Shafted

Top Gun is the most popular movie this week as the escapism of film drew a news-weary populace to the theatres. Markets are also following a script, but this one must be a horror film. The first half of the year for risk assets was one of the worst on record. The good news is we are actually watching a sequel. And like all remakes, there are similarities and differences. But the pattern of bull and bear markets never changes.

We go up an escalator and down an elevator.

Why? Because the markets are, at the margin, driven by human behaviour, and the Federal Reserve is showing itself to be all too human. They are firm in their questionable conviction to exert control on an uncontrollable variable - people. Chairman Powell is more data-dependent than ever and is still waiting for bad data to pile up.

We are emotional beings, prone to irrational thoughts. Driven by a 1 million-year history, our visceral reaction to fear is built into our DNA like source code in a computer program. It's come full circle from last year's escalator of TINA/FOMO optimism. Just ask the Bitcoin/NFT crowd how they are feeling today.

Hence the asymmetry in markets. We are more responsive to fear than we are to greed. That was an existential reality for the early hominids who cowered around their fire pits every night while the bushes around them mysteriously rustled. Their main advantage of superior brainpower was negated by the unseen carnivorous threats in the darkness.

The good news for investors is we spend more time in rising markets than in falling ones. And although I am currently bearish (net short in my U.S. trading portfolio), I expect this weak market to be over sooner rather than later. You will note I said, 'market' and not 'economy'. This allows for any level of economic deceleration from a growth slowdown to a deep recession without any further equity valuation compression at the macro level. Any way it comes, I expect that the 'bad' news we are getting - pick anything from a plentiful list that includes war, earnings, credit spreads, currencies - and we are building to a positive reversal of expectations. Unfortunately for the investor, we never really know how many floors are in the elevator shaft. I'm still braced for impact.

Markets often rally off the bottom by 20% before you even know they're done falling. It's like calling a recession - if you start to wonder if one is coming, it's probably already here. I for one am cheering on the negative headlines that are starting to pile up this morning. Norwegian gas workers and Netflix analysts are helping both me and the Fed get to our happy place. I can't wait for the dismal earnings season to start. I'm hoping for one last negative reaction wave when estimate expectations recede. A buy-on-news trade and summer rally would shape up nicely from that reaction. More on that next week as the macro focus dims and micro news begins to flow.

My advice to those looking for a definitive bottom is to forget about trying. The first signs of a recovery will come out of the blue and well after the lows have been plumbed. And like our frightened, shivering early ancestors who saw a faint light in the morning sky, your fears will gradually recede as the financial dawn slowly creeps into view. There is already enough valuation compression and negative sentiment to create a low. Market internals and momentum metrics are at bear market extremes and positioning has been pared back. The only thing missing is a dovish Fed pivot. Now you know why I'm still craving a hard landing. My only worry is that we won't get it and I'll miss the bottom again.

Meanwhile, buy-and-hold investors are getting their asses handed to them, as they always do in down markets. I know - because I'm also one of them for most of my net worth. My trading portfolios are a fraction of that and I only use them as a reality check to the blog calls - both good and bad. The fact that it's still up this year is cold comfort in my personal wealth aggregate. I know, I know... no tag days for you, Deck.

So how is the movie gonna end? I don't know exactly because nobody can. But I do know, like a plunging elevator, it will be a painfully sudden stop. But more and more stocks will buck the trend as we discover the true value of long-term quality companies. The babies-in-bathwater approach I see some now taking should ultimately pay off. We must be close, now that the bad guys are having their way with the narrative. I'm looking for a spectacular finale soon, but only after this painful plunge reaches the ground floor. But the important point here is that since Fed has pushed the 'G' button, there may still be more floors left on this elevator ride.

Risk Model: 0/5 - Risk Off

The Model says it all - "Risk Off" is winning. I don't expect it to turn around quickly either. Our feckless friends at the Fed have strapped themselves to the hood of a car that is plunging over a cliff and seemingly can only see as far as the ornament. Only a Hail Mary collapse in oil prices from the upcoming MBS/Biden summit or a sudden reversal of employment prospects and its consequent demand shock can dissuade our monetary misanthropes from engineering an economic sudden stop. The main source of economic weakness is external to their mandated domestic data set so they won't hear the bullet that kills them. The soaring U.S. dollar says it all. Financial conditions are too tight already relative to global growth prospects. Just as they were slavishly easing into strength, they are dogmatically tightening into weakness this year. The money illusion of rising consumer prices, themselves a lagging indicator, cannot be used to manage monetary policy prospectively. With the next two 75 basis point hikes tattooed on their foreheads, the FOMC is likely already head of the curve.

Copper/Gold has once again reaffirmed its status as the best economic forecaster of all time. With the roll-over of the entire commodity board now that oil is seasonally weakening, the surprises on inflation should start to become more negative. This is the source of the expectations of a dovish Fed pivot I am looking for to generate a playable rally, if not a durable low. We are getting close!