consumers to increase debt, on the belief that they can grow their incomes at a pace that will offset the rising debt burden. But that's not what is happening.

Financial markets are ignoring what's happening in the underlying economy: 

Ironically, this same sequence of events played out in 2008: An end of cycle rally attended by an uptick in consumer sentiment, and a Fed totally concerned with inflation. A massive policy error, and then an unforeseen collapse. 

"On the morning after Lehman Brothers filed for bankruptcy in 2008, most Federal Reserve officials still believed that the American economy would keep growing despite the metastasizing financial crisis"

The transcript for that meeting contains 129 mentions of “inflation” and five of “recession.”

What does all of this have to do with casino gambling? Pretty much nothing, since money has to go somewhere hence there will always be a bullish investment hypothesis on offer, no matter how moronic. Investment managers do not get paid to sit in cash.

Another popular investment hypothesis championed by Tom Lee of Fundstrat is that fundamentals no longer matter, all that matters is the flow of funds. There is only one problem with that theory - it's not working. Not for lack of trying mind you: 

"Individual investors have been snapping up stocks at the fastest pace on record as U.S. equity markets have charged higher to start the year. Over the past month, retail investors funneled an average of $1.51 billion each day into U.S. stocks, the highest amount ever recorded"

It turns out that if you pay a trillion dollars for a brick, its valuation doesn't increase, unless you find someone else who is even dumber. Generally speaking, these are not the types of people who are sitting on piles of cash. 

As of Tuesday's close, the Dow has given up all gains for the year. 

Meanwhile, this decline is still tracking the Feb/March 2020 crash week by week. The difference being, that one was attended by global bailout whereas this one is attended by global tightening. 

Which means that investors will get to experience the excitement of real investing without a Fed safety net. Which will test the predominant hypothesis that printed money is the secret to effortless wealth.

PANDEMONIUM 2.0

Central banks bailed them out of pandemic, so they went ALL IN at the end of the cycle. THE END.

I've been recalcitrant in my blogging lately. Bullish malaise has apparently comatized even the most bearish of bloggers. Something about collapsed volume and volatility will do that. However, next week is the anniversary of the pandemic crash three years ago AND the start of the war in Ukraine one year ago. So, it would be highly ironic if all of this widely ignored risk all exploded in the same timeframe. They didn't see it last time, and clearly they are clueless this time around as well. Three years ago next week, at the start of the crash, the weekend Barron's lead story claimed "It's STILL A Bull Market Everywhere You Look". It was already too late to get out. 

Feb. 21st, 2020:

Since the Fed hiked rates by 1/4 point at their meeting two weeks ago, the economic data has all run on the side of hot. And yet gamblers have been totally unperturbed by rising rate risk. To paraphrase Zerohedge: rising rates means rising recession risk, rising crash risk, and therefore rising chance of rate cuts. To get the rate cuts, you have to first get the rate hikes, the recession, and the crash. Meaning the bullish hypothesis is the same as the bearish hypothesis. Crack dosage being the only difference. 

I would remind everyone at this juncture that it wasn't emergency rate cuts in March 2020 that saved markets and it wasn't the restart of QE - those were both limit DOWN events. What saved markets is when the Fed panicked and took over the Treasury bond market. Something that is so far off the radar right now, there is not the slightest inkling that it will happen. Whereas back in 2020, the Fed was already in rate cutting mode and QE mode, due to the Repo crisis.

In other words, the exorbitant Fed bailout that took place three years ago is the reason why inflation is running too hot today, and it's also the entire premise of the bullish hypothesis. We all agree a bailout is inevitable, but from what level? 

Not this one. 

This week's CPI ran hot, but that also didn't faze markets. Year over year, CPI dropped from 6.5% to 6.4%. That's after 18 1/4 point rate hikes in one year - more than took place in the three years leading up to the 2008 GFC. As we see below, back in 2007 when the Fed pivoted, the CPI shot up 4%. If that were to happen now, the CPI would blow through 10%. 

