Earlier this week I had an epiphany about a much better way to structure the article I was going to post today, so I'm going to wait until I write that version. I happen to be extra busy for the next few weeks or so, which means it might take until after the holidays to finish.
I have a lot to say about the markets, but I'm kinda exhausted, and since everything can change completely based on the election results, I don't see the point. Clearly, so far, there was no selloff into the election. Now that Opex is over, maybe we get a down tick, in fact, the most bullish thing that can happen for a six month time frame is putting everyone who bought the breakout after Fed day underwater and then a big reversal day, which, of course, needs follow through to new highs. The reason I say that is because in the medium term I think the market goes way down. In the long term it goes way, way up. So the question for me is when does the medium term start and peeps might be like: why way down?
I listened closely to a soft landing person the other day and I can articulate the difference between our viewpoints. She was saying inflation came down without unemployment going way up, so that's a soft landing. That's not my view at all. Inflation was never the problem. It was always going to come down due to the nature of its causes. This particular soft landing person is the typical mainstream, micro, individual stock focused perma bull, which is the right way to be, except that she doesn't distinguish between "the economy" from the 90s, 00s, 10s, and now. Her subsconscious assumption is it's all basically the same.
As you know by now, my view is you can't replace stable, well paying manufacturing jobs with all the benefits that go with it for the less educated masses with Uber and Lift gig economy jobs. The economic hole this creates is only sustainable by negative real rates and/or huge deficits, which are both unsustainable. This is where the rubber meets the road. Man, I didn't want to do this and now I'm writing an article.
Everyone is giddy about the Fed in a rate cutting cycle helping to support stocks, which is fine, makes sense, I get it. However, the Fed is only cutting with stocks at all-time highs to get closer to neutral. Some people make the case that neutral is higher and stocks, gold, and now silver are ripping because the Fed is still not restrictive, so they worry about inflation coming back. You already know I think that's impossible unless money is broadly distributed. I keep asking the inflationists to explain how there will be an imbalance of supply and demand for broad general prices and no one answers the question. They just say I believe inflation is coming with no explanation. I'm open to changing my mind but not without a better explanation than you believe it. That doesn't mean bond yields can't rise from supply concerns.
Anyway, the point is once the Fed gets closer to what they think neutral is, why would they keep going? We will be right back in the old Fed playbook of only easing if the data requires it, but if the data deteriorates enough to require it then stocks will be falling. In other words, there's only a brief window of time with the Fed easing into all-time highs.
So if I'm correct that the economy is nonfunctional, and I can prove it with one question: what do you think would happen if Congress balanced the budget so we had zero deficit spending? I think the economy would implode. This is the key variable behind my view of a soft landing is not even a possible outcome. You might argue yes but deficits are baked in the cake for as far as we can see. And that's fair, but now we're talking about timing and not the inevitability of the waterfall we're headed for.
There's a few things I think are most important to monitor. One is what Eric Basmajian and Warren Pies keep an eye on, which is residential construction employment. The idea is when rates were historically low and stimulus was flowing and remote work was gaining steam, the backlog of new housing built up, and all of those houses financed at low rates took the last two years to work through, which means we should be now entering the period of time when rates started rising and kept going (or stayed high) from March 22' until last month. So we get to see how much residential housing activity was initiated during that time of high prices and high rates. And that period lasted 2.5 years. Since housing is such a huge component of an.economy it makes sense that a sustainable layoff in that sector that keeps going would lead to a downward spiral, which is what happens in recessions. If there's no slowdown there, it seems unlikely that there will be a slowdown in general, so I think watching new starts, building permits, and layoffs in that area is a key variable as the most leading indicator that we're headed for trouble in 3-6 months.
Secondly, here's a video I recommend watching of Michael Howell on Adam Taggart's show about liquidity. It's an hour long so if you're going to not watch it, the main point is the global economy has like 350 trillion dollars of debt to rollover at an average maturity of 7 years, which equates to around 50 trill a year. A lot debt was refinanced at the historic low rates, but we are still headed for the wall of maturity that will force refinancing rollover debt at much higher rates than the last 15 years. This combined with the housing backlog being over is the definition of the lag effect. Meaning, there isn't a soft landing until you get through the wall of maturity for both housing and corporate refinancing without causing layoffs and/or hurting earnings at historically high valuations.
