Load the Boat
We hope investors enjoyed another week of “bad news is good news” for general equity markets.
The IMF (so reliable) downgrades Global GDP growth as much as the narrative can take, real economic indicators in the US have fallen off a cliff, inflation runs rampant, rising rates choke growth (as intended) leading financial institutions to “scramble” for collateral as the EU threatens fracture whilst geopolitical conflict risks continue to rise….
Equity markets are telling us that everything really is still “awesome”, leading to the strongest week for share markets since the shock and awe stimulus of April/May 2020.
The slightest sniff of expected policy capitulation pivot by the US Fed ignites the bull spirits in equity markets, yet again. Investors should consider closely if this really is the pivot they were waiting for or whether there will be another serious leg down before a proper pivot. Today’s note contains our view.
If last week marks “the pivot” road to accommodation it will be the shortest rate rise cycle, ever!
Or, is this just a massive short squeeze? Are global central banks, in particular the US Fed, so timid or fearful of what lies below that they will not even wait for a proper equity drawdown or recession before fully destroying their credibility before becoming accommodative?
Markets have been conditioned to expect central banks to capitulate in the face systemic fears and move to accommodative policy, even in the face of soul-destroying inflation.
Investors that have participated in this recent rally by filling their boots with their bear market bottom shopping list should be aware that bear market rallies have proven over many decades to suck in even the most seasoned investor. This risk is present.
On the other hand, Investors sitting in overweight cash positions are experiencing serious FOMO right now.
It is a fact that markets were waiting for the slightest change in US Fed language to “data dependent” from full steam ahead tightening (which never really happened anyway) They got what they were waiting for last week.
The reaction, as expected, dollar down, equity markets up, tech and crypto rally to the moon, as has been the condition over 14 years of loose monetary conditions. Cripes, even precious metals were allowed to rally.
So, do you feel lucky, or, is worth considering an alternate scenario?
Below, courtesy of one of Wall St’s most accurate analysts, if not consistently a little bearish, BoA’s Mike Hartnett shares a view similar to ours. This is a bear market rally, sell the rip!!
Hartnett next reminded readers in his latest note that while Bears are the worst people to listen to at the lows (just as bulls are the worst to listen to at the highs) clearly envisioning himself in the former camp, he nonetheless warns that optimism that “Fed done by Thanksgiving = lows are in” are premature for the following reasons:
- Inflation remains very high everywhere…
- … and has become a very big political problem (see Biden job approval ratings )
- (note from Aurum Echo, how on earth does Biden have any approval rating at all)
- Neutral Fed funds (3%-ish) by definition not a “tight” Fed funds; de minimis Quantitative Tightening thus far (Fed has barely sold $1 of every $100 bonds it bought past 2½ years – $5tn),
- Big stock rally SPX >4400 unlikely to encourage Fed pause/cut given Wall St (6X US GDP ) drives Main Street
- 1967, 1973, 1980, 1998…examples of premature Fed easing that caused inflation, required policy reversal & recessions to correct: this is precisely why both Zero Hedge and BofA expect the meltup to transform into another very painful meltdown sending the S&P < 3000, one will force the Fed to capitulate and restart QE with a vengeance (think about how gold will react to this!!)
Which is not to say that the pivot won’t come: it will, but one just needs a little patience and a few more catalysts:
- Payroll: payrolls <100k, initial unemployment claims >300k,
- Inflation: headline & core CPI prints of 0-0.2% (would still leave headline >6%, core >4% year-end),
- Volatility: VIX >50, /MOVE >150, HY spreads >600bps,
- Oil: WTI <$80/barrel,
- Treasuries: yield curve inverts into recession, but always “bull steepens” as recession begins (Chart 10)
All of the above have to be roughly in place for the Fed to truly capitulate. But before it does, the final question is what are the catalysts for final bear move in stocks. Here, the answers according to Hartnett are:
- higher-than-expected inflation,
- fresh geopolitical policy mistakes/ new highs in oil,
- European stagflation/energy crisis,
- US/EM/EU credit events,
- contraction of housing prices (activity weakening v sharply) causes deeper recession than expected next 12 months (housing bubble has been global…US, UK, Canada, Australia, New Zealand, Sweden, Germany…and of course China)
And, as usual, all of this comes with a “watch out for systemic risks” caveat.
Having experienced a rush for collateral firsthand in the GFC we never forget how quickly it happens and never ignore the warning signals.
Rather than reforming an overleveraged, over financialised system in the wake of the 2008/09 GFC, decisions were may made to endlessly kick the can down the road and let the problem grow exponentially worse, which is where we are now.
Hence the commitment by central planners to continue the 14 year bail out and at the core of all concerns for those that understand these risks is collateral, or most importantly, a lack of it.
We’ve covered property leverage in Australia in previous notes and as we do not wish to be burned at the stake we’ll not mention it again and hope you find the following chart of interest, we do.
Chinese economic stress is on our radar from an Australian economic/investing perspective.
And this is amazing.
As Chinese consumer sentiment goes wile coyote.
Gold has rallied over the last week as markets expect more accommodation.
Although we may see some volatility in the short term, the accommodation/QE printing stimulus (possible the last) is definitely coming.
Remember this, Gold has been a currency and store of value through millennia of leveraged cycles.
If you get a better opportunity than the last month or two to load your boat with precious metals our hat will tip to your patience and courage.
We’ll touch more on this little anomaly below in precious metals in our next note.
Finally, to further avoid being cancelled or burnt at the stake we acknowledge the most serious matters of Climate Change, ESG and OSH as serious matters and not just hobbies of those that can most afford them.
Peace.