Which means the Fed can't pivot until there's a crash. Which fortunately is the bullish hypothesis anyways. 

Everything the Fed is doing right now is making T-bonds more attractive relative to stocks. They're actively raising rates which compresses the forward P/E multiple, they're slowing GDP growth and profit growth, and yet stocks remain record overvalued relative to bonds. Why? Because the inflation premium is still in the market. We are a binary event away from repricing that assumption out of the market, at which point it will be the end of the cycle and stocks will be bidless.

All because investors believed that THIS Fed could keep interest rates, demand, profits, equity multiples, stocks, housing prices all at record highs. 

While  bringing inflation down. 

For the first time in World history.

Chart gallery:

Today's technicians are TOTALLY clueless. This right shoulder is a mess compared to the left shoulder.  

Aussie disconnect deja vu of Feb 2020:

Dax deja vu

In summary, the most bullish thing I can say is that as of this moment, it's still a bull market everywhere you look. 

FRONT-RUNNING COLLAPSE

We have now reached the lethal juncture predicted by hedge fund manager Hugh Hendry - the stock market is now inversely correlated to the economy. The worse the reality of the economy becomes, the greater the anticipation of imminent dramatic bailout...

The UK has both the worst performing economy in the G20 and the best performing stock market in the world. 

 

Where to begin...

Worst week for stonks since December. First down week for the Nasdaq in 2023.

This week, Gallup surveyed Americans and found that the greatest percentage feel their finances have imploded year over year since 2009:

In the same week we got that news, Fed futures have started to price in a 6% Fed rate by September. But then we found out that may be "too low".

No one questions this insanity. Monetary policy operates on a lagged basis, so traders will learn far too late the Fed has already over-tightened on interest rates. Their balance sheet is a whole other story. No one questions that at the current rate of run-off the Fed balance sheet will take FOUR YEARS to return to the pre-pandemic level. Meanwhile, interest rates are 3x higher than pre-pandemic. 

Below, I call this the moral hazard death spiral:

Investors keep front-running Fed bailout, and therefore the Fed must keep raising interest rates imploding the economy. Monetary policy is lagged, therefore the dunces at large don't question it.

Consider that at a 6% target rate, we now have the highest bullish sentiment since the market's all time high in December 2021.

I ask the bulls, why did you wait for 6% to get so bullish?

What was wrong with 3%? 

But many ask, why would this death spiral all of a sudden end now? Why can't death spirals last forever?

That's a good question - Can the market keep stair stepping lower or does it reach an acceleration point and explode?

For that we must rely upon Elliott Wave Theory, so here's the short lesson on EWT: Basically, the fundamental tenet of EWT is that markets are driven by emotions - greed and fear. Sure there other factors involved in market performance, however, at the extremes greed and fear are the dominant forces. 

Many people believe that as long as retirement investors keep ploughing money into stocks regardless of valuation, then the market will just keep going higher. Like a Ponzi scheme in over-drive. There's only problem with that theory, it didn't work in 2022. 401k investors remained on auto-pilot and the market went down -20% at the lows.

EWT is not complicated, and it's not financial voodoo as most fundamentalists call it. On the other hand, guessing where corporate profits will be a year from now when the majority of corporations have suspended forward guidance due to "lack of visibility", is a fool's errand of the highest order, hence it's standard practice. It gets far less reliable when the market is negatively correlated to the economy.

Therefore, according to EWT, we look for indications that speculative froth is running high. On crack. And about to implode. And then we look for technical confirmation in the form of pattern recognition. Which is something that today's technicians assiduously avoid. Why make it so easy? Why not leave room for imagination and speculation?

Do we have any indication that speculative froth is running high?

"A speculative frenzy after Fed Chairman Jerome Powell spoke last week helped drive record trading in call options Thursday"

But the record volume in call options on stocks last week may also be the sign of a medium-term peak in speculative behavior"

RECORD speculative frenzy. CHECK. 

Next, we look around for some technical indicators that point to momentum rolling over. 

