To The Moon

Holding heads up high before the deep dive?

The US indices continues to defy the odds and keep grinding higher. The contrarians keep calling for a new bull market amongst the bearish sentiments and many are hopeful that the FOMC will pivot soon and help the market bulls chug ahead. I believe that it is still a bit too early to call for a new bull market. The bond market yields are receding indicating that they are pricing in a possible recession ahead or some credit event that may be deflationary (M2 money supply has gone down a lot and the effects of this again lags) rather than disinflationary. The FOMC always follow the bond market (2 year yield lead Fed fund rates) and might be made to cut rates soon and if they do it might be worrying considering inflation is still around and they must be very concerned about something to do so after talking big against inflation all these while.

The academics might note that it takes 6-9 months based on research for any credit event such as rate hikes to filter through to the economy and vice versa rate cuts. As such, the full effects of the rate hikes are not really baked into the economy yet if that data holds water. There are already some indications of the rate hikes taking effect in the labour market and economy but imagine the full effect when that really takes hold. Anyone still dreaming of no landing or soft landing?

Let us take a look at the charts when the FOMC last went on a big rate hiking cycle (4.5-6% 1998-2000 and then 1-5% from 2003-2007). Now correlate it to the broad market index chart. We notice that the markets continue haemorrhaging for a while even as the FOMC cut rates and rates go lower and then only picked up after fed fund rates have reached its low. Now notice also that those rate hikes are gentler compared to what we have over the past year where the rates went from 0-5% in only one year! Getting worried now?

I believe the markets had a lagging transitory (pun intended!) effect from the Covid stimulus and monetary injections which was fuelling inflation etc but that effect may be wearing off (that is what the markets have been cheering the past few months). However thanks to the FOMC most rapid rate increases in history, the tsunami that is in waiting caused by the very rapid quantitative tightening will sideswipe the economy. The FOMC will cut rates to prevent a collapse but the equity markets will take a big hit and that I believe will be that final big C wave down that will herald the end of the bear market.

Now look at the XLF chart. That contains the biggest financial names that are too big to fail. Any technical analyst worth their salt will be able to tell you the charts look anaemic and do not look like what the news have been telling us. Charts usually tell us the story before the headlines and those charts are saying “Watch out!” So if the contagion is just limited to the regional banks, why is that chart looking the way they do?

I am a bull by nature. I really want the markets to do well. Who doesn’t? I am an investor too. But the charts are just telling us one thing that the headlines are not. And do not be deceived by looking at the big indices. I use the SPX as an indicator for simplicity but the broad market index itself is actually being held up by names such as Apple and Microsoft which makes up a big component of the index ironically. When you look at the Russells, they look weak. When you look at individual market components as well as other global markets, there are too many divergences and warning signs around. I am just too concerned with all the warning signs and yet some are talking about a new bull market.

Technically, there might still be some leg left in this rally. But I am still holding firm to my belief that this is a bear market rally. If 4040 holds, we might head towards the 4300 levels in the next few weeks. But I believe that is where the bulls will fall (if they do not fall earlier). After that I am expecting a deep C wave down to the 3200 and even the 3050 level. At those levels, no one will want to buy stocks. But that is where I want to be buying. Here and now, I am being defensive. Some might laugh at me especially if the market keeps grinding higher. But I rather err on the upside than on the downside. Capital preservation is key at these times. Better to hold what you have than chase what may not be!

Thanks for reading my lengthy commentary. Hope the sharing helps!

Stay safe!

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