Now throw in the years of stimulus that created excess savings which are now gone so the lower half of income earners have no buffer, no job stability, and limited credit card.
This is what I mean when I say the plane never left the tarmac. These deep structural problems are being masked by all this stimulus and deficits and low rates. I do not believe this economy can handle anywhere close to the rates we have now, and, in fact, my predication is by the end of 2026 we will be back at ZIRP and QE. This is what gold and silver see.
Put it like this. The patient is depressed for a decade and on meds (low rates, QE). Then a terrible event happens (the pandemic), so the doctor prescribes ever higher doses of morphine (stimmies). Then the doctor realized he administered too much, so he started the process of weaning the patient off (raising rates), but the effects of the morphine injections kept going, so the doctor got really aggressive. In October of 2022, some of us recognized this is peak inflation, and that's never going to happen again, so from here forward all assets will go UP because the doctor can only raise rates so far, so essentially this is pricing in the end of the rate cycle even though it's 9 months away. And that was the bottom in gold and stocks.
Now we're at the exact opposite situation. The economic effects from the historic low rates and stimmies have completed. Obviously, this is not an exact science like on this date the data will turn down, especially with stocks because they're irrational. However, with multiples at the high end of historic range any further advances will require actual earnings beats in excess of estimates, which is why global companies have the best chances and NVDA who sells new tech to those same global companies with all the cash flow. Most likely though there will be a point where the new gen isn't that much better so they'll wait.
With the debt ceiling approaching again in Jan-ish there will be a drain from the TGA which should increase liquidity. What most people tend to do is way overweight the current data and the current emotions. I'm looking 6-12 months out. It's perfectly reasonable if nothing really bad happens with the election results that these forces I'm describing take until spring to manifest. Then we get to see the lag effects of how much of this economy can handle these rates. Technically, Michael Howell's work says the real wall of refinancing isn't until 2026, but you have to be way ahead of that.
Here's the thing. What supercedes all of this is price action. The market doesn't just decide one day to go straight down for two years. Typically, tops are long processes and often have a classical pattern like a head and shoulders or a double top etc. If you want an example of what that would look like just look at the SPX now. If this were the top we would move down to the low around 5400 and then on the ensuing rally you'd be on the lookout for forming the right shoulder. Technically, the pattern isn't activated until that low gets taken out, but that would mean we would be forming the head now (I'm not saying that's happening - just making an example). Other times there's a strong impulse move down like in 2022, then you keep an eye on the fib levels of the retracement, but there's has to be something bearish going on like everyone knew we just started a rate hiking cycle - at the moment there's nothing bearish like that.
So the question is what are you going to do about it anyway? Are you a trader or an investor? Personally, I would never be able to be 100% long stocks, except if the world was ending and we were in the depths of a bear market. It's easy to be tempted into the opposite where you're most long at the top and puking up your position at the bottom. That means your position size is too big or you're not diversified enough in something non correlated that you can sell at the equity low and buy at cheap valuation. Nothing worse than having lifetime buying opportunity but you have nothing to buy with.
I do think there's a case to be made, probably the base case, of a rally into spring barring some freak election or geopolitical event. But I believe there is a giant waterfall ahead when all these forces of low end consumer/lag effects/liquidity/economy-can't-handle-higher-rates-but-Fed-will-be-late collide. That could be totally wrong and I am the type of person who changes his mind, but I just don't see how it's possible for a soft landing to occur, meaning, like a permanent condition that's just interrupted by slight disturbances going forward.
What we'd all like to happen is the data deteriorates so obviously that everyone knows a bear market is about to happen but stocks are still at the highs so we can casually sell. Unfortunately, by the time it becomes obvious in the data and emotions of the present it's way off the highs and you're stuck. One thing I toyed with was what if I was a 100% long only stock person, how would I manage that? All I could come up with is fading the extremes. So when the market is raging bull you want to be dollar cost average selling high beta growth and buying low beta dividend paying defensives or covered call funds, then when the market goes down in the depths of the bear market you sell your defensives and go 100% in high beta growth. Anyway, I'm not going to do that because I have such a large allocation to gold and silver, so it's not possible for me to be 100% stocks.
Okay, gotta go. I'll let you know when I finish my last two articles. Maybe I'll have the time for a more coherent last post on the markets. The last two are the whole point of the series. I want to get them right. Hopefully, I made sense today. Later.