For example, Microsoft peaked three years ago THIS WEEK ahead of the pandemic. And we see it made a massive reversal this week as well:

Here we see semiconductors rolling over at the neckline which was formed beginning in January 2021, during the first meme stock pump and dump.

Emerging Markets are sticking to the annual rollover schedule that has been in place since 2018:

In summary, if you believe Jim Cramer, you are doomed. 

And, you deserve your certain fate.

That is Darwin's Law and it's the only way we will raise societal IQ. 

THE GLOBAL MADOFF MOMENT

When enough people believe a lie, then it becomes the truth. For a while...

The reason the Madoff Ponzi scheme went on so long is because investors never questioned it. They enjoyed their outsized returns and therefore didn't ask questions. Prior to 2008, there was never a mass exodus from the fund so there was no prior "discovery" of insolvency. The inbound money from new investors was always sufficient to pay out the few people who exited his fund. In addition, his fund did not trade on an exchange so there was no way to know its true price and therefore no way to know that the Net Asset Value was zero.

A similar dynamic is taking place in today's Ponzified stock market.  No one questioned the outsized returns, so it has remained solvent. Due to the aging population there hasn't been a mass redemption event since 2008. In March 2020, retirement investors held on through the panic phase which only lasted a few weeks. Unlike Madoff's fund however, it won't take a mass redemption to reveal this market's true underlying value. All it will take is an illiquid market and margin calls to discover "true value". The sequence of events leading up to this juncture have essentially created a bidless market, because stocks are now massively overvalued relative to bonds, due to the inflationary mentality. When inflation turns to deflation and recession, then stocks will be MORE overvalued relative to Treasury bonds.

The chart below shows the "Equity Risk Premium" (ERP) which is the yield on stocks minus the yield on Treasury bonds. Here we see that in past bear markets/recessions the ERP rose because stocks fell faster than profits AND interest rates fell as well. However, this time interest rates have been rising and profits are now falling. Which means that stocks have become MORE overvalued during this decline. Which is why David Rosenberg says stocks could easily drop -30% from these levels:

"The stock market bottoms 70% of the way into a recession and 70% of the way into the easing cycle"

Also, on the topic of "fundamentals", this week when asked if she saw a recession on the horizon, Treasury Secretary Janet Yellen replied: 

"Recessions don't happen when the unemployment rate is at a 53 year low".

However, it just so happens that TWO recessions took place when unemployment was at a record low. One was exactly 53 years ago in 1970 and the other was three years ago in 2020. In my last post I showed that in an inflationary economy, the jobs market is lagged by so much that it rolls over well AFTER recession has started. Currently, due to pandemic mass layoffs and early retirements, job openings relative to job seekers are still at an all time high. 

More importantly, REAL wages are deeply NEGATIVE. So you don't need a lot of unemployed people to start a recession, all you need is a lot of broke people. 

Of course the problem with saying that stocks will go down a specific 30% based upon historical baselines, is that it's an impossible prediction to make. Until we get down there, we won't DISCOVER how many Bernie Madoffs have been going into business since 2008. So far, we've seen the spontaneous explosion of hedge fund Archegos in 2021 which was over-leveraged to Chinese Tech stocks. In October 2022 FTX Crypto exchange spontaneously exploded due to the Crypto decline. And just recently Indian conglomerate Adani went into full scale meltdown during a global rally. If Ponzi schemes can implode in a massive rally, imagine what is waiting for these markets on the other side of a global crash. People will be shocked at the level of criminality that has accumulated in these central bank Disneyfied markets. 

 

In summary, from a long term investor's standpoint, there has never been a worse time in modern history to be fully invested in stocks. If someone is in their 20's then sure they will recover. But for anyone over the age of 40, this event will be cataclysmic to their retirement plans.

When my wife asked me recently what should everyone do, short the market? My response was no, most people should never short anything. What they should do is spend less and save more. Because that's what the Chinese and Japanese do now that their Ponzi markets have exploded. 

For most people - especially passive investors - that is the ONLY true retirement now.

Not betting their life savings on Ponzified markets. 

