Shorts Weather

The simple definition of a bull market is a persistent period of more buyers than sellers. With the S&P 500 at 4100+, we seem to be in a bull market, despite my protestations to the contrary. At least on the surface. The broader market is lagging but the widely quoted S&P 500 is again being juiced by a narrow rally driven by the likes of AAPL and MSFT. But that hasn't deterred the bulls. Much to my chagrin, they are still in control of this market. Why can't I have nice things?

Partly, it's the triumph of hope over reason. The calls for a soft landing are now expanding again. We can now add the redoubtable Mr. El-Erian to their ranks. Mohammed, I thought I knew you! But the credit contraction stemming from the bank crisis hasn't hit the economy yet. Could his optimism stem from a place of wishful thinking?

New York Fed Governor John Williams has depicted the sudden collapse of Silicon Valley Bank as "idiosyncratic" and not as a result of a 450 basis point jacking of the funds rate. He went further to state that he hasn't seen any evidence of a credit crisis. But the latest data are showing a pending collapse in lending from tightened standards (chart below). Talk about driving in the rear-view mirror!

Bank Standards & Lending

The Fed is making the same mistake as they did when inflation was deemed "transitory". They are anchored in the data of the past six months when they should be looking ahead and leading the markets. To rehash a Cramer quote from September 2008 "The Fed Knows Nothing!!" Their mantra of "data dependancy" is just a crutch to excuse their lack of vision and economic leadership. Maybe we should start a campaign to defund the Fed!

Unfortunately for them, the dangerous structural problems in banking remain given record levels of yield curve inversion. If banks can't charge borrowers more than they pay depositors, the system is still upside down. Enter the Powell Put 2.0 - the Bank Term Funding Program, BTFP. By temporarily papering over the deposit run-offs at the regional banks, the Fed has implicitly 'eased' monetary conditions. It's like the cops at a car crash: Move along now, nothing to see here people!

I'm not convinced. But the markets a shrugging it off this week.

Let's review the case for this recent equity pain trade for the bears. It is based on the same factors that righted the market ship last fall. Positioning and Sentiment.

Positioning

There is a hugely crowded trade on the short side of this market.

Equity Futures

Sentiment

The run off of deposits has inflated the perceived level of cash on the sidelines. The surge in Money Market assets has emboldened the bulls who view this as a contrarian positive. But it is simply a transfer of the cash being drawn down in the banking system. There is no equivalent decline in the equity market positions. If fact the ETF flows have been consistently positively.

Bank Deposits & Money Market Assets

The survey data on AAII members (smoothed data) has levels below both the GFC and the pandemic low. Sentiment has been beaten down by the preponderance of 'bad news' - Inflation, Fed Hikes, Ukraine - for over two years now. Nobody seems to be very optimistic. But that's the problem. The bear phase of the market was so front-end loaded that the urge to reinvest can be easily aroused on "positive" news.

AAII Bull/Bear Ratio - 30 wk ma

I think the market should be lower based on valuation alone. An increase in the risk premium is typically necessary for adequate compensation inherent in volatile equities in uncertain times. But my protection trades from last week are offside already. So what am I missing?

The ability of the market to look forward has a powerful effect on current price levels for risk assets. And with the second derivative of inflation having gone negative, investors are now anticipating an interest rate drop by year end. But try to get your mind around this: bond markets are pricing a hard landing, yet stocks are using that interest rate forecast to justify a soft landing signal. Somebody is wrong here!

With the 'market' seemingly rising off the gloom of last fall, supported by a cashed-up investor one can be tricked into believing that a new bull market has begun. Unfortunately, there is a hollow feel to this latest upsurge. Can a rising price trend be trusted when it isn't corroborated by volume?

Vanguard Total Market ETF

In a Pavlovian response to the rally, long slumbering bulls have perked up last week. The latest AAII survey jumped in response to a collective sigh of relief over the Fed's bank crisis triage. It's never good that a well constructed policy of monetary tightening can so quickly be abandoned in the face of a seemingly isolated problem at one risky financial firm. But I didn't expect the expectations of others to turn so optimistic based on a temporary bandaid. Again, we are coming from such a sentiment low, there weren't a lot of bears left to sell and get in their way.

AAII Bull/Bear Ratio

If bond yields are mis-priced vs equities, it will be because growth and inflation will continue to stay higher than expected by a 5 and 10YR yield below 4%. If equities are mis-priced to bonds, it will be the elevated earnings forecasts under a bogus soft landing scenario that is to blame. Place your bets folks, this is a make-or-break phase for the markets.

Should this week's inflation data, however woefully lagged and stale, be used as an excuse to further the upward move in equities, it should be sold. Seasonality alone argues for caution after the typical spring risk-on phase. There are more reasons than usual this year to 'Sell in May'.

Now that the weather is conducive to putting on shorts, What are you waiting for?

Risk Model - 3/5 - Risk On

The rally is pushing the market up the RSI but the $VXV has stayed muted. Some are thinking that the migration to the use of daily options is to blame but time will tell. AAII as I showed is supporting as the herd has moved to the buy side.

At the same time, and despite the China optimism, Copper is underperforming Gold. And Millennial Gold - aka Bitcoin - is strong as well. These twin risk-off indicators acting well is not comforting.