Edition #194

Premium Market Analysis

Investors,

As I look at the market today, I see hope and desire fueling narratives. Considering that we all want our portfolios to increase, we feed ourselves positive narratives and beat the drums to magnify the good energy because it’s what we want to hear. This self-perpetuating positivity doesn’t typically lead to good results, other than the occasional lucky draw. In fact, I’d argue that hope-fueled narratives during a bear market typically lead to larger capitulation events, particularly if fundamentals continue to deteriorate. As economic data trends towards an outright recession, an explicit goal of the Federal Reserve, and inflation continues to accelerate higher, I don’t see how markets can sustainably accelerate higher. Even if inflation “cools off” and reaches +7.5% over the next 3-6 months, is that really something to celebrate?

My outlook is based on the current economic trajectory and my belief that persistent inflation will cause the Federal Reserve to remain aggressive on their endeavor of monetary tightening. In March of this year, I posited that the current inflation dilemma is Jerome Powell’s Volcker moment, referring to the bold monetary tightening from Paul Volcker’s Fed to combat rampant inflation in the late-70’s & early-80’s. I even caveated this comparison by stating the following:

“To be clear, I know the Fed can't raise rates to 20% today's economy... but what if Powell does a 3% hike? What about multiple 1% hikes? The market doesn't think the Fed can do this. It would have severe repercussions, which is similar to how Volcker fought inflation.”

People scoffed at my question and the idea of an aggressive Federal Reserve, insisting that “the Fed can’t raise rates”. Yet here we are, preparing to raise rates by another 75 basis points. This is eerily reminiscent of the sentiment during the Volcker era, which is described in Christopher Leonard’s book “The Lords of Easy Money”:

“At first, people didn’t think Volcker was serious about raising rates. Then they didn’t think he’d actually be able to do it… It seemed inconceivable that the Federal Reserve would go through with a plan that would push the economy into a recession…

Volcker’s rate hikes devastated the economy, put millions of people out of work, and ended the Great Inflation.”

I’ll admit that I’ve felt a certain degree of FOMO in this recent market rally, but I must remain consistent with the perspectives that I’ve been sharing with premium members. In particular, I’ve been advocating that market rallies should be used as an opportunity to de-risk. On May 22nd, I told investors that “I think it remains appropriate to to emphasize risk management, patience, and essentially prepare for more downside. In the event that stocks do rally in the short-term, I think this will provide investors with another opportunity to de-risk their portfolio, similar to the price action that we saw in mid-March”.

Thereafter, the Nasdaq rallied +11.7% until the local peak on 6/2, giving investors that opportunity to de-risk. After that local peak, the Nasdaq proceeded to decline -14.5% in 11 trading days. As of today, we’re still trading below the market close on 6/2. This concept of “fading the rally” has been a worthwhile strategy in 2022, as is typically the case during bear markets. As such, my sentiment hasn’t changed. Here’s what I had to say this week:

The economic factors pushing asset prices lower haven’t subsided and only appear to be getting worse. Markets are celebrating economic deterioration because it implies that we’re getting closer to a recession. Why? Are recessions good for asset prices in the short run? Not that I’m aware of, though they certainly provide long-term investors with beautiful opportunities to buy blue-chip assets at a discount. Short-term market pain produces long-term market gain, therefore I continue to reiterate that this is a long-term investors dream market. Still, I believe that short-term headwinds remain.

For the rest of this newsletter, I’ll be covering the key charts and data that I’m using to gauge the current market pulse. This will include under-the-hood metrics for the S&P 500, analysis of risk sentiment, and price structure analysis to identify areas of strength & weakness in the market. I believe that conducting relative analysis, comparing Asset ABC vs. Asset XYZ is one of the best ways to understand market dynamics, risk appetite, and investor trends.