BULLS ARE OFFICIALLY TRAPPED

This will be the first RISK ON recession in world history...

Here we see the Baltic Dry Index and Global Dow. Every other time the BDI was at this level, global risk markets were selling off.

This week, global stocks are back near their all time high.

Which means we are VERY LATE in the Ponzi cycle and all warnings have been totally ignored. 

The standard narrative for the past year is that the Fed kept interest rates too low for too long which caused rampant inflation. This narrative is totally unquestioned and yet a total fabrication. During the 2008 Global Financial crisis, the Fed lowered interest rates from 5% to 0% and kept them at 0% for SIX YEARS. In March 2020, the Fed lowered interest rates by 1.5% to 0% and kept them there for two years. Subsequently, they have raised interest rates to 4.5% which is 3x the pre-pandemic level. If interest rates were causing inflation then why hasn't inflation come back down to the pre-pandemic level? It's because in the meantime, they have only brought their balance sheet down by a minor amount (see chart below).

This massive policy error has caused markets to remain in RISK ON mode throughout the end of the cycle. Which has never happened before in market history. Usually the prospect of rate hikes and a recession have caused markets to de-risk and de-leverage. Not this time. Throughout the past year, investors have been continually buying every dip in order to front-run what they view as the inevitable bailout. However, the irony is that THEY are the reason why the Fed can't stop raising interest rates. They are the reason this will be a depression instead of a recession. Granted, they were conditioned by Fed bailouts. 

In other words, via misallocated capital, investors have created their own illusion of solvency which is now totally divorced from the economy. Friday's blowout jobs number caused the bond market to finally price in a 5% rate by May. Pundits can rationalize the seasonality of that massive jobs print all they want, but the fact remains that the Treasury market is starting to believe the Fed when they say that interest rates are going higher. However, risk markets are STILL in total denial.  

As a measure of misallocated risk capital, here we see the high yield spread is HALF the level it's usually at when the leading indicators are at this level. 

 

Those who believe the U.S. can't go into recession when the jobs market is still strong, don't know their history. During the inflationary recessions of the 1970s, the jobs market always rolled over long AFTER recession had already begun:

1970-1980:

Sky-rocketing credit card debt and interest rates shows that consumers for now still maintain an inflationary mindset. However the belief that this can continue indefinitely is totally fantastical.

Credit card carrying costs: 

The rest of the world is making the same massive mistake of keeping risk markets elevated via their bloated monetary balance sheets while imploding their economy. 

This week, Europe's market round-tripped back to the all time highs of a year ago right before the Ukraine war:

All of which means that bulls are now trapped by their own greed and hubris. 

The dominoes have been falling for two years now since the February 2021 melt-up which imploded IPOs, SPACs, Meme stonks, and Emerging Markets. 

This is a two year head and shoulders top as indicated by "Momentum stocks" which is a basket of the top performing stocks. 

The Adani meltdown is merely a symptom of a much larger problem:

The TOTAL Ponzification of markets. Meaning ALL return is dependent upon the next greater fool willing to provide return to exiting investors. 

Soon ALL risk markets will be in Adani mode at the same time. Which will be a clusterfuck of unprecedented proportion causing dislocation and panic we have not seen in our lifetimes. 

Yet. 

Oil stocks rolled over hard this week. Oil is already down -40% from the March 2022 highs (not shown). Clearly late cycle Energy stocks are rolling over later in the economic cycle than they did in the last major recession:

In summary, we are very late in the Ponzi cycle. And all warnings have been ignored.  

"Shares crash, hopes are dashed. People forget it's bullshit"

PREPARE FOR BROWN SWAN EVENT

A Black Swan event - coined by Nassim Taleb - is a rare and highly unpredictable event that no one sees coming. A Brown Swan event  - coined by me - is a rare and highly predictable event that no one sees coming.

Those who know their history know that the U.S. Navy was on high alert for imminent attack in the days before the Pearl Harbor attack. Which is considered one of the greatest Black Swan events in history. But, the Navy didn't expect the attack in Hawaii they expected it in Indonesia. Similarly, during the lead up to the  2020 pandemic, global markets melted up even as the pandemic grew larger and more lethal in scale. At the beginning it was a RISK ON event.

Complacency reigned supreme: 

Rewind to February 26th, 2020:

Via Emerging Markets, we can see that where Suze Orman said to rejoice at the buying opportunity was that first dip down ~10%. Which was followed by a three day oversold rally and then explosion lower. Whether that sequence repeats again remains to be seen. This market is so far still significantly overbought. 

 

As of this past week, the Nasdaq was enjoying its biggest January up month since 2001. Which happened to be the beginning of the post-Y2K recession. 

This is a headline from TODAY:

"Traders are rushing to profit from the January rally in the stock market, sending call options trading to one of the highest levels ever. More than 33 million calls changed hands on Friday, the fourth-highest level on record"

The Nasdaq VIX shows there is not even the slightest sign of fear in this market. The volatility algos are working overtime to monetize put options and otherwise prevent a RISK OFF event.

 

In order to be a true contrarian investor and survive the entire economic cycle, one must be able to endure times like these when the herd is stampeding off a cliff. I can tell from my Twitter stats, that many bears capitulated in January and joined the stampeding bulls. That's what happens at the end. 

In the lower pane below, we see the the Nasdaq Market Thrust , which equals (Nasdaq advances * advancing volume) - (declines * declining volume). Basically it shows the amount of buying or selling pressure.

This level of speculation has only been seen three times in the past decade. February 2021. March 2022. And now. The last time it was this high (March 2022), the Nasdaq fell straight down to the 200 week moving average. Where the Nasdaq is now.

"Earnings from high-profile technology companies last week ranged from uninspiring to downright disastrous. But that didn’t stop traders from scooping up tech stocks ahead of more potential land mines"

Almost everywhere you look in the stock market, fear is vanishing"

Which gets us to option skew, which measures investor fear:

"The October 1987 crash sensitized the market to the possibility of large downwards jumps in the S&P 500. The distribution of S&P 500 log-returns (“S&P 500 distribution”) is unlikely to be normal if there are large jumps in returns. Jumps fatten the weights of the tails and asymmetric jumps skew the distribution. The standard deviation of returns is then insufficient to characterize risk and the probability of returns two or three standard deviations below the mean is not negligible, as it is under a normal distribution" 

To paraphrase, in English - crashes are far more common than a normal aka. random distribution would have us believe. However, recall that in "Fooled By Randomness" when Nassim Taleb introduces the Black Swan event he calls it a RANDOM event. Hence the name of the book. However, the problem is that as the CBOE admits, crashes are NOT random. They are highly correlated to WELL KNOWN risk factors such as over-valuation, interest rates, positioning, lack of hedging, and SPECULATION. In the Minsky Hypothesis, crashes are inevitable and usually caused by monetary tightening in an inflationary economy such as the one we are in right now:

"Over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values"

Be that as it may, hedging is expensive. And under Wall Street's heads I win, tails you lose, no one hedges anymore. Why would they, when they have the "Fed put". Under today's bullish hyper fantasy, the Fed can both implode markets AND then rescue markets at the same time. Like a baseball pitcher catching his own pitch. 

Here we see option skew was very high at the stock market's all time high, but subsequently it has collapsed as hedge funds monetized their hedges. In other words, they don't use hedges for hedging they use them to generate income. Which means when they see fat premiums they sell into it. Similar to how hedge funds were selling subprime CDS contracts in the burgeoning risk of 2008.  

In summary, this event will be highly predictable but highly unpredicted. The herd is currently stampeding into risk and skeptics have been getting run over. All that means is that there will be far more carnage on the other side of this unforeseen collapse. The problem of course is that the RISK OFF "event" is invisible right up until it takes place. Hence, it is subject to plausible deniability of the likes we are witnessing right now.

Few people will see this coming, and far fewer will be positioned for it. Therefore we should expect SERIOUS dislocation.