The Inflation Trade Is Dead and the Fed Put Isn’t

In September of last year, during the correction we were having, I wrote an article titled “The Reflation Trade Isn’t Dead and Evergrande Isn’t Lehman.” I took a lot of flack for that, and yet, the S&P 500 went on to rally almost 9% further, and oil—a major point of discussion in my article—went on to rally almost 90% further. And furthermore, Evergrande’s demise has had no discernible impact on the global financial system.

I turned out to be right.

Now the talk is that inflation is going to destroy us all, so let me tell you why I do not think that is true.

As with the previous article, I want to involve energy. In the other article, I showed how oil was developing some very bullish structure. Presently, I now believe energy is in a very bearish configuration. That will not serve the “inflation will destroy us all” narrative. For this discussion, I will use $XLE.

Last summer, I came to interpret the large sideways structure as an expanding triangle “B-wave,” the central structure of a larger, 3-wave corrective pattern (the pink A-B-C you see below). I expected us to rally in the final leg of that structure, the big pink “C-Wave,” and we did.

XLE

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Next Major Targets for the S&P 500 and the Psychology I Think Will Accompany Them

This article is long and perhaps even tedious. Forgive me for that. There’s a lot I want to cover.

I know things look like hell in a hand basket at the moment, but I think things are proceeding according to my expectations. I also know that it’s been frustrating the last few days as the market capitulated, but I have not been interested in that because—to my mind—that is chasing into a low, and much like chasing into a high presents us with great danger, so does, I believe, trying to catch every inch of this move down we’ve had. I think we’re bottoming, and that can reverse sharply at any moment, and I’m in no mood to be caught in that.

I could also be wrong here, and I will be the first to own that if I turn out to be. But, looking at things as a whole, it seems to me as if half the people who are freaking out about their belief that the Fed has no options here have never actually lived through a rate hike cycle before.

The chorus identifying today with the likes of 2008 seems to me to have not actually lived through that as an adult. This is literally nothing like that. By 2008, people were defaulting on their mortgages in droves and the banks were already starting to crack. Literally the biggest financial giants in the world were crumbling. It was a literal catastrophe. Nothing like that is happening here. At worst, so far, the rate of change of growth has slowed. But we’re literally still growing. And the banks are flush with cash. No stress there whatsoever. And while prices may be a bit high by some measures here, they may not be that high (see my section on prices in this article).

So, if the Fed has to hike quickly to combat inflation, it may eventually have an impact. But keep in mind, in 2008, the Fed was already two years into a hiking cycle. We’ve hardly even had a hike at this point (I covered the timing of hiking cycles and market tops in the second section of this article). Based on that, and the shocking sentiment readings we’re getting here, I think we may have years before we top.

In addition to the points made about sentiment here, where 2 of the worst 23 “bull percent” readings were discussed, we now have 3 of the worst 24 “bull percent” readings, and even better now, the “bear percent” reading this week was the 5th highest ever.

We are right now experiencing a total sentiment washout.

If we were having this price action this year, and everybody interpreted it as a nice, healthy correction, eagerly anticipating new highs, with sentiment surveys bursting with joy and excitement, it’s time to be bearish. But right now, same price action (“every rally fails for months”) and people are calling for Armageddon. In my opinion—and I may be proved wrong about this—I believe this is setting us up for an opportunity that only comes to us a few times in a lifetime. Mid-nineties sort of rally material is possible to us here.

I know we’re all enjoying making fun of David Hunter and his ad nauseam melt-up call, but he is effectively right. Bear in mind, the man has been in the markets for decades, and he is basically right regarding sentiment. We’re nowhere near a euphoric high. He’s right about that, I think, and yes, it is funny that his wanting to make the big call keeps getting stuffed in his face. That actually serves his call well now, as now that he’s become a meme, people will laugh at his next melt-up call, and I bet that’s when we get it.


The other day, I referred to a structure on Apple and I want to discuss it at greater length here.

This channel, despite moving “up,” is still effectively “consolidation,” because of its choppy nature:

AAPL

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Quick Morning Notes

I continue to remain skeptical of what I believe is the consensus here. That said, $ES has made little overnight progress and has gotten tied up at these trend lines (green), instead of outright recapturing them.

If we fail to begin moving up sharply, we may go to the lower bull wedge trend line (red). That’s disappointing because that’s then a mere 100 points from everyone’s primary target, and so it would mean they’ve sort of been right all along.

I’m not quite sure how I would need to interpret that, as the majority is necessarily wrong. Could it mean that everyone is hoping to buy that level and they’ll be wrong about that, i.e., that that level will actually not be a bottom but rather a top? That’s a scary thought. But, I have to at least be open to it, because we keep falling, and if we’re falling, it’s because not enough people are short.

ES

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Weekend Market Commentary: Let’s Look at Several Possibilities, Ranked From Least to Most Probable

A quick recap:

  1. I had been looking lower (here),
  2. Then I suspected we would rally (here),
  3. And then I worried that 4500 as resistance could lead to a drop (here),
  4. And since then I have looked at a couple of technicals that could support a bounce (here and then here).

So now what?

I will present 3 possibilities (2 bearish, 1 bullish), listed in order of least probable to most probable, in my present opinion.


The bearish possibilities certainly can be justified here:

  • Local price action looks like shit
  • “Don’t fight the Fed” is a reality we all must face, and they’re certainly jawboning hawkishly
  • The news flow (e.g., Europe, China, inflation) is not optimistic

A) Bear Wedge Possibility

This bear wedge possibility remains possible here. It is the most bearish possibility because it assumes that the highs are in. When I originally floated this idea, I did so because during the last rally, it seemed to me that sentiment was much, much too bullish and that not enough people were taking the risks we face seriously enough (for instance, the yield curve inversion). I now believe this is the least likely possibility, and I will explain more on why below. But, if the highs are in, if we are replicating the Dot-com top, and if we rally this week from these present lows, this structure remains possible. We would expect a 3-wave move for orange E of pink B before collapsing in a huge, multi-month (almost certainly over a year), 5-wave decline, a true bear market bloodbath.

SPY

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Weekend Observations on the Stock Market: Bear Porn Edition

Though I have been determined to give the bulls the benefit of the doubt for as long as possible (bubbles can go on far longer than most of us can think is even sane), cracks first appeared, and now there are plenty of additional outright crevices at this point.

Let’s look at a variety of things.

My working hypothesis for the moment is that the S&P 500 may be forming a large bear wedge, perhaps even replicating the one found at the top of the dot-com bubble (discussed here, for instance). And so far, the rejection of 4600 continues to support that thought:

ES

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Let’s Talk Yield Curve, Historical Fractals, and More

On my data (TradingView), it looked like the yield curve almost inverted but did not, but I’ve now seen some screenshots from some Bloomberg terminals showing that it in fact did today. And the data on those will be better. And that introduces a whole new set of ideas for us.

As most of you will know, when the 10-year and 2-year treasury yields invert, it is among the very best forecasters of recessions. Also, as many of you know, an inversion tends to lead market tops, averaging about six months (a few times it’s been shorter, often much longer).

It is also true that everybody knows this.

So, a lot of people will accept this as an equity bullish signal, at least for the time being.

But there are a few things that concern me here.

  1. We had an inversion in August of 2019, and though we did have a pandemic lockdown-induced recession, we didn’t really have a recession, nor did we really have a bear market, either. As it turned out, the COVID crash was a mere correction, in the big scheme of things. While it was greater than a 20% decline, it was hardly long enough to give us that feeling of a bear market.
  2. Inversions often happen in groups: for instance, we inverted briefly in June of 1998, then the curve rallied, then it inverted again in January of 2000, and then the market topped in March of 2000, after which we had both a recession and a bear market.
  3. Notice that the ’98 inversion led the actual dot-com bust by over two years. As it turns out, the 2019 inversion may have led a looming recession by about the same amount of time.
  4. In other words, what I think no one will anticipate here, is that we may be much closer to a serious bearish decline, not realizing that the 2019 & 2022 inversions belong in the same family. I’m not saying this will happen: I’m suggesting that I am wide open to it here, and I will lay out a few reasons:
    • We do not know the extent to which the collapse of Russia’s economy will have on the world, but it may be more than we at first think; and their collapse is almost certain, in my opinion.
    • It seems to me that the Fed really may have to raise rates hard to fight inflation, and that may also send us into a deeper recession.
    • Everyone is looking at yield curve inversions from the last 20 years, but not many people are old enough to think to look back 40 years, and we’re all programmed through recency bias to expect the market to behave as it has in the last two decades, but an actual inflationary environment is something few of us have traded as adults, and we need to look back further.
    • As a result, expecting the Fed to ease before they’ve even begun to really tighten may be entirely wishful thinking.
    • They may have to raise rates a lot and for a long time, if they’re serious about inflation. I see very little that is equity bullish about that.

Furthermore, I am increasingly convinced that this rally is short covering and once it’s done, I am expecting it to fade. There seems to me to be way too many people suddenly calling for the melt up now just mere weeks after everyone was calling for a bear market (this is the result of an emotional market, driven in large part by retail traders, and that should mean that we are very near if not past a major top.

And the structure I think the S&P 500 is forming, is something I have seen before. And I don’t really like it. I hinted at it as a possibility here, and I have a better variation of it now after some more consideration.

ES

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Let’s Discuss a Few Technicals

I have been somewhat agnostic here, recognizing that we would enter some period of sideways chop, which we did, though it’s been a little more up and sideways rather than simply sideways. That said, between the two counts expressed here, I am beginning to favor the bearish one more than the bullish one, though they both remain possible.

I have a feeling that this rally is simply a short covering rally (in part because of the moves we’re seeing in the meme stocks and much of the heavily shorted tech stocks—which were under-performers during the move off the all-time highs). If that’s so, we still need to see some supply enter the market.

That said, I would like to review a few things.

Previously, I discussed the channel on the US indices that I expected to serve as some resistance. While it did temporarily slow the Nasdaq 100 and the S&P 500 down a little bit, they have managed to get back into their channels, but the Dow and the Russell’s respective technicals remain unchanged:

The Dow futures have come back to retest the channel yet again but have not recaptured it:

YM